Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 2Q07 Results, Probable Last Update Prev. Ed.: July 18, 2007
Recent Events: Summary
August 6: KOMG reports financial results for the second quarter ended June 30, 2007.
June 28: WDC announces acquisition of KOMG for $1 billion, and also updated its 2Q07 outlook.
April 13: KOMG completes its previously announced redemption of all of its 2.0% convertible subordinated notes due 2024.
Overview
Komag Inc. (KOMG or the Company) engages in the design, manufacture, and marketing of thin-film media (disks) for incorporation into hard disk drives (HDD). These drives are used to record, store, retrieve, and protect digital information in personal computers, high-end server (enterprise) storage systems, communications infrastructure, and consumer electronics appliances.
Analysts have identified the following issues in evaluating the investment merits of KOMG:
Key Positive Arguments / Key Negative ArgumentsLeading Hard Drive Component Supplier: Leading independent supplier of finished disk media for hard drives. Increasing global demand for more storage capacity supports a strong outlook for hard drive unit growth and related components for the next several years.
Strong Demand Outlook: Emerging consumer electronics devices such as PVR/DVR as well as low-cost enterprise applications are driving demand for multiple-platter, high-capacity drives, and these trends are expected to continue through 2007.
Strong liquidity position: The Company has a strong cash balance and free cash flow.
Broadening customer base: KOMG continues to expand its addressable market.
Improved customer relation: KOMG continues to maintain solid relations with its strategic customers since long by providing them with quality products.
Efficient and sound management: Management seen as doing a commendable job of balancing capacity growth with business management. / Supply/Demand Imbalance: Volatile nature of the hard drive industry leads to a lack of visibility into OEM/customer demand, which in turn results in excess supply or shortages, both of which can adversely affect the health of the industry.
Competing Technology: Komag historically has not supplied glass-based disk platters, superior for mobile and smaller form factor applications, primarily because of better shock protection. While other applications utilizing aluminum substrates are growing rapidly, if glass-based drives grow faster than or replace aluminum-based applications, Komag could lag competitors.
Acquisition of Maxtor by Seagate: Seagate's acquisition of Maxtor represents a long-term risk for revenues.
Under capacity utilization: The Company has been suffering from capacity constraints due to weaker industry macro economic conditions.
Weak Industry environment: The Company is expected to face various challenges such as softer industry demand, upside pricing pressure, higher material costs, and adverse impact of foreign currency translation due to sick industry environment.
Note: The Company’s fiscal references coincide with the calendar year.
The Company also offers single-sided disks, aluminum substrate disks, plated disks, textured disks, and polished disks. The Company’s products offer a range of coercivities, glide height capabilities, and other parameters to meet specific customer requirements. Komag sells its products to original equipment manufacturers in the disk drive market worldwide. Komag has employed over 6,100 people and is headquartered in San Jose, California. For more information about the Company, please visit its website at www.komag.com
Recent Events: Details
On August 6, 2007, KOMG announced financial results for 2Q07. Highlights are as follows:
· Revenue in the quarter was $187.2 million versus $233.6 million in 2Q06.
· Non-GAAP net income was ($13.3) million versus $41.0 million in 2Q06.
· Non-GAAP diluted earnings per share in the quarter were ($0.57) versus $1.22 in 2Q06.
On June 28, 2007, KOMG announced that it entered into an acquisition agreement with Western Digital Corporation for a value of approximately $1 billion, whereby WDC will pay $32.25 in cash per share to KOMG shareholders. On the same date, KOMG updated its 2Q07 outlook.
On April 13, 2007, Komag completed its previously announced redemption of all of its 2.0% convertible subordinated notes due 2024. According to the terms of the 2.0% notes, holders of all of the notes elected to convert their notes into shares of the Company's common stock rather than having their notes redeemed and receiving the redemption price. In connection with the conversion of the 2.0% notes, the Company issued 3,049,234 shares of its common stock.
On March 21, 2007, KOMG issued $250.0 million of 2.125% convertible subordinate notes due in 2024. It had used the proceeds of around $125.0 million for share repurchases under a $200.0 million share buyback program.
Revenues
2Q07 total revenue, as per Zacks Digest was $187.2 million, down 19.9% yoy and 29.3% sequentially. For 2Q07, the Company reported total revenue of $187.2 million, down 20% yoy. Analysts attributed the results to the market pressure on unit volumes and average selling prices. KOMG’s finished disk shipments decreased 29% in this quarter compared to the prior year period.
Total Rev ($M) / 2006A / 1Q07A / 2Q07A / 3Q07E / 4Q07E / 2007E / 2008E / 2009EDigest High / $938.0 / $265.0 / $187.2 / $231.5 / $267.4 / $950.7 / $1,073.9 / $957.8
Digest Low / $937.7 / $264.7 / $187.2 / $170.2 / $187.2 / $809.2 / $772.1 / $957.8
Digest Average / $937.7 / $264.7 / $187.2 / $194.8 / $213.5 / $860.1 / $922.0 / $957.8
Y/Y Growth / 36.7% / 27.0% / -19.9% / -18.7% / -16.6% / -8.3% / 7.2% / 3.9%
Seq. Growth / 3.4% / -29.3% / 4.1% / 9.6%
Sales to Western Digital (WD), Seagate and Hitachi Global Storage Technologies accounted for 40%, 34% and 18% of disk product (media and substrates), respectively, of total 2Q07 revenue.
Segment Revenue
Finished disk revenue, as per Zacks Digest, was $142.1 million, and comprised 75.9% of total revenue in 2Q07. Other disk revenue was 45.1 million in 2Q07. According to the Company press release, high capacity 3.5-inch advanced disks with storage capacities of 160GB and above represented approximately 55% of total finished disk shipments in 2Q07. These disks are primarily targeted for high capacity desktop and multi-platter consumer applications. These rapidly growing consumer applications include personal video recorders (PVRs), digital video recorders (DVRs), high definition television (HDTV), external storage, gaming, and other home entertainment devices.
Other disk revenue, which includes sales of aluminum substrates, nickel-plated polished aluminum substrates and textured substrates, and the sale of precious metals inventory, accounted for 24% of total revenue in 2Q07. Komag is the world's largest hard disk aluminum substrate manufacturer. While substrates are primarily produced for internal use in the manufacture of finished disks, according to analysts, the high quality of Komag's substrates provides continuing opportunities to sell substrates to strategic customers, particularly for PMR quality substrates.
Segment ($M) / 2006A / 1Q07A / 2Q07A / 3Q07E / 4Q07E / 2007E / 2008E / 2009EFinished Disk / $838.0 / $217.0 / $142.1 / $171.8 / $197.3 / $728.2 / $809.9 / $754.2
As % of Total Revenue / 89.4% / 82.0% / 75.9% / 88.2% / 92.4% / 84.7% / 87.8% / 78.7%
Other Disk / $99.7 / $47.7 / $45.1 / $42.8 / $43.7 / $179.3 / $169.7 / $203.6
As % of Total Revenue / 10.6% / 18.0% / 24.1% / 22.0% / 20.4% / 20.8% / 18.4% / 21.3%
Total Revenue / $937.7 / $264.7 / $187.2 / $194.8 / $213.5 / $860.1 / $922.0 / $957.8
KOMG also reported $2.3 million in sale of precious metals inventory in 2Q07.
Outlook
One analyst (J.P. Morgan) has no bearing on the stock, owing to Western Digital’s pending acquisition of KOMAG.
For more details on individual analyst opinions on revenues, please see the consensus tab of the KOMG spreadsheet.
Margins
As per Zacks Digest, gross margin was 3.3% in 2Q07 versus 27.8% in 2Q06, EBITDA margin was 0.0% versus 24.9% in 2Q06, and operating margin was (10.4%) versus 17.4% in 2Q06. There are various reasons for this weakening margin structure, according to analysts:
Margins / 2006A / 1Q07A / 2Q07A / 3Q07E / 4Q07E / 2007E / 2008E / 2009EGross / 26.4% / 22.3% / 3.3% / 8.9% / 9.9% / 12.1% / 18.0% / 19.1%
EBITDA / 24.4% / 22.5%
Operating / 15.9% / 12.9% / -11.1% / -2.1% / 1.2% / 1.6% / 7.6% / 6.4%
Pre tax / 16.4% / 13.2% / -10.8% / -1.8% / 1.6% / 1.9% / 8.0% / 6.7%
Net / 16.8% / 12.4% / -11.2% / -1.6% / 1.5% / 1.6% / 7.5% / 6.3%
1. Adverse impact of Malaysian currency translation of 200 basis points on the overall margin structure.
2. Lower capacity utilization and higher deprecation costs associated with the transition to PMR media.
3. Higher raw materials costs resulting in pricing pressure.
4. Weak industry fundamentals and seasonal demand trends, particularly in the HDD industry.
Outlook
According to analysts, KOMG is focusing on growing demand on digital storage by cutting down costs and improving its quality standards. It is also stressing technological development and product innovation to garner substantial returns for stockholders in the long run.
With the Company’s revenue assumptions, the mix of finished media and substrate sales and lower capacity utilization, the non-GAAP gross and net margin is expected by analysts to be 8.0% and negative 5.9% in 3Q07.
One analyst (Goldman) is of the opinion that due to operating inefficiencies arising from the transition to PMR media, the margin structure would weaken in the coming quarters. Lower shipment volumes and utilization, together with pricing, and higher expenses associated with the transition to PMR, net margin would be negative for the September quarter. The analyst expects net margin to remain well below recent levels for the remainder of the year.
For more details on individual analyst opinions on margins, please see the consensus tab of the KOMG spreadsheet.
Earnings per Share
2Q07 EPS, as compiled by Zacks Digest, was ($0.57), a decrease of 147.1% from $1.22 in 2Q06 and 157.7% from $0.99 in 1Q07.
Pro forma EPS / 2006A / 1Q07A / 2Q07A / 3Q07E / 4Q07E / 2007E / 2008E / 2009EDigest High / $4.54 / $1.00 / ($0.57) / $0.38 / $0.89 / $3.35 / $3.90 / $4.10
Digest Low / $4.47 / $0.97 / ($0.58) / ($0.63) / ($0.56) / ($0.93) / ($0.81) / $1.92
Digest Avg. / $4.52 / $0.99 / ($0.57) / ($0.14) / $0.05 / $0.77 / $1.99 / $3.01
Y/Y Growth / 27.7% / -9.3% / -147.4% / -113.0% / -95.9% / -82.9% / 157.7% / 51.1%
Sequential Growth / -16.2% / -158.0% / -76.5% / -135.8%
Zacks Consensus / $0.55 / 0.75 / $2.46 / $3.27
Highlights from the EPS chart are as follows:
· The Zacks consensus is $2.46 for FY07 and $3.27 for FY08.
· 2007 forecasts (total 7) range from ($0.93) to $3.35, the average is $0.77.
· 2008 forecasts (total 6) range from ($0.81) to $3.90, the average is $1.99.
· 2009 forecasts (total 2) range from $1.92 to $4.10, the average is $3.01.
Outlook
One analyst (Caris & Company) lowered the EPS estimates from $2.60 to ($0.93) for FY07 and from $2.69 to $1.45 for FY08, respectively, based on weak margin assumptions. Another analyst (J.P. Morgan) lowered the EPS estimates from $0.60 to ($0.04) for FY07 and from ($0.28) to ($0.81) for FY08.
Please refer to the Zacks Research Digest spreadsheet on KOMG for more extensive EPS figures.
Target Price/Valuation
Target prices for KOMG range from a low of $23.00 to a high of $32.25. The analyst (J.P. Morgan) at the low end did not provide the valuation methodology. The analysts (Zacks Investment Research and Piper Jaffray) also did not provide the valuation methodology to calculate the target price. The Zacks Digest average price target is $30.59 ( by $0.45 from the previous Digest report).
Rating DistributionPositive / 0.0%
Neutral / 89.0%
Negative / 11.0%
Avg. Target Price / $30.59
Digest High / $32.25
Digest Low / $23.00
According to analysts, risks to the achievement of the target price include the cyclicality of the disk drive business, capacity expansion by other players, pricing instability in the industry, unforeseen macroeconomic and industry events that adversely affect the demand for the Company’s products and services, product obsolescence due to rapid technological change, a potential inability to recruit and retain competent personnel, changes in investor sentiment toward the Company or the industry, and adverse market conditions.
Metrics detailing current management effectiveness are as follows:
Metric (TTM) / Company / Industry / S&P 500Return on Assets (ROA) / 9.51% / 6.45% / 8.29%
Return on Equity (ROE) / 17.39% / 10.95% / 21.24%
Return on Investment (ROI) / 13.22% / 9.04% / 12.28%
For more details on individual analyst opinions please see the Valuation tab of the KOMG spreadsheet.
Capital Structure/Cash Flow/Solvency/Governance/Other
Balance Sheet: KOMG ended 2Q07 with $183.0 million in cash and Cash Equivalents versus $190.2 million in 2Q06 and $253.5 million in 1Q07.
Capital expenditure in 2Q07 totaled $17.2 million, while depreciation was $26.7 million versus $18.3 million in the prior quarter. KOMG projects 2007 capital spending of $100.0 million.
Long-Term Debt: KOMG decreased its long-term debt from $330.5 million to $250.0 million.
Share Repurchase Program: The Company has a $200 million share buyback program in place, which would be financed with the proceeds from the fresh issue of $250 million of 2.125% convertible subordinated notes due in 2014.
Inventory: Inventory was $191.7 million at the end of 2Q07 versus $75.4 million in 2Q06 and $159.6 million in 1Q07, attributable to the raw materials inventory buildup to help with the Company’s ramp of PMR. Accounts receivable totaled $112.6 million at the end of 2Q07 versus $128.0 million in 2Q06 and $136.9 million in 1Q07.
Current Liabilities: Current liabilities were $225.7 million at 2Q07 versus $317.0 million in 2Q06 and $265.6 million in 1Q07.