10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Quarter Ended April 3, 2005
Commission File Number 0-16852

KOMAG, INCORPORATED

(Registrant)

Incorporated in the State of Delaware
I.R.S. Employer Identification Number 94-2914864
1710 Automation Parkway, San Jose, California 95131
Telephone: (408) 576-2000

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act rule 12b-2). Yes þ No o

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

     On April 3, 2005, 28,962,074 shares of the Registrant’s common stock, $0.01 par value, were issued and outstanding.

INDEX
KOMAG, INCORPORATED

	Page No.
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Statements of Income — three months ended April 3, 2005 and April 4, 2004		3
Condensed Consolidated Balance Sheets — April 3, 2005 and January 2, 2005		4
Condensed Consolidated Statements of Cash Flows — three months ended April 3, 2005 and April 4, 2004		5
Notes to Condensed Consolidated Financial Statements		6-13
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		14-33
Item 3. Quantitative and Qualitative Disclosures about Market Risk		34
Item 4. Controls and Procedures		34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		35
Item 2. Unregistered Sales of Equity Securities		35
Item 3. Defaults Upon Senior Securities		35
Item 4. Submission of Matters to a Vote of Security Holders		36
Item 5. Other Information		36
Item 6. Exhibits		36
SIGNATURES		37
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 10.3
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

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PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

KOMAG, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts

	Three Months Ended
	April 3, 2005			April 4, 2004
Net sales	$	140,275		$	123,585
Cost of sales		105,212			86,656
Gross profit		35,063			36,929
Operating expenses:
Research, development, and engineering		11,155			11,622
Selling, general, and administrative		5,535			5,354
Gain on disposal of assets		(389	)		(190	)
		16,301			16,786
Operating income		18,762			20,143
Other income (expense):
Interest income		750			281
Interest expense		(441	)		(1,862	)
Other, net		(28	)		(50	)
		281			(1,631	)
Income before income taxes		19,043			18,512
Provision for income taxes		516			539
Net income	$	18,527		$	17,973
Basic net income per share	$	0.66		$	0.68
Diluted net income per share	$	0.59		$	0.61
Number of shares used in basic per share computations		28,261			26,307
Number of shares used in diluted per share computations		32,313			29,778

See notes to condensed consolidated financial statements.

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KOMAG, INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

	April 3, 2005			January 2, 2005
ASSETS
Current assets
Cash and cash equivalents	$	31,811		$	26,410
Short-term investments		84,700			77,700
Accounts receivable (less allowances of $2,666 and $1,075, respectively)		85,655			79,213
Inventories		41,982			35,815
Prepaid expenses and deposits		831			1,815
Total current assets		244,979			220,953
Property, plant, and equipment (net of accumulated depreciation of $109,061 and $99,065, respectively)		212,103			205,642
Intangible assets, net		581			1,523
Other assets		2,939			2,977
	$	460,602		$	431,095
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Trade accounts payable	$	55,853		$	43,082
Accrued expenses and other liabilities		14,154			19,887
Total current liabilities		70,007			62,969
Long-term debt		80,500			80,500
Long-term deferred rent		640			—
Total liabilities		151,147			143,469
Stockholders’ equity
Common stock, $0.01 par value per share:
Authorized - 50,000 shares
Issued and outstanding - 28,962 and 28,065 shares, respectively		289			281
Additional paid-in capital		253,848			241,960
Deferred stock-based compensation		(8,685	)		(91	)
Retained earnings		64,003			45,476
Total stockholders’ equity		309,455			287,626
	$	460,602		$	431,095

See notes to condensed consolidated financial statements.

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KOMAG, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands

	Three Months Ended
	April 3, 2005			April 4, 2004
Operating Activities
Net income	$	18,527		$	17,973
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of property, plant, and equipment		10,100			9,464
Tax adjustment to additional paid-in capital		297			—
Amortization and adjustments of intangible assets		942			1,060
Stock-based compensation		841			235
Deferred rent		640			—
Non-cash interest charges		38			321
Gain on disposal of assets		(389	)		(190	)
Changes in operating assets and liabilities:
Accounts receivable, net		(6,442	)		(11,937	)
Inventories		(6,167	)		(13,143	)
Prepaid expenses and deposits		984			324
Trade accounts payable		12,771			9,220
Accrued expenses and other liabilities		(5,733	)		(7,773	)
Net cash provided by operating activities		26,409			5,554
Investing Activities
Acquisition of property, plant, and equipment		(16,615	)		(23,706	)
Purchases of short-term investments		(67,150	)		(24,000	)
Proceeds from short-term investments		60,150			19,850
Proceeds from disposal of property, plant, and equipment		443			386
Other		—			(161	)
Net cash used in investing activities		(23,172	)		(27,631	)
Financing Activities
Payment of debt		—			(116,341	)
Proceeds from the issuance of long-term debt		—			77,419
Proceeds from sale of common stock, net of issuance costs		2,164			67,649
Net cash provided by financing activities		2,164			28,727
Increase in cash and cash equivalents		5,401			6,650
Cash and cash equivalents at beginning of period		26,410			27,208
Cash and cash equivalents at end of period	$	31,811		$	33,858

See notes to condensed consolidated financial statements

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KOMAG, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
APRIL 3, 2005

Note 1. Basis of Presentation and Summary of Significant Accounting Policies

     The accompanying unaudited condensed consolidated financial statements include the accounts of Komag, Incorporated, a Delaware corporation (the Company), and its wholly-owned subsidiaries. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. While the financial information furnished is unaudited, in the opinion of management, all normal recurring adjustments considered necessary for a fair presentation of the condensed consolidated financial position, operating results, and cash flows for the periods presented, have been included. Operating results for the three months ended April 3, 2005, are not necessarily indicative of the results that may be expected for the year ending January 1, 2006. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements for the year ended January 2, 2005 included in its Annual Report on Form 10-K.

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

     Fiscal Year: The Company uses a 52-53 week fiscal year ending on the Sunday closest to December 31. The Company’s 2005 fiscal year will include 52 weeks; accordingly, the Company’s three-month reporting period included in this report included 13 weeks. Because the Company’s 2004 fiscal year included 53 weeks, its three-month reporting period ended April 4, 2004 included 14 weeks.

     Reclassification: Certain amounts in fiscal 2004 as reported on the Condensed Consolidated Balance Sheet and Condensed Consolidated Statements of Cash Flows have been reclassified to conform to the current year presentation. The Company reclassified $77.7 million in auction rate securities from cash and cash equivalents to short-term investments on the condensed Consolidated Balance Sheet as of January 2, 2005. The reclassification to short-term investments is based on the latest interpretation of cash equivalents pursuant to Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 95, Statement of Cash Flows.

     Cash and Cash Equivalents: The Company considers as a cash equivalent any bank deposits, money market investments and any highly-liquid investment that mature within three months of its purchase date.

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     Short-Term Investments: The Company invests its excess cash in high-quality, short-term debt instruments and auction rate preferred securities (which the Company rolls over every three months or less). Interest and dividends on the investments are included in interest income. The cost of the Company’s investments approximates fair value.

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

	April 3, 2005		January 2, 2005
Raw materials	$	23,293	$	20,647
Work in process		6,934		7,785
Finished goods		11,755		7,383
	$	41,982	$	35,815

     Stock-Based Compensation: The Company uses the intrinsic value method to account for employee stock-based compensation. The intrinsic value method is in accordance with the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, compensation cost is recorded on the date of grant to the extent that the fair value of the underlying share of common stock exceeds the exercise price for a stock option or the purchase price for a share of common stock.

     In accordance with SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123), and SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of SFAS 123, the Company provides pro forma disclosure of the effect on net income and earnings per share had the fair value method, as prescribed by SFAS 123, been used.

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

	Three Months Ended
	April 3, 2005			April 4, 2004
Net income, as reported	$	18,527		$	17,973
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		841			235
Deduct: Stock-based compensation expense determined under the fair value method for all awards, net of related tax effects		(1,566	)		(987	)
Pro forma net income	$	17,802		$	17,221
Net income per share:
Basic - as reported	$	0.66		$	0.68
Diluted - as reported	$	0.59		$	0.61
Basic - pro forma	$	0.63		$	0.65
Diluted - pro forma	$	0.56		$	0.59

     For pro forma disclosure purposes, the Company used the Black-Scholes option pricing model to estimate the fair value of each option and stock purchase right grant on the date of grant.

     The following assumptions were used to estimate the fair value of option grants in the first three months of 2005 and 2004: risk-free interest rates of 4.04% and 2.46%, respectively; volatility factors of the expected market price of the Company’s common stock of 71.8% and 82.6%, respectively; and a weighted-average expected option life of 4.0 years. The weighted-average fair value of options granted during the first three months of 2005 and 2004 was $11.43 and $11.58, respectively.

     The following assumptions were used to estimate the fair value of employee purchase rights under the Amended and Restated 2002 Employee Stock Purchase Plan (ESPP) for the first three months of 2005 and 2004: risk-free interest rates of 1.68% and 1.00%, respectively; volatility factors of 50.77% and 73.5%, respectively; and weighted-average expected purchase rights lives of six months. The weighted-average fair value of those purchase rights granted in the first three months of 2005 and 2004 was $3.12 and $4.64, respectively.

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

     In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment (SFAS 123R). SFAS 123R is a revision of SFAS 123, which addresses financial accounting and reporting for costs associated with stock-based compensation. SFAS 123 addresses all forms of share-based payment (SBP) awards, including shares issued under employee stock purchase plans, stock options, restricted stock, and

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stock appreciation rights. SFAS 123R requires the Company to adopt the new accounting provisions beginning in its first quarter of 2006, and applies to all outstanding and unvested SBP awards at the Company’s adoption date. The Company is allowed to select one of three alternative transition methods – each having different reporting implications. On March 29, 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107) on SFAS 123R to assist preparers by simplifying some of the implementation challenges of SFAS 123R. The Company has not completed its evaluation or determined the impact of adopting SFAS 123R; however, we expect the adoption to have a significant impact on our net income and net income per share.

     Computation of Net Income Per Share: The Company determines net income per share in accordance with SFAS No. 128, Earnings per Share.

     Basic net income per common share is computed by dividing income available to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing income available to common stockholders by the weighted-average number of shares and dilutive potential shares of common stock outstanding during the period. The dilutive effect of outstanding options and stock purchase rights is reflected in diluted net income per share by application of the treasury stock method.

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

	Three Months Ended
	April 3, 2005		April 4, 2004
Numerator for basic net income per share:
Net income as reported	$	18,527	$	17,973
Numerator for diluted net income per share:
Net income as reported	$	18,527	$	17,973
Interest adjustment related to contigently convertible debt		441		327
	$	18,968	$	18,300
Denominator for basic income per share:
Weighted average shares		28,261		26,307
Denominator for diluted income per share:
Weighted average shares		28,261		26,307
Effect of dilutive securities:
Contingently convertible shares under convertible debt		3,049		2,116
Stock options		522		629
Warrants		460		528
Stock purchase rights		21		198
		32,313		29,778
Basic net income per share	$	0.66	$	0.68
Diluted net income per share	$	0.59	$	0.61

     Incremental common shares attributable to outstanding common stock options (assuming proceeds would be used to purchase treasury stock) of approximately 21,131 for the three months ended April 3, 2005, and 17,741 for the three months ended April 4, 2004 were not included in the diluted net income per share computation because the effect would have been anti-dilutive.

     In January 2004, the Company issued $80.5 million of 2.0% Convertible Subordinated Notes (the Notes). The Notes are convertible, under certain circumstances, into shares of the Company’s common stock at an initial conversion price of $26.40, or approximately 3,049,000 shares. In October 2004, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 04-08, Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share. This consensus, which became effective in the fourth quarter of 2004, requires the Company to include these additional shares in its calculation of diluted earnings per share as of the date of issuance of the Notes (the first quarter of 2004). Accordingly, these shares have been included in the Company’s diluted earnings per

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share calculations for the first quarters of 2005 and 2004. Therefore, diluted net income per share has been adjusted for the first quarter of 2004 to $0.61 from $0.65.

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

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

Note 2. Concentration of Customer, Supplier and Geographic Risk

     The following table reflects the percentage of the Company’s revenue by major customer:

	Three Months Ended
	April 3, 2005			April 4, 2004
Maxtor Corporation		35	%		45	%
Hitachi Global Storage Technologies		25	%		21	%
Western Digital Corporation		19	%		19	%
Seagate		16	%		8	%

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

     A majority of our long-lived assets is located at our Malaysian manufacturing facilities. These assets totaled $195.7 million as of April 3, 2005, and $190.0 million as of January 2, 2005.

Note 3. Income Taxes

     The Company’s estimated annual effective income tax rate for 2005 is 2.7% and reflects income tax expenses related to the Company’s U.S. and international operations. In the first quarter of 2004, the Company’s estimated annual effective tax rate was approximately 3.0%.

     The Company’s manufacturing facilities located in Malaysia have been granted various tax holidays. These holidays expire at various times beginning in December 2006 through June 2011.

     In the first quarter of 2005 and 2004, the Company utilized tax credits and net operating loss carryforwards. The Company provided a full valuation allowance against all tax assets; therefore, upon utilization of the tax credits and net operating loss carryforwards, the Company first reduced intangible assets (as these were related to time periods that were pre-emergence from bankruptcy) and then credited additional paid-in capital. Future usage of net operating loss carryforwards and tax credit carryforwards will be credited to additional paid-in capital.

Note 4. Accrued Expenses and Other Liabilities

     The following table summarizes accrued expenses and other liabilities balances at April 3, 2005 and January 2, 2005 (in thousands):

	April 3, 2005		January 2, 2005
Accrued compensation and benefits	$	104,794	$	15,777
Other liabilities		3,360		4,110
	$	14,154	$	19,887

Note 5. Stock Purchase Rights

     On February 15, 2005, the Company issued a total of 453,110 stock purchase rights with an exercise price of $0.01. The vesting for the stock purchase rights grants is one-third at the end of each of

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the first three anniversaries of the date of grant, subject to the employee continuing to be a service provider of the Company on each such date. In the first quarter of 2005, the Company recorded deferred stock-based compensation of $9.4 million, which is being amortized to expense ratably over the vesting period.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion should be read in conjunction with the condensed consolidated financial statements and the accompanying notes included in Part I. Financial Information, Item 1. Condensed Consolidated Financial Statements of this report.

     The following discussion contains predictions, estimates, and other forward-looking statements that involve a number of risks and uncertainties about our business, including but not limited to: our belief that we are a leading independent supplier of disks; our belief that we have developed a deep understanding of market needs in the disk drive market; our belief that our manufacturing and technology development programs provide us with competitive advantages in maintaining and growing our market share; our belief that we have developed strong relationships with many of the leading disk drive manufacturers; our belief that our manufacturing operations, together with our experience in the industry and our economies of scale, provide us with timing and cost advantages in delivering consistently high-quality products to our customers in high volumes; our plan to continue to generate cash from our operations for the remainder of 2005; our belief that we will continue to investigate areas where we can expand our presence in the disk market; our expectation that we will continue to generate cash from operations; and our belief that the estimates and judgments made regarding future events in connection with the preparation of our financial statements are reasonable. These statements may be identified by the use of words such as “expects,” “anticipates,” “intends,” “plans,” and similar expressions. In addition, forward-looking statements include, but are not limited to, statements about our beliefs, estimates, or plans about our ability to maintain low manufacturing and operating costs and costs per unit, our ability to estimate revenues, shipping volumes, pricing pressures, returns, reserves, demand for our disks, selling, general, and administrative expenses, taxes, research, development, and engineering expenses, spending on property, plant, and equipment, expected sales of disks and the market for disk drives generally and certain customers specifically, and our beliefs regarding our liquidity needs.

     Forward-looking statements are estimates reflecting the best judgment of our senior management, and they involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Our business is subject to a number of risks and uncertainties. While this discussion represents our current judgment on the future direction of our business, these risks and uncertainties could cause actual results to differ materially from any future performance suggested herein. Some of the important factors that may influence possible differences are continued competitive factors, technological developments, pricing pressures, changes in customer demand, and general economic conditions, as well as those discussed in the Risk Factors section below. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of such statements. Readers should review the Risk Factors section below, as well as other documents filed from time to time by us with the Securities and Exchange Commission.

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Results of Operations

Overview

     We design, manufacture, and market thin-film media (disks), which are incorporated into disk drives. Disks, such as the ones we manufacture, serve as a primary storage medium for digital data. Our net sales are driven by the level of demand for disks by disk drive manufacturers and the average selling prices of our disks. Demand for our disks is dependent on unit growth in the disk drive market, the growth of storage capacity in disk drives, which affects the number of disks needed per drive, and the number of disks our customers purchase from external suppliers. Average selling prices are dependent on overall supply and demand for disks and our product mix.

     Our business is capital-intensive and is characterized by high fixed costs, making it imperative that we sell disks in high volume. Our contribution margin per disk sold varies with changes in selling price, input material costs and production yield. As demand for our disks increases, our total contribution margin increases, improving our financial results because we do not have to increase our fixed cost structure in proportion to increases in demand and resultant capacity utilization. Conversely, our financial results would deteriorate rapidly if the disk market were to worsen and our production volume were to decrease.

     Our three-month reporting period ended April 3, 2005 included 13 weeks. Because our 2004 fiscal year contained 53 weeks, our three-month reporting period ended April 4, 2004 included 14 weeks.

Net Sales

     Consolidated net sales increased by 13.5%, to $140.3 million in the first quarter of 2005, from $123.6 million in the first quarter of 2004. The overall increase primarily reflected an increase in finished unit sales volume, to 22.2 million units in the first quarter of 2005 from 19.2 million units in the first quarter of 2004, partially offset by a decrease in the finished unit average selling price, to $5.53 in the first quarter of 2005 from $5.94 in the first quarter of 2004. The finished unit shipment increase in the first quarter of 2005 compared to the same period in 2004 resulted from an overall improvement in industry conditions.

     Sales of 80 GB per platter disks increased to 94% of net sales in the first quarter of 2005, compared to 79% in the same period of 2004. The increase reflected the continued customer evolution to higher storage densities. Finished disk shipments for desktop and consumer applications together represented 94% of our first quarter of 2005 unit shipment volume, compared to 89% in the first quarter of 2004. The remaining finished disk shipments in the first quarters of 2005 and 2004 were disks for high-end server (enterprise) drives.

     Net other disk sales in the first quarter of 2005 were $17.4 million, compared to $9.6 million in the first quarter of 2004. Aluminum substrate, polished disk, textured disks and single sided disk sales were all higher in the first quarter of 2005 compared to the first quarter of 2004. Disk substrate sales vary from period to period based on customer requirements.

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     Based on continuing strong market demand from all customers, we expect total revenue for the second quarter of 2005 could be comparable to or up to 10% higher than the first quarter of 2005.

     In the first quarter of 2005, sales to Maxtor Corporation (Maxtor), Hitachi Global Storage Technologies (HGST), Western Digital Corporation (Western Digital), and Seagate Technology (Seagate) accounted for 35%, 25%, 19%, and 16%, respectively, of our revenues. In the first quarter of 2004, sales to Maxtor, HGST, Western Digital, and Seagate accounted for 45%, 21%, 19%, and 8%, respectively, of our revenue. We expect to continue to derive a substantial portion of our sales from these customers.

Gross Profit

     Our overall gross profit percentage for the first quarter of 2005 was 25.0% compared to a gross profit percentage of 29.9% for the first quarter of 2004. The decrease is primarily related to the lower finished unit average selling price in the first quarter of 2005 compared to the first quarter of 2004.

     We expect to maintain our variable cost per unit at levels similar to the first quarter of 2005 while continuing to advance our technology. We expect our fixed cost per unit in the remainder of 2005 to vary based on changes in production volumes from the level achieved in the first three months of 2005.

Research, Development, and Engineering Expenses

     Research, development, and engineering (R&D) expenses of $11.2 million in the first quarter of 2005 were $0.4 million lower compared to the $11.6 million in the first quarter of 2004. Expenses in the first quarter of 2004 included a $1.4 million non-recurring payroll-related charge and an additional week of expenses as compared to the first quarter of 2005. Higher development costs, including increased payroll related costs, in the first quarter of 2005 mostly offset the effect of the absence of the non-recurring charge and the return to a thirteen-week fiscal quarter in 2005 compared to a fourteen-week fiscal quarter in 2004. We expect R&D spending in the second quarter of 2005 to be relatively flat with the first quarter of 2005, as a percentage of net sales.

Selling, General, and Administrative Expenses

     Selling, general, and administrative (SG&A) expenses of $5.5 million in the first quarter of 2005 were $0.1 million higher compared to the $5.4 million incurred in the first quarter of 2004. The increase was primarily due to higher consulting, audit and payroll-related costs, offset by the return to a thirteen-week fiscal quarter in 2005 . We expect SG&A spending in the second quarter of 2005 to be relatively flat with the first quarter of 2005 as a percentage of net sales.

Interest Expense

     Interest expense in the first quarter of 2005 was $0.4 million. This amount reflected interest expense on the $80.5 million, 2% Convertible Subordinated Notes, which were issued on January 28, 2004.

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Interest expense in the first quarter of 2004 was $1.9 million and included $1.6 million of interest expense on the Senior Secured Notes and certain promissory notes and $0.3 million of interest expense on the 2% Convertible Subordinated Notes. The Senior Secured Notes and promissory notes were redeemed in full, including accrued interest, in February 2004. There was no gain or loss on the redemption, and there were no unamortized debt issuance costs.

Income Taxes

     Our estimated annual effective income tax rate for 2005 is 2.7% and reflects tax expenses related to our U.S. and international operations. In the first quarter of 2004, our estimated annual effective income tax rate for 2004 was approximately 3.0%.

     The Company’s manufacturing facilities located in Malaysia have been granted various tax holidays. These holidays expire at various times beginning in December 2006 through June 2011.

Critical Accounting Policies

     In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. We regularly evaluate our estimates, including those related to our revenues, allowance for inventories, commitments and contingencies, income taxes, and asset impairments. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results could differ significantly from those estimates if our assumptions are incorrect. We believe that the following discussion addresses our most critical accounting policies. These policies are most important to the portrayal of our financial condition and results and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Allowance for Sales Returns

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

     Since estimated sales returns are recorded as a reduction in revenues, any significant difference between our estimated and actual experience or changes in our estimate would be reflected in our reported revenues in the period we determine that difference.

     There were no significant changes from prior year estimates in the first quarter of 2005.

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Impairment of Long-lived Assets

     Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that these assets may be impaired or the estimated useful lives are no longer appropriate. We consider the primary indicators of impairment to include significant decreases in unit volumes, unit prices or significant increases in production costs. We review our long-lived assets for impairment based on estimated future undiscounted cash flows attributable to the assets. In the event that these cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values utilizing discounted estimates of future cash flows. The discount rate used is based on the estimated incremental borrowing rate at the date of the event that triggers the impairment.

     There were no impairments of long-lived assets in the first quarter of 2005.

Inventory Obsolescence

     Our policy is to provide for inventory obsolescence based upon an estimated obsolescence percentage applied to the inventory based on age, historical trends, and requirements to support forecasted sales. In addition, and as necessary, we may provide additional charges for future known or anticipated events.

     There were no significant changes from prior year estimates in the first quarter of 2005.

Liquidity and Capital Resources

     Cash, cash equivalents, and short-term investments of $116.5 million at the end of the first quarter of 2005 increased by $12.4 million from the end of the 2004 fiscal year. The increase primarily reflected a $26.4 million increase resulting from consolidated operating activities and $2.2 million in proceeds from the sale of common stock, offset by $16.6 million of spending on property, plant, and equipment.

     Consolidated operating activities generated $26.4 million in cash in the first three months of 2005. The primary components of this change include the following:

•   net income of $18.5 million, net of non-cash depreciation and amortization of property, plant and equipment of $10.1 million and other non-cash charges/gains which net to $2.3 million;

•   an accounts receivable increase of $6.4 million primarily due to an increase in sales during the first quarter of 2005 compared to the fourth quarter of 2004;

•   an inventory increase of $6.2 million;

•   a prepaid expense decrease of $1.0 million primarily due to amortization of insurance premiums;

•   an accounts payable increase of $12.8 million related to increased inventory and higher capital spending; and

•   an accrued expenses and other liabilities decrease of $5.7 million, which primarily reflected payment of accrued incentive compensation.

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     Our total capital spending in the first quarter of 2005 was $16.6 million, which included capital expenditures to increase our substrate capacity, to improve our equipment capability for the manufacture of advanced products, and for projects designed to improve yield and productivity. There are no significant non-cancelable capital commitments as of April 3, 2005. For 2005, we plan to spend approximately $85 million to $90 million on property, plant, and equipment in order to increase our finished disk and related substrate capacity and continue to ramp new production processes.

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

     We have a Malaysian ringgit 12.5 million (approximately $3.3 million) bank guarantee. There is no expiration date on the bank guarantee. No interest will be charged on the bank guarantee, but there is a commission of 0.05% on the amount of bank guarantee utilized. As of April 3, 2005, there were no liabilities outstanding related to this bank guarantee.

     We have a Malaysian ringgit 4.0 million (approximately $1.1 million) stand-by letter of credit (LOC), which expires on September 30, 2005. The LOC is secured by a fixed deposit of Malaysian ringgit 4.0 million.

     We lease our research and administrative facility in San Jose, California under an operating lease, which expires in 2014. We also lease, and have sublet, another building in San Jose. This lease was terminated after the end of the first quarter of 2005 and the related sublease was assigned to the landlord. Additionally, we lease certain equipment under operating leases. These leases expire on various dates through 2008. We have no capital leases.

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     At April 3, 2005, our long-term debt obligations, operating lease obligations, and unconditional purchase obligations were as follows (in thousands):

	Remainder of 2005		2006		2007		2008		2009		Thereafter		Total
Long-Term Debt Obligations	$	—	$	—	$	—	$	—	$	—	$	80,500	$	80,500
Operating Lease Obligations (1)		980		3,096		2,261		2,042		3,144		16,382		27,905
Unconditional Purchase Obligations (2)		10,711		1,266		1,129		1,129		1,129		3,387		18,751
Total Contractual Cash Obligations	$	11,691	$	4,362	$	3,390	$	3,171	$	4,273	$	100,269	$	127,156

(1)	These represent gross operating lease obligations, and are not reduced by sublease income. The gross lease obligations include $2.0 million for a lease, which was terminated subsequent to the end of the first quarter of 2005.
(2)	Unconditional purchase obligations are defined as agreements to purchase goods or services that are enforceable and legally binding, and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum, or variable pricing provisions; and the approximate timing of the transactions. The amounts are based on our contractual commitments.

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RISK FACTORS

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

Risks Related to Our Business

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

     The market for our products depends on economic conditions affecting the disk drive manufacturing and related markets. Our products are incorporated into disk drives manufactured by our customers for the desktop personal computer market as well as the enterprise storage systems market and electronic device market. Because of the concentration of our products in the disk drive market, which we expect to continue, our business is linked to the success of this market. The disk drive market has historically been seasonal and cyclical, and has experienced periods of oversupply and reduced production levels, resulting in significantly reduced demand for disks and pricing pressures. The effect of these cycles on suppliers has been magnified by disk drive manufacturers’ practice of ordering components, including disks, in excess of their needs during periods of rapid growth, thereby increasing the severity of the drop in the demand for components during periods of reduced growth or contraction. Accordingly, downturns in the disk drive market may cause disk drive manufacturers to delay or cancel projects, reduce their production, or reduce or cancel orders for our products. This, in turn, may lead to longer sales cycles, delays in payment and collection, pricing pressures, and unused capacity, causing us to realize lower revenues and margins. For example, in the fourth quarter of fiscal year 2003, disk drive manufacturers appear to have overbuilt product, which resulted in an excess of supply of disk drives that was not fully corrected until approximately the third quarter of fiscal year 2004.

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

     Our business is characterized by high fixed overhead costs including expensive plant facilities and production equipment. Our per-unit costs and our gross profit are significantly affected by the number of units we produce and the amount of our production capacity that we utilize. In the third quarter of 2004, we completed the installation of additional equipment, which increased our production capacity from approximately 20 million disks a quarter to approximately 24 million disks a quarter. Our finished disk shipments were below this capacity level in the third quarter and fourth quarter of 2004. In the first quarter of 2005, we increased our capacity to approximately 25 million disks per quarter. If we are unable to utilize our expanded capacity, we may be unable to increase or sustain our gross margins.

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     If our capacity utilization decreases for any reason, including lack of customer demand or cancellation or delay of customer orders, we could experience significantly higher unit production costs, lower margins and potentially significant losses, as occurred for several years prior to 2003. Underutilization of our production capacity could also result in equipment write-offs, restructuring charges, and employee layoffs. If our production capacity is underutilized for any reason, our financial results and our business would be severely harmed.

If future demand for our products exceeds the production capability of our existing facilities, we may be required to invest significant capital expenditures to increase capacity or else risk losing market share.

     In the third quarter of 2004, we completed the installation of additional equipment, which increased our production capacity to approximately 24 million disks a quarter. In the first quarter of 2005, we increased our capacity to 25 million disks per quarter. We believe that our ability to expand further our production capacity using our existing facilities is limited. As a result, if demand for our products were to exceed significantly our current capacity levels, we may not be able to satisfy this increased demand. To increase our production capacity to meet significant increases in demand for our disks, we would be required to expand our existing facilities, construct new facilities, or acquire entities with additional production capacities. These alternatives would require significant capital investments by us and would require us to seek additional equity or debt financing. There can be no assurance that such financing would be available to us when needed on acceptable terms, or at all. If we were unable to expand capacity on a timely basis to meet increases in demand, we could lose market opportunities for sales, and our market share could decline. Further, we cannot assure you that the increased demand for our disk products would continue for a sufficient period of time to recoup our capital investments associated with increasing our production capacity.

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

     Our customers are disk drive manufacturers. A relatively small number of disk drive manufacturers dominates the disk drive market. In the first quarter of 2005, four of these manufacturers (HGST, Maxtor, Seagate, and Western Digital) accounted for approximately 80% of worldwide hard disk drive sales. Accordingly, we expect that the success of our business will continue to depend on a limited number of customers that have comparatively strong bargaining power in negotiating contracts with us.

     In the first quarter of 2005, 35% of our net sales were to Maxtor, 25% were to HGST, 19% were to Western Digital, and 16% were to Seagate. In 2004, 47% of our net sales were to Maxtor, 29% were to HGST, and 14% were to Western Digital. If any one of our significant customers reduces its disk requirements, cancels existing orders or develops or expands capacity to produce its own disks, and we are unable to replace these orders with sales to new customers, our sales would be reduced and our business would suffer.

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

     We rely on a limited number of suppliers for some of the materials and equipment used in our manufacturing processes, including aluminum blanks, aluminum substrates, nickel plating solutions, polishing and texturing supplies, and sputtering target materials. For example, Kobe Steel, Ltd. is our sole supplier of aluminum substrate blanks, which is a fundamental component in producing our disks. Further, as a result of current increased worldwide demand, the supply of sputtering target materials is constrained, resulting in longer lead times and product allocation from certain suppliers. We rely on a single supplier, Heraeus Incorporated, for a substantial quantity of our sputtering target requirements. In addition, we also rely on OMG Fidelity, Inc. for supplies of nickel plating solutions. The supplier base has been weakened by the poor financial condition of the industry in recent years, and some suppliers have exited the business. Additionally, the increasing demand for many of these materials provides our sole-source suppliers with additional bargaining power. Our production capacity would be limited if one or more of these materials were to become unavailable or available in reduced quantities, or if we were unable to find alternative suppliers. For example, due to the significant growth in demand for our disk products in the fourth quarter of 2002, our sales were lower during the quarter than the available market opportunity due to our inability to acquire additional aluminum substrates. If our sources of materials and supplies were limited or unavailable for a significant period of time or the costs of such materials were to increase, our production, operating results, and ability to grow our business could be adversely affected.

We had a history of operating losses, and emerged from chapter 11 bankruptcy in 2002. Despite operating profitability during each of our nine most recent fiscal quarters, we cannot be assured that we will be able to maintain or improve our profitability in the future.

     In 2001, after defaulting on our debt obligations, we filed a voluntary petition for relief under chapter 11 of the United States Bankruptcy Code. We emerged from chapter 11 bankruptcy in June 2002. Although we have been profitable in our most recent nine quarters, we had a history of losses prior to 2003. Due to the factors discussed in this Risk Factors section, including the very competitive, capital-intensive, and historically cyclical nature of the disk and disk drive markets on which our business is dependent, we cannot assure you that we will be able to sustain or improve our profitability in the future.

Price competition may force us to lower our prices, causing our gross margin to suffer.

     We face significant price competition in the disk industry. High levels of competition have historically put downward pressure on prices per unit. Additionally, the average selling price of disks and disk drives rapidly declines over their commercial life as a result of technological enhancements, productivity improvements and industry supply increases. We may be forced to lower our prices or add new products and features at lower prices to remain competitive, and we may otherwise be unable to introduce new products at higher prices. We cannot be assured that we will be able to compete successfully in this kind of price competitive environment. Lower prices would reduce our ability to generate sales, and our gross margin would suffer. If we fail to mitigate the effect of these pressures through increased sales volume or changing our product mix, our net sales and gross margin could be adversely affected. Price

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declines are also affected by any imbalances between demand and supply. For most of 2002, as in the several years prior, disk supply exceeded demand. As independent suppliers like us struggled to utilize their capacity, the excess disk supply caused average selling prices for disks to decline. Supply and demand conditions have improved since 2002, resulting in a more stable pricing environment. Supply and demand factors and industry-wide competition could adjust in the future and force disk prices down, which, in turn, would put pressure on our gross margin.

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

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

All of our manufacturing operations have been consolidated in Malaysia and our foreign operations and international sales subject us to additional risks inherent in doing business on an international level that make it more costly or difficult to conduct our business.

     As a result of our consolidation of manufacturing operations in Malaysia, technology developed at our U.S.-based research and development center must now be first implemented for high-volume production at our Malaysian facilities without the benefit of being implemented at a U.S. factory. Therefore, we rely heavily on electronic communications between our U.S. headquarters and our Malaysian facilities to transfer specifications and procedures, diagnose operational issues, and meet customer requirements. If our operations in Malaysia or overseas communications are disrupted for a prolonged period for any reason, including a failure in electronic communications with our U.S. operations, the manufacture and shipment of our products would be delayed, and our results of operations would suffer.

     Additionally, because a large portion of our payroll, certain manufacturing and operating expenses, and inventory and capital purchases is transacted in the Malaysian ringgit (ringgit), we are particularly sensitive to any change in the foreign currency exchange rate for the ringgit. For approximately the last six years, the exchange rate between the ringgit and the U.S. dollar has been pegged at 3.8 ringgits to one U.S. dollar by the Malaysian government. News reports and certain Malaysian government officials

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have indicated that the Malaysian government may be considering a change in the exchange rate. If the Malaysian government elects to change the pegging of the ringgit to the U.S. dollar and the ringgit proves to be undervalued, the change in exchange rates could adversely affect the amount we spend on our payroll, certain manufacturing and operating expenses, and raw materials and capital purchases. In the first quarter of 2005, our spending on payroll, manufacturing, and operating expenses, and raw materials and capital purchases that were denominated in ringgit was approximately $42.6 million. Additionally, in the first quarter of 2005, we paid approximately $16.9 million for raw materials purchases from a vendor we pay in U.S. dollars, based on a cost plus a percentage arrangement. This vendor incurs costs that are denominated in ringgit; therefore, any change in the valuation of the ringgit in the future could materially adversely impact the cost per unit we pay for such raw materials.

     Furthermore, our ability to transfer funds from our Malaysian operations to the United States is subject to Malaysian rules and regulations. In 1999, the Malaysian government repealed a regulation that restricted the amount of dividends that a Malaysian company may pay to its stockholders. Had it not been repealed, this regulation would have potentially limited our ability to transfer funds to the United States from our Malaysian operations. Because a significant percentage of our revenues is generated from our Malaysian operations, we would be unable to finance our U.S.-based research and development and/or repay our U.S. debt obligations if similar regulations are enacted in the future.

     Additionally, there are a number of risks associated with conducting business outside of the United States. Our sales to Asian customers, including the foreign subsidiaries of domestic disk drive companies, account for substantially all of our net sales. While our Asian customers assemble a substantial portion of their disk drives in Asia, they subsequently sell these products throughout the world. Therefore, our high concentration of Asian sales does not accurately reflect the eventual point of consumption of the assembled disk drives. We anticipate that international sales will continue to represent the majority of our net sales, and as a result the success of our business is subject to factors affecting global markets generally.

     We are subject to these risks to a greater extent than most companies because, in addition to selling our products outside the United States, our Malaysian operations account for substantially all of our net sales. Accordingly, our operating results are subject to the risks inherent with international operations, including, but not limited to:

•   compliance with changing legal and regulatory requirements of foreign jurisdictions;

•   fluctuations in tariffs or other trade barriers;

•   foreign currency exchange rate fluctuations;

•   difficulties in staffing and managing foreign operations;

•   political, social and economic instability;

•   increased exposure to threats and acts of terrorism;

•   exposure to taxes in multiple jurisdictions;

•   local infrastructure problems or failures including but not limited to loss of power and water supply; and

•   transportation delays and interruptions.

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

     The market for our products is highly competitive, and we expect competition to continue in the future. Competitors in the thin-film media industry fall primarily into two groups: Asian-based independent disk manufacturers, and captive disk manufacturers. Our major Asian-based independent competitors include Fuji Electric, Hoya, and Showa Denko (of which Trace Storage Technology became a part in mid-2004). The captive disk manufacturers who produce thin-film media internally for their own use include HGST, Maxtor, and Seagate. Many of these competitors have greater financial resources than we have, which could allow them to adjust to fluctuating market conditions better than we. Further, they may have greater technical and manufacturing resources, more extensive name recognition, more marketing power, a broader array of product lines and preferred vendor status. To the extent our competitors continue to consolidate and achieve greater economies of scale, we will face additional competitive challenges. If we are not able to compete successfully in the future, we would not be able to gain additional market share for our products, or we may lose our existing market share, and our operating results could be harmed.

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

     With short product life cycles and the rapid technological change experienced in the disk drive industry, we must frequently qualify new products with our disk drive manufacturing customers, based on criteria such as quality, storage capacity, performance, and price. Qualifying disks for incorporation into new disk drive products requires us to work extensively with our customer and the customer’s other suppliers to meet product specifications. Therefore, customers often require a significant number of product presentations and demonstrations, as well as substantial interaction with our senior management, before making a purchasing decision. Accordingly, our products typically have a lengthy sales cycle, which can range from six to twelve months or longer. During this time, we may expend substantial financial resources and management time and effort, while having no assurances that a sale will result, or that disk drive programs ultimately will result in high-volume production. To the extent we expend significant resources to qualify products without realizing sales, our operations will suffer.

If our customers cancel orders, our sales could suffer and we are generally not entitled to receive cancellation penalties to offset the loss of sales revenue.

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

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Disk drive program life cycles are short, and disk drive programs are highly customized. If we fail to respond to our customers’ demanding requirements, we will not be able to compete effectively.

     The disk industry is subject to rapid technological change, and if we are unable to anticipate and develop products and production technologies on a timely basis, our competitive position could be harmed. In general, the life cycles of disk drive programs are short. Additionally, disks must be more customized to each disk drive program. Short program life cycles and customization have increased the risk of product obsolescence, and as a result, supply chain management, including just-in-time delivery, has become a standard industry practice. In order to sustain customer relationships and sustain profitability, we must be able to develop new products and technologies in a timely fashion in order to help customers reduce their time-to-market performance, and continue to maintain operational excellence that supports high-volume manufacturing ramps and tight inventory management throughout the supply chain. Accordingly, we have invested, and intend to continue to invest heavily, in our research and development program. If we cannot respond to this rapidly changing environment or fail to meet our customers’ demanding product and qualification requirements, we will not be able to compete effectively. As a result, we would not be able to maximize the use of our production facilities, and our profitability would be negatively impacted.

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

     Our products primarily serve the 3 1/2-inch disk drive market where product performance, consistent quality, price and availability are of great competitive importance. Advances in disk drive technology require continually lower flying heights and higher areal density. Until recently, areal density was roughly doubling from year-to-year and even today continues to increase rapidly, requiring significant improvement in every aspect of disk design. These advances require substantial on-going process and technology development. New process technologies, including SAF and PMR, must support cost-effective, high-volume production of disks that meet these ever-advancing customer requirements for enhanced magnetic recording performance. We may not be able to develop and implement these technologies in a timely manner in order to compete effectively against our competitors’ products or entirely new data storage technologies. In addition, we must transfer our technology from our U.S.-based research and development center to our Malaysian manufacturing operations.

     If we cannot advance our process technologies or do not successfully implement those advanced technologies in our Malaysian operations, or if technologies that we have chosen not to develop prove to be viable competitive alternatives, we would not be able to compete effectively. As a result, we would lose market share and face increased price competition from other manufacturers, and our operating results would suffer. Further, as we introduce more technologically advanced product offerings, they can result in lower introductory yields, which would negatively impact our gross margins.

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

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

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

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

If we are not able to attract and retain key personnel, our operations could be harmed.

     Our future success depends on the continued service of our executive officers, our highly-skilled research, development, and engineering team, our manufacturing team, and our key administrative, sales and marketing, and support personnel. Acquiring and retaining talented personnel who possess the advanced skills we require has been difficult, particularly at our Malaysian manufacturing facilities where there is high growth in the marketplace We may not be able to attract, assimilate, or retain highly-qualified personnel to maintain the capabilities that are necessary to compete effectively. Further, we do not have key person life insurance on any of our key personnel. If we are unable to retain existing or hire key personnel, our business, financial condition, and operating results could be harmed.

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

     It is commonplace to protect technology through patents and other forms of intellectual property rights in technically sophisticated fields. In the disk and disk drive industries, companies and individuals have initiated actions against others in the industry to enforce intellectual property rights. Although we attempt to protect our intellectual property rights through patents, copyrights, trade secrets, and other measures, we may not be able to protect adequately our technology. In addition, we may not be able to

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discover significant infringements of our technology or successfully enforce our rights to our technology if we discover infringing uses by others, and such infringements could have a negative impact on our ability to compete effectively. Competitors may be able to develop similar technology and also may have or may develop intellectual property rights and enforce those rights to prevent us from using such technologies, or demand royalty payments from us in return for using such technologies. Either of these events may affect our production, which could materially reduce our revenues and harm our operating results.

We may face intellectual property infringement claims that are costly to resolve, may divert our management’s attention, and may negatively impact our operations.

     We have occasionally received, and may receive in the future, communications from third parties that assert violation of intellectual property rights alleged to cover certain of our products or manufacturing processes or equipment. We evaluate on a case-by-case basis whether it would be necessary to defend against such claims or to seek licenses to the rights referred to in such communications. In certain cases, we may not be able to negotiate necessary licenses on commercially reasonable terms, or at all. Also, if we have to defend such claims, we could incur significant expenses and our management’s attention could be diverted from our core business. Further, we may not be able to anticipate claims by others that we infringe on their technology or successfully defend ourselves against such claims. Any litigation resulting from such claims could have a material adverse effect on our business and financial results.

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

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

•   timing of significant orders, or order cancellations;

•   changes in our product mix and average selling prices;

•   modified, adjusted, or rescheduled shipments;

•   availability of disks versus demand for disks;

•   the cyclical nature of the disk drive industry;

•   our ability to develop and implement new manufacturing process technologies;

•   increases in our production and engineering costs associated with initial design and production of new product programs;

•   fluctuations in exchange rates, particularly between the U.S. dollar and the Malaysian ringgit;

•   the ability of our process equipment to meet more stringent future product requirements;

•   our ability to introduce new products that achieve cost-effective high-volume production in a timely manner, timing of product announcements, and market acceptance of new products;

•   the availability of our production capacity, and the extent to which we can use that capacity;

•   changes in our manufacturing efficiencies, in particular product yields and input costs for direct materials, operating supplies and other running costs;

•   prolonged disruptions of operations at any of our facilities for any reason;

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•   changes in the cost of or limitations on availability of labor;

•   structural changes within the disk industry, including combinations, failures, and joint venture arrangements; and

•   changes in tax regulations in foreign jurisdictions that could potentially reduce our tax incentives in areas such as Malaysian capital allowances, tax holidays, and exemptions on withholding tax on royalty payments made by our Malaysian operations to our subsidiary in The Netherlands.

     We cannot forecast with certainty the impact of these and other factors on our revenues and operating results in any future period. Our expense levels are based, in part, on expectations as to future revenues. If our revenue levels are below expectations, our operating results are likely to suffer.

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

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

•   difficulties in integrating the operations, technologies, products and personnel of the acquired companies, especially given the specialized nature of our technology;

•   diversion of management’s attention from normal daily operations of the business;

•   potential difficulties in completing projects associated with in-process research and development;

•   initial dependence on unfamiliar supply chains or relatively small supply partners; and

•   the potential loss of key employees of the acquired companies.

     Acquisitions may also cause us to:

•   issue stock that would dilute our current stockholders’ percentage ownership;

•   assume liabilities;

•   record goodwill and non-amortizable intangible assets that will be subject to impairment testing and potential periodic impairment charges;

•   incur amortization expenses related to certain intangible assets;

•   incur large and immediate write-offs; or

•   become subject to litigation.

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

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possible issues that might arise with respect to products or the integration of the company into our company.

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

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

•   the use, storage, discharge, and disposal of hazardous materials used during our manufacturing process;

•   the treatment of water used in our manufacturing process; and

•   air quality management.

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

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

•   we could be subject to significant penalties;

•   our ability to expand or operate in California or Malaysia could be restricted;

•   our ability to establish additional operations in other locations could be restricted; or

•   we could be required to obtain costly equipment or incur significant expenses to comply with environmental regulations.

     Furthermore, our manufacturing processes rely on the use of hazardous materials, and any accidental hazardous discharge could result in significant liability and clean-up expenses, which could harm our business, financial condition, and results of operations.

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

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

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

     Our U.S. facilities are located in San Jose, California. In addition, Kobe and other Japanese suppliers of our key manufacturing supplies and sputtering machines are located in areas with seismic activity. Our Malaysian operations have been subject to temporary production interruptions due to localized flooding, disruptions in the delivery of electrical power, and, on one occasion in 1997, by smoke generated

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by large, widespread fires in Indonesia. If any natural or man-made disasters do occur, operations could be disrupted for prolonged periods, and our business would suffer.

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

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

Risks Related to our Indebtedness

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

     In the first quarter of 2004, we completed a public common stock offering of 4.0 million shares (of which 0.5 million were sold by selling stockholders) and a public $80.5 million Convertible Subordinated Notes offering. Debt service obligations arising from the offering of our Convertible Subordinated Notes could limit our ability to borrow more money for operations and implement our business strategy in the future. We will continue to be more leveraged than some of our competitors, which may place us at a competitive disadvantage because our interest and debt repayment requirements makes us more susceptible to downturns in our business.

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

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

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

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

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. We invest primarily in high-quality, short-term debt instruments and auction rate preferred securities (which the Company rolls over every three months or less), and are accounted for as cash equivalents or short-term investments, depending upon the period of time from the purchase date to the maturity date.

     We are exposed to foreign currency exchange rate risk. We currently do not use derivative financial instruments to hedge such risk.

     A majority of our revenue, expense, and capital purchasing activities is transacted in U.S. dollars. However, a large portion of our payroll, certain manufacturing and operating expenses, and inventory and capital purchases are transacted in the Malaysian ringgit (ringgit). For approximately the last six years, the exchange rate between the ringgit and the U.S. dollar has been pegged at 3.8 ringgits to one U.S. dollar by the Malaysian government. News reports and certain Malaysian government officials have indicated that the Malaysian government may be considering a change in the exchange rate. If the Malaysian government elects to change the pegging of the ringgit to the U.S. dollar and the ringgit proves to be undervalued, the change in exchange rates could adversely affect the amount we spend on our payroll, certain manufacturing and operating expenses, and raw materials and capital purchases. In the first quarter of 2005, our spending on payroll, manufacturing, and operating expenses, and raw materials and capital purchases that were denominated in ringgit was approximately $42.6 million. Additionally, we paid approximately $16.9 million for raw materials purchases in the first quarter of 2005 from a vendor we pay in U.S. dollars based on a cost plus a percentage arrangement. This vendor has costs that are incurred which are denominated in ringgit; therefore, any change in the valuation of the ringgit in the future could adversely impact the cost per unit we pay for such raw materials.

     We have $80.5 million in convertible subordinated notes outstanding. These notes bear interest at 2% and mature in February 2024. A hypothetical 100 basis point increase in interest rates would result in approximately $0.8 million of additional interest expense each year.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

     As of April 3, 2005, our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), has conducted an evaluation of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15(b) of the Exchange Act. Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely manner.

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Internal Control over Financial Reporting

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

•   pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;

•   provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and

•   provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

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

Changes in Internal Control Over Financial Reporting

     There has been no change in our internal control over financial reporting during our first fiscal quarter ended April 3, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

     Not applicable.

ITEM 2. Unregistered Sales of Equity Securities

     Not applicable.

ITEM 3. Defaults Upon Senior Securities

     Not applicable.

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ITEM 4. Submission of Matters to a Vote of Security Holders

     Not applicable.

ITEM 5. Other Information

     Effective as of May 3, 2005, our Board of Directors approved a modification to our 2005 Target Incentive Plan to increase the target bonus percentage of the Chief Executive Officer under the plan from 65% to 80%. Therefore, under the modified plan, if our actual performance meets our target operating income goals for the year and our Chief Executive Officer meets individual performance goals, the plan provides that our Chief Executive Officer may receive a target cash incentive bonus payment equal to 80% of his eligible base salary (rather than 65% of his eligible base salary), subject to the terms and conditions of the plan. A copy of the modified plan is filed as Exhibit 10.2 to this report.

     On May 4, 2005, we entered into an Executive Retention Agreement with our executive officer William G. Hammack, the Vice President of Human Resources. This agreement is a reinstatement of our prior 2002 Executive Retention Agreement with Mr. Hammack, with the same terms and conditions. Mr. Hammack left the Company in January 2005 and returned on March 14, 2005, resuming his position and duties as Vice President of Human Resources. The new agreement continues to provide for base salary compensation, a term of employment until July 16, 2005, benefits and certain other change of control and severance benefits as approved by our Board of Directors. A copy of Mr. Hammack’s agreement is filed as Exhibit 10.3 to this report.

ITEM 6. Exhibits

10.1	Amended and Restated 2002 Qualified Stock Option Plan
10.2	2005 Target Incentive Plan
10.3	Executive Retention Agreement dated May 4, 2005 with William G. Hammock
31.1	Rule 13a – 14 (a) Certification of Chief Executive Officer
31.2	Rule 13a – 14 (a) Certification of Chief Financial Officer
32	Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

KOMAG, INCORPORATED
(Registrant)

DATE: May 6, 2005	BY:	/s/ Thian Hoo Tan
	Thian Hoo Tan
	Chief Executive Officer

DATE: May 6, 2005	BY:	/s/ Kathleen A. Bayless
	Kathleen A. Bayless
	Vice President, Chief Financial Officer

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EXHIBIT INDEX

10.1	Amended and Restated 2002 Qualified Stock Option Plan
10.2	2005 Target Incentive Plan
10.3	Executive Retention Agreement dated May 4, 2005 with William G. Hammock
31.1	Rule 13a – 14 (a) Certification of Chief Executive Officer
31.2	Rule 13a – 14 (a) Certification of Chief Financial Officer
32	Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

EX-10.1

EXHIBIT 10.1

KOMAG, INCORPORATED

AMENDED AND RESTATED 2002 QUALIFIED STOCK PLAN

(as of April 2005)

     1. Purposes of the Plan. The purposes of this Amended and Restated 2002 Qualified Stock Plan are:

• to attract and retain the best available personnel for positions of substantial responsibility,

• to provide additional incentive to Service Providers, and

• to promote the success of the Company’s business.

          Awards granted under the Plan may be Incentive Stock Options, Nonstatutory Stock Options, Stock Purchase Rights, Stock Appreciation Rights, Performance Shares or Performance Units, as determined by the Administrator at the time of grant.

     2. Definitions. As used herein, the following definitions shall apply:

          (a) “Administrator” means the Board or any of its Committees as shall be administering the Plan, in accordance with Section 4 of the Plan.

          (b) “Applicable Laws” means the requirements relating to the administration of equity compensation plans under U. S. state corporate laws, U.S. federal and state securities laws, the Code, any stock exchange or quotation system on which the Common Stock is listed or quoted and the applicable laws of any foreign country or jurisdiction where Awards are, or will be, granted under the Plan.

          (c) “Award” means individually or collectively, a grant under the Plan of Options, Stock Purchase Rights, Stock Appreciation Rights, Performance Shares or Performance Units.

          (d) “Award Agreement” means the written agreement setting forth the terms and provisions applicable to each Award granted under the Plan. The Award Agreement is subject to the terms and conditions of the Plan.

          (e) “Awarded Stock” means the Common Stock subject to an Award.

          (f) “Board” means the Board of Directors of the Company.

          (g) “Change in Control” means the occurrence of any of the following events:

               (i) Any “person” (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becomes the “beneficial owner” (as defined in Rule 13d-3 of the Exchange Act), directly or indirectly, of securities of the Company representing fifty percent (50%) or more of the total voting power represented by the Company’s then outstanding voting securities; or

               (ii) The consummation of the sale or disposition by the Company of all or substantially all of the Company’s assets;

               (iii) A change in the composition of the Board occurring within a two-year period, as a result of which fewer than a majority of the directors are Incumbent Directors. “Incumbent Directors” means directors who either (A) are Directors as of the effective date of the Plan, or (B) are elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the Incumbent Directors at the time of such election or nomination (but will not include an individual whose election or nomination is in connection with an actual or threatened proxy contest relating to the election of directors to the Company); or

               (iv) The consummation of a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity or its parent) at least fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity or its parent outstanding immediately after such merger or consolidation.

          (h) “Code” means the Internal Revenue Code of 1986, as amended.

          (i) “Committee” means a committee of Directors appointed by the Board in accordance with Section 4 of the Plan.

          (j) “Common Stock” means the common stock of the Company, or in the case of Performance Units, the cash equivalent thereof.

          (k) “Company” means Komag, Incorporated, a Delaware corporation.

          (l) “Consultant” means any natural person, including an advisor, engaged by the Company or a Parent or Subsidiary to render services to such entity.

          (m) “Deferred Stock Unit” means a deferred stock unit Award granted to a Service Provider pursuant to Section 13.

          (n) “Director” means a member of the Board.

          (o) “Disability” means total and permanent disability as defined in Section 22(e)(3) of the Code.

          (p) “Employee” means any person, including Officers and Directors, employed by the Company or any Parent or Subsidiary of the Company. A Service Provider shall not cease to be treated as an Employee in the case of (i) any leave of absence approved by the Company or

2

(ii) transfers between locations of the Company or between the Company, its Parent, any Subsidiary, or any successor. For purposes of Incentive Stock Options, no such leave may exceed ninety days, unless reemployment upon expiration of such leave is guaranteed by statute or contract. If reemployment upon expiration of a leave of absence approved by the Company is not so guaranteed, then three (3) months following the 91^st day of such leave any Incentive Stock Option held by the Participant shall cease to be treated as an Incentive Stock Option and shall be treated for tax purposes as a Nonstatutory Stock Option. Neither service as a Director nor payment of a director’s fee by the Company shall be sufficient to constitute “employment” by the Company.

          (q) “Exchange Act” means the Securities Exchange Act of 1934, as amended.

          (r) “Fair Market Value” means, as of any date, the value of Common Stock determined as follows:

               (i) If the Common Stock is listed on any established stock exchange or a national market system, including without limitation the Nasdaq National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its Fair Market Value shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or system on the day of determination, as reported in The Wall Street Journal or such other source as the Administrator deems reliable;

               (ii) If the Common Stock is regularly quoted by a recognized securities dealer but selling prices are not reported, the Fair Market Value of a Share of Common Stock shall be the mean between the high bid and low asked prices for the Common Stock on the day of determination, as reported in The Wall Street Journal or such other source as the Administrator deems reliable; or

               (iii) In the absence of an established market for the Common Stock, the Fair Market Value shall be determined in good faith by the Administrator.

               (iv) Notwithstanding the preceding, for federal, state, and local income tax reporting purposes and for such other purposes as the Administrator deems appropriate, the Fair Market Value shall be determined by the Administrator in accordance with uniform and nondiscriminatory standards adopted by it from time to time.

     (s) “Incentive Stock Option” means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code and the regulations promulgated thereunder.

     (t) “Nonstatutory Stock Option” means an Option not intended to qualify as an Incentive Stock Option.

     (u) “Notice of Grant” means a written or electronic notice evidencing certain terms and conditions of an individual Award. The Notice of Grant is part of the Award Agreement.

     (v) “Officer” means a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder.

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          (w) “Option” means a stock option granted pursuant to the Plan.

          (x) “Parent” means a “parent corporation,” whether now or hereafter existing, as defined in Section 424(e) of the Code.

          (y) “Participant” means the holder of an outstanding Award granted under the Plan.

          (z) “Performance Goals” means the goal(s) determined by the Administrator (in its discretion) to be applicable to a Participant with respect to an Award. As determined by the Administrator, the Performance Goals applicable to an Award may provide for a targeted level or levels of achievement using one or more of the following measures: (i) cash flow, (ii) customer satisfaction, (iii) earnings, (iv) gross margin, (v) market price of stock, (vi) market share, (vii) net income, (viii) operating income, (ix) operating margin, (x) return on capital, (xi) return on equity, (xii) return on net assets, (xiii) revenue and (xiv) sales. The Performance Goals may differ from Participant to Participant and from Award to Award. Any criteria used may be measured, as applicable, (i) in absolute terms, (ii) in relative terms (including, but not limited to, passage of time and/or against another company or companies), (iii) on a per-share basis, (iv) against the performance of the Company as a whole or a segment of the Company, and (v) on a pre-tax or after-tax basis.

          (aa) “Performance Share” means a performance share Award granted to a Service Provider pursuant to Section 11.

          (bb) “Performance Unit” means a performance unit Award granted to a Service Provider pursuant to Section 12.

          (cc) “Plan” means this Amended and Restated 2002 Qualified Stock Plan.

          (dd) “Restricted Stock” means Shares, acquired upon exercise of a Stock Purchase Right, that are subject to vesting, if any.

          (ee) “Rule 16b-3” means Rule 16b-3 of the Exchange Act or any successor to Rule 16b-3, as in effect when discretion is being exercised with respect to the Plan.

          (ff) “Section 16(b) “ means Section 16(b) of the Exchange Act.

          (gg) “Service Provider” means an Employee, Director or Consultant.

          (hh) “Share” means a share of the Common Stock, as adjusted in accordance with Section 16 of the Plan.

          (ii) “Stock Appreciation Right” or “SAR” means an Award, granted alone or in connection with a related Option, that pursuant to Section 10 is designated as a SAR.

          (jj) “Stock Purchase Right” means the right to purchase Shares pursuant to Section 9 of the Plan, as evidenced by a Notice of Grant.

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          (kk) “Subsidiary” means a “subsidiary corporation”, whether now or hereafter existing, as defined in Section 424(f) of the Code.

     3. Stock Subject to the Plan. Subject to the provisions of Section 16 of the Plan, the maximum aggregate number of Shares that may be issued under the Plan is 3,925,000 Shares, plus 317,054 Shares available for issuance under the Company’s 2002 Employee Stock Purchase Plan. The Shares may be authorized, but unissued, or reacquired Common Stock.

          If an Award expires or becomes unexercisable without having been exercised in full, or, with respect to Restricted Stock, Performance Shares, Performance Units or Deferred Stock Units, is forfeited back to or repurchased by the Company, the unpurchased Shares (or for Awards other than Options and SARs, the forfeited or repurchased Shares) which were subject thereto shall become available for future grant or sale under the Plan (unless the Plan has terminated). However, Shares that have actually been issued under the Plan, under any Award, shall not be returned to the Plan and shall not become available for future distribution under the Plan, except that if Shares of Restricted Stock, Performance Shares, Performance Units or Deferred Stock Units are repurchased by the Company at their original purchase price or are forfeited to the Company, such Shares shall become available for future grant under the Plan. To the extent an Award under the Plan is paid out in cash rather than stock, such cash payment shall not result in reducing the number of Shares available for issuance under the Plan.

          If a Participant pays the exercise price (or purchase price, if applicable) of an Award through the tender of Shares, or if Shares are tendered or withheld to satisfy any Company withholding obligations, the number of Shares so tendered or withheld shall again be available for issuance pursuant to future Awards under the Plan.

     4. Administration of the Plan.

          (a) Procedure.

               (i) Multiple Administrative Bodies. Different Committees with respect to different groups of Service Providers may administer the Plan.

               (ii) Section 162(m). To the extent that the Administrator determines it to be desirable to qualify Options granted hereunder as “performance-based compensation” within the meaning of Section 162(m) of the Code, the Plan shall be administered by a Committee of two or more “outside directors” within the meaning of Section 162(m) of the Code.

               (iii) Rule 16b-3. To the extent desirable to qualify transactions hereunder as exempt under Rule 16b-3, the transactions contemplated hereunder shall be structured to satisfy the requirements for exemption under Rule 16b-3.

               (iv) Other Administration. Other than as provided above, the Plan shall be administered by (A) the Board or (B) a Committee, which committee shall be constituted to satisfy Applicable Laws.

5

          (b) Powers of the Administrator. Subject to the provisions of the Plan, and in the case of a Committee, subject to the specific duties delegated by the Board to such Committee, the Administrator shall have the authority, in its discretion:

               (i) to determine the Fair Market Value;

               (ii) to select the Service Providers to whom Awards may be granted hereunder;

               (iii) to determine the number of Shares to be covered by each Award granted hereunder;

               (iv) to approve forms of agreement for use under the Plan;

               (v) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any Award granted hereunder. Such terms and conditions include, but are not limited to, the exercise price, the time or times when Options, Stock Purchase Rights or SARs may be exercised (which may be based on performance criteria), any vesting acceleration or waiver of forfeiture or repurchase restrictions, and any restriction or limitation regarding any Award or the Shares relating thereto, based in each case on such factors as the Administrator, in its sole discretion, shall determine;

               (vi) to construe and interpret the terms of the Plan and Awards granted pursuant to the Plan;

               (vii) to prescribe, amend and rescind rules and regulations relating to the Plan, including rules and regulations relating to sub-plans established for the purpose of qualifying for preferred tax treatment under foreign tax laws;

               (viii) to modify or amend each Award (subject to Section 18(c) of the Plan), including the discretionary authority to extend the post-termination exercisability period of Options or SARs longer than is otherwise provided for in the Plan. Notwithstanding the previous sentence, the Administrator may not modify or amend an Option or SAR to reduce the exercise price of such Option or SAR after it has been granted (except for adjustments made pursuant to Section 16) nor may the Administrator cancel any outstanding Option or SAR and replace it with a new Option or SAR with a lower exercise price, unless, in either case, such action is approved by the Company’s stockholders;

               (ix) to offer to buyout for a payment in cash or Shares an Award previously granted under the Plan, provided any such offer is approved by the Company’s stockholders;

               (x) to allow Participants to satisfy withholding tax obligations by electing to have the Company withhold from the Shares or cash to be issued upon exercise or vesting of an Award that number of Shares or cash having a Fair Market Value equal to the amount required to be withheld. The Fair Market Value of any Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined. All elections by a Participant to have Shares or

6

cash withheld for this purpose shall be made in such form and under such conditions as the Administrator may deem necessary or advisable;

               (xi) to authorize any person to execute on behalf of the Company any instrument required to effect the grant of an Award previously granted by the Administrator; and

               (xii) to make all other determinations deemed necessary or advisable for administering the Plan.

          (c) Effect of Administrator’s Decision. The Administrator’s decisions, determinations and interpretations shall be final and binding on all Participants.

     5. Eligibility. Stock Purchase Rights, Performance Shares, Performance Units, Stock Appreciation Rights, Deferred Stock Units and Nonstatutory Stock Options may be granted to Service Providers. Incentive Stock Options may be granted only to Employees.

     6. Limitations.

          (a) ISO $100,000 Rule. Each Option shall be designated in the Award Agreement as either an Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding such designation, to the extent that the aggregate Fair Market Value of the Shares with respect to which Incentive Stock Options are exercisable for the first time by the Participant during any calendar year (under all plans of the Company and any Parent or Subsidiary) exceeds $100,000, such Options shall be treated as Nonstatutory Stock Options. For purposes of this Section 6(a), Incentive Stock Options shall be taken into account in the order in which they were granted. The Fair Market Value of the Shares shall be determined as of the time the Option with respect to such Shares is granted.

          (b) No Rights as a Service Provider. Neither the Plan nor any Award shall confer upon a Participant any right with respect to continuing his or her relationship as a Service Provider, nor shall they interfere in any way with the right of the Participant or the right of the Company or its Parent or Subsidiaries to terminate such relationship at any time, with or without cause.

          (c) 162(m) Limitation. The following limitations shall apply to Awards under the Plan:

               (i) No Service Provider shall be granted, in any fiscal year of the Company, (A) Option or SARs to purchase more than 1,500,000 Shares, (B) Stock Purchase Rights to purchase more than 500,000 Shares, (C) Performance Shares covering more than 500,000 Shares and (D) Performance Units with an initial value in excess of $5,000,000.

               (ii) In connection with his or her initial service, a Service Provider may be granted Options or SARS to purchase up to an additional 1,500,000 Shares, which shall not count against the limit set forth in subsection (i) above.

               (iii) The foregoing limitations shall be adjusted proportionately in connection with any change in the Company’s capitalization as described in Section 16(a).

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               (iv) If an Award is cancelled in the same fiscal year of the Company in which it was granted (other than in connection with a transaction described in Section 16(c)), the cancelled Award will be counted against the limits set forth in subsections (i) and (ii) above.

     7. Term of Plan. The Plan shall become effective upon its adoption by the Board. It shall continue in effect for a term of ten (10) years unless terminated earlier under Section 18 of the Plan.

     8. Stock Options.

          (a) Term of Options. The term of each Option shall be ten (10) years from the date of grant or such shorter term as may be provided in the Award Agreement. Moreover, in the case of an Incentive Stock Option granted to a Participant who, at the time the Incentive Stock Option is granted, owns stock representing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Parent or Subsidiary, the term of the Incentive Stock Option shall be five (5) years from the date of grant or such shorter term as may be provided in the Award Agreement.

          (b) Option Exercise Price and Consideration.

               (i) Exercise Price. The per Share exercise price for the Shares to be issued pursuant to exercise of an Option shall be determined by the Administrator, subject to the following:

                    (A) In the case of an Incentive Stock Option

                         (a) granted to an Employee who, at the time the Incentive Stock Option is granted, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the per Share exercise price shall be no less than 110% of the Fair Market Value per Share on the date of grant.

                         (b) granted to any Employee other than an Employee described in paragraph (a) immediately above, the per Share exercise price shall be no less than 100% of the Fair Market Value per Share on the date of grant.

                    (B) In the case of a Nonstatutory Stock Option, the per Share exercise price shall be determined by the Administrator. In the case of a Nonstatutory Stock Option intended to qualify as “performance-based compensation” within the meaning of Section 162(m) of the Code, the per Share exercise price shall be no less than 100% of the Fair Market Value per Share on the date of grant.

               (ii) The exercise price for the Shares to be issued pursuant to an already granted Option may not be changed without the consent of the Company’s stockholders. This shall include, without limitation, a repricing of the Option as well as an option exchange program whereby the Participant agrees to cancel an existing Option in exchange for an Option, SAR or other Award.

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          (c) Waiting Period and Exercise Dates. At the time an Option is granted, the Administrator shall fix the period within which the Option may be exercised and shall determine any conditions that must be satisfied before the Option may be exercised.

          (d) Form of Consideration. The Administrator shall determine the acceptable form of consideration for exercising an Option, including the method of payment. In the case of an Incentive Stock Option, the Administrator shall determine the acceptable form of consideration at the time of grant. Such consideration to the extent permitted by Applicable Laws may consist entirely of:

               (i) cash;

               (ii) check;

               (iii) promissory note;

               (iv) other Shares which meet the conditions established by the Administrator to avoid adverse accounting consequences (as determined by the Administrator);

               (v) consideration received by the Company under a cashless exercise program implemented by the Company in connection with the Plan;

               (vi) a reduction in the amount of any Company liability to the Participant, including any liability attributable to the Participant’s participation in any Company-sponsored deferred compensation program or arrangement;

               (vii) any combination of the foregoing methods of payment; or

               (viii) such other consideration and method of payment for the issuance of Shares to the extent permitted by Applicable Laws.

          (e) Exercise of Option.

          (i) Procedure for Exercise; Rights as a Stockholder. Any Option granted hereunder shall be exercisable according to the terms of the Plan and at such times and under such conditions as determined by the Administrator and set forth in the Award Agreement. Unless the Administrator provides otherwise, vesting of Options granted hereunder shall be suspended beginning on the 91^st day of a Participant’s leave of absence and will resume on the date the Participant returns to work on a regular schedule as determined by the Company; provided, however, that no vesting credit will be awarded for the time vesting has been suspended during such leave of absence. An Option may not be exercised for a fraction of a Share.

     An Option shall be deemed exercised when the Company receives: (i) written or electronic notice of exercise (in accordance with the Award Agreement) from the person entitled to exercise the Option, and (ii) full payment for the Shares with respect to which the Option is exercised. Full payment may consist of any consideration and method of payment authorized by the Administrator and permitted by the Award Agreement and the Plan. Shares issued upon exercise of an Option shall be issued in the name of the Participant or, if requested by the Participant, in the name of the

9

Participant and his or her spouse. Until the Shares are issued (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company), no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to the Awarded Stock, notwithstanding the exercise of the Option. The Company shall issue (or cause to be issued) such Shares promptly after the Option is exercised. No adjustment will be made for a dividend or other right for which the record date is prior to the date the Shares are issued, except as provided in Section 16 of the Plan.

     Exercising an Option in any manner shall decrease the number of Shares thereafter available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised.

          (f) Termination of Relationship as a Service Provider. If a Participant ceases to be a Service Provider, other than upon the Participant’s death or Disability, the Participant may exercise his or her Option within such period of time as is specified in the Award Agreement to the extent that the Option is vested on the date of termination (but in no event later than the expiration of the term of such Option as set forth in the Award Agreement). In the absence of a specified time in the Award Agreement, the Option shall remain exercisable for three (3) months following the Participant’s termination. If, on the date of termination, the Participant is not vested as to his or her entire Option, the Shares covered by the unvested portion of the Option shall revert to the Plan. If, after termination, the Participant does not exercise his or her Option within the time specified by the Administrator, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan.

          (g) Disability of Participant. If a Participant ceases to be a Service Provider as a result of the Participant’s Disability, the Participant may exercise his or her Option within such period of time as is specified in the Award Agreement to the extent the Option is vested on the date of termination (but in no event later than the expiration of the term of such Option as set forth in the Award Agreement). In the absence of a specified time in the Award Agreement, the Option shall remain exercisable for twelve (12) months following the Participant’s termination. If, on the date of termination, the Participant is not vested as to his or her entire Option, the Shares covered by the unvested portion of the Option shall revert to the Plan. If, after termination, the Participant does not exercise his or her Option within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan.

          (h) Death of Participant. If a Participant dies while a Service Provider, the Option may be exercised following the Participant’s death within such period of time as is specified in the Award Agreement to the extent that the Option is vested on the date of death (but in no event may the option be exercised later than the expiration of the term of such Option as set forth in the Award Agreement), by the Participant’s designated beneficiary, provided such beneficiary has been designated prior to Participant’s death in a form acceptable to the Administrator. If no such beneficiary has been designated by the Participant, then such Option may be exercised by the personal representative of the Participant’s estate or by the person(s) to whom the Option is transferred pursuant to the Participant’s will or in accordance with the laws of descent and distribution. In the absence of a specified time in the Award Agreement, the Option shall remain exercisable for twelve (12) months following Participant’s death. If, at the time of death, the Participant is not vested as to his or her entire Option, the Shares covered by the unvested portion of

10

the Option shall immediately revert to the Plan. If the Option is not so exercised within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan.

     9. Stock Purchase Rights.

          (a) Rights to Purchase. Stock Purchase Rights may be issued either alone, in addition to, or in tandem with other Awards granted under the Plan and/or cash awards made outside of the Plan. After the Administrator determines that it will offer Stock Purchase Rights under the Plan, it shall advise the offeree in writing or electronically, of the terms, conditions and restrictions related to the offer, including the number of Shares that the offeree shall be entitled to purchase, the price to be paid, and the time within which the offeree must accept such offer. The offer shall be accepted by execution of an Award Agreement in the form determined by the Administrator.

          (b) Repurchase Option. Unless the Administrator determines otherwise, the Award Agreement shall grant the Company a repurchase option exercisable upon the voluntary or involuntary termination of the purchaser’s service with the Company for any reason (including death or Disability). The purchase price for Shares repurchased pursuant to the Award Agreement shall be the original price paid by the purchaser and may be paid by cancellation of any indebtedness of the purchaser to the Company. The repurchase option shall lapse at a rate determined by the Administrator. However, if the Administrator determines it is desirable for the Award to qualify as “performance-based compensation” for purposes of Section 162(m) of the Code, the repurchase option shall lapse based upon the achievement of Performance Goals.

          (c) Other Provisions. The Award Agreement shall contain such other terms, provisions and conditions not inconsistent with the Plan as may be determined by the Administrator in its sole discretion.

          (d) Rights as a Stockholder. Once the Stock Purchase Right is exercised, the purchaser shall have the rights equivalent to those of a stockholder, and shall be a stockholder when his or her purchase is entered upon the records of the duly authorized transfer agent of the Company. No adjustment will be made for a dividend or other right for which the record date is prior to the date the Stock Purchase Right is exercised, except as provided in Section 16 of the Plan.

     10. Stock Appreciation Rights.

          (a) Grant of SARs. Subject to the terms and conditions of the Plan, SARs may be granted to Service Providers at any time and from time to time as shall be determined by the Administrator, in its sole discretion. The Administrator shall have complete discretion to determine the number of SARs granted to any Participant.

          (b) Exercise Price and other Terms. The Administrator, subject to the provision of the Plan, shall have complete discretion to determine the terms and conditions of SARs granted under the Plan; provided, however, that no SAR may have a term of more than ten (10) years from the date of grant. The exercise price for the Shares or cash to be issued pursuant to an already granted SAR may not be changed without the consent of the Company’s stockholders. This shall include, without limitation, a repricing of the SAR as well as an SAR exchange program whereby the Participant agrees to cancel an existing SAR in exchange for an Option, SAR or other Award.

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          (c) Payment of SAR Amount. Upon exercise of a SAR, a Participant shall be entitled to receive payment from the Company in an amount determined by multiplying:

               (i) the difference between the Fair Market Value of a Share on the date of exercise over the exercise price; times

               (ii) the number of Shares with respect to which the SAR is exercised.

          (d) Payment upon Exercise of SAR. At the discretion of the Administrator, payment for a SAR may be in cash, Shares or a combination thereof.

          (e) SAR Agreement. Each SAR grant shall be evidenced by an Award Agreement that shall specify the exercise price, the term of the SAR, the conditions of exercise, and such other terms and conditions as the Administrator, in its sole discretion, shall determine.

          (f) Expiration of SARs. Subject to the term stated in Section 10(b), a SAR granted under the Plan shall expire upon the date determined by the Administrator, in its sole discretion, and set forth in the Award Agreement.

          (g) Termination of Relationship as a Service Provider. If a Participant ceases to be a Service Provider, other than upon the Participant’s death or Disability, the Participant may exercise his or her Stock Appreciation Right within such period of time as is specified in the Award Agreement to the extent that the Stock Appreciation Right is vested and exercisable on the date of termination (but in no event later than the expiration of the term of such Stock Appreciation Right as set forth in the Award Agreement). In the absence of a specified time in the Award Agreement, the Stock Appreciation Right shall remain exercisable for three (3) months following the Participant’s termination. If, on the date of termination, the Participant is not vested as to his or her entire Stock Appreciation Right, the Shares covered by the unvested portion of the Stock Appreciation Right shall revert to the Plan. If, after termination, the Participant does not exercise his or her Stock Appreciation Right within the time specified by the Administrator, the Stock Appreciation Right shall terminate, and the Shares covered by such Stock Appreciation Right shall revert to the Plan.

          (h) Disability of Participant. If a Participant ceases to be a Service Provider as a result of the Participant’s Disability, the Participant may exercise his or her Stock Appreciation Right within such period of time as is specified in the Award Agreement to the extent the Stock Appreciation Right is vested and exercisable on the date of termination (but in no event later than the expiration of the term of such Stock Appreciation Right as set forth in the Award Agreement). In the absence of a specified time in the Award Agreement, the Stock Appreciation Right shall remain exercisable for twelve (12) months following the Participant’s termination. If, on the date of termination, the Participant is not vested as to his or her entire Stock Appreciation Right, the Shares covered by the unvested portion of the Stock Appreciation Right shall revert to the Plan. If, after termination, the Participant does not exercise his or her Stock Appreciation Right within the time specified herein, the Stock Appreciation Right shall terminate, and the Shares covered by such Stock Appreciation Right shall revert to the Plan.

          (i) Death of Participant. If a Participant dies while a Service Provider, the Stock Appreciation Right may be exercised within such period of time as is specified in the Award Agreement (but in no event later than the expiration of the term of such Stock Appreciation Right as

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set forth in the Notice of Grant), by the Participant’s estate or by a person who acquires the right to exercise the Stock Appreciation Right by bequest or inheritance, but only to the extent that the Stock Appreciation Right is vested and exercisable on the date of death. In the absence of a specified time in the Award Agreement, the Stock Appreciation Right shall remain exercisable for twelve (12) months following the Participant’s termination. If, at the time of death, the Participant is not vested as to his or her entire Stock Appreciation Right, the Shares covered by the unvested portion of the Stock Appreciation Right shall immediately revert to the Plan. The Stock Appreciation Right may be exercised by the executor or administrator of the Participant’s estate or, if none, by the person(s) entitled to exercise the Stock Appreciation Right under the Participant’s will or the laws of descent or distribution. If the Stock Appreciation Right is not so exercised within the time specified herein, the Stock Appreciation Right shall terminate, and the Shares covered by such Stock Appreciation Right shall revert to the Plan.

     11. Performance Shares.

          (a) Grant of Performance Shares. Subject to the terms and conditions of the Plan, Performance Shares may be granted to Service Providers at any time and from time to time as shall be determined by the Administrator, in its sole discretion. The Administrator shall have complete discretion to determine (i) the number of Shares subject to a Performance Share award granted to any Participant, and (ii) the conditions that must be satisfied, which typically will be based principally or solely on achievement of performance milestones but may include a service-based component, upon which is conditioned the grant or vesting of Performance Shares; provided, however, that the performance milestones will be based on Performance Goals if the Administrator desires that the Award qualify as “performance-based compensation” under Section 162(m) of the Code. Performance Shares shall be granted in the form of units/rights to acquire Shares. Each such unit/right shall be the equivalent of one Share for purposes of determining the number of Shares subject to an Award. Until the Shares are issued, no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to the units/rights to acquire Shares.

          (b) Other Terms. The Administrator, subject to the provisions of the Plan, shall have complete discretion to determine the terms and conditions of Performance Shares granted under the Plan. Performance Share grants shall be subject to the terms, conditions, and restrictions determined by the Administrator at the time the stock is awarded, which may include such performance-based milestones as are determined appropriate by the Administrator. The Administrator may require the recipient to sign a Performance Shares agreement as a condition of the award. Any certificates representing the Shares of stock awarded shall bear such legends as shall be determined by the Administrator.

          (c) Performance Share Award Agreement. Each Performance Share grant shall be evidenced by an agreement that shall specify such other terms and conditions as the Administrator, in its sole discretion, shall determine.

     12. Performance Units.

          (a) Grant of Performance Units. Performance Units are similar to Performance Shares, except that they shall be settled in a cash equivalent to the Fair Market Value of the underlying Shares, determined as of the vesting date. Subject to the terms and conditions of the

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Plan, Performance Units may be granted to Service Providers at any time and from time to time as shall be determined by the Administrator, in its sole discretion. The Administrator shall have complete discretion to determine (i) the number of Shares subject to a Performance Unit award granted to any Participant, and (ii) the conditions that must be satisfied, which typically will be based principally or solely on achievement of performance milestones but may include a service-based component, upon which is conditioned the grant or vesting of Performance Units; provided, however, that the performance milestones will be based on Performance Goals if the Administrator desires that the Award qualify as performance-based compensation under Section 162(m) of the Code. Performance Units shall be granted in the form of units/rights to acquire Shares. Each such unit/right shall be the cash equivalent of one Share of Common Stock. No right to vote or receive dividends or any other rights as a stockholder shall exist with respect to Performance Units or the cash payable thereunder.

          (b) Other Terms. The Administrator, subject to the provisions of the Plan, shall have complete discretion to determine the terms and conditions of Performance Units granted under the Plan. Performance Unit grants shall be subject to the terms, conditions, and restrictions determined by the Administrator at the time the stock is awarded, which may include such performance-based milestones as are determined appropriate by the Administrator. The Administrator may require the recipient to sign a Performance Unit agreement as a condition of the award. Any certificates representing the Shares of stock awarded shall bear such legends as shall be determined by the Administrator.

          (c) Performance Unit Award Agreement. Each Performance Unit grant shall be evidenced by an agreement that shall specify such terms and conditions as the Administrator, in its sole discretion, shall determine.

     13. Deferred Stock Units. Deferred Stock Units shall consist of a Restricted Stock, Performance Share or Performance Unit Award that the Administrator, in its sole discretion permits to be paid out in installments or on a deferred basis, in accordance with rules and procedures established by the Administrator.

     14. Non-Transferability of Awards. Unless determined otherwise by the Administrator, an Award may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the recipient, only by the recipient. If the Administrator makes an Award transferable, such Award shall contain such additional terms and conditions as the Administrator deems appropriate.

     15. Leaves of Absence. Subject to any other provision of the Plan, unless the Administrator provides otherwise or as otherwise required by Applicable Laws, vesting of Awards granted hereunder shall cease commencing on the first day of any unpaid leave of absence and shall recommence only upon return to active service.

     16. Adjustments Upon Changes in Capitalization, Dissolution, Merger, or Asset Sale.

          (a) Changes in Capitalization. Subject to any required action by the stockholders of the Company, the number of Shares covered by each outstanding Award, the number of Shares

14

which have been authorized for issuance under the Plan but as to which no Awards have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Award, the number of Shares as well as the price per share of Common Stock covered by each such outstanding Award, and the 162(m) annual share issuance limits under Section 6(c) shall be proportionately adjusted for any increase or decrease in the number of issued Shares resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued Shares effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been “effected without receipt of consideration.” Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of Shares subject to an Award.

          (b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Administrator shall notify each Participant as soon as practicable prior to the effective date of such proposed transaction. The Administrator in its discretion may provide for a Participant to have the right to exercise his or her Option or SAR until ten (10) days prior to such transaction as to all of the Awarded Stock covered thereby, including Shares as to which the Award would not otherwise be exercisable. In addition, the Administrator may provide that any Company repurchase option or forfeiture rights applicable to any Award shall lapse 100% , and that any Award vesting shall accelerate 100%, provided the proposed dissolution or liquidation takes place at the time and in the manner contemplated. To the extent it has not been previously exercised (with respect to Options and SARs) or vesting (with respect to other Awards), an Award will terminate immediately prior to the consummation of such proposed action.

          (c) Merger or Change in Control.

               (i) Options and SARs. In the event of a merger or Change in Control, each outstanding Option and SAR shall be assumed or an equivalent option or SAR substituted by the successor corporation or a Parent or Subsidiary of the successor corporation. In the event that the successor corporation refuses to assume or substitute for the Option or SAR, the Participant shall fully vest in and have the right to exercise the Option or SAR as to all of the Awarded Stock, including Shares as to which it would not otherwise be vested or exercisable. If an Option or SAR becomes fully vested and exercisable in lieu of assumption or substitution in the event of a merger or Change in Control, the Administrator shall notify the Participant in writing or electronically that the Option or SAR shall be fully vested and exercisable for a period of fifteen (15) days from the date of such notice, and the Option or SAR shall terminate upon the expiration of such period. For the purposes of this paragraph, the Option or SAR shall be considered assumed if, following the merger or Change in Control, the option or stock appreciation right confers the right to purchase or receive, for each Share of Awarded Stock subject to the Option or SAR immediately prior to the merger or Change in Control, the consideration (whether stock, cash, or other securities or property) received in the merger or Change in Control by holders of Common Stock for each Share held on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding Shares); provided, however, that if such consideration received in the merger or sale or assets is not solely common stock of the successor corporation or its Parent, the Administrator may, with the consent of the successor

15

corporation, provide for the consideration to be received upon the exercise of the Option or SAR, for each Share of Awarded Stock subject to the Option or SAR, to be solely common stock of the successor corporation or its Parent equal in fair market value to the per share consideration received by holders of Common Stock in the merger or Change in Control.

               (ii) Officer Adjustment. Officers subject to the short-swing profit restrictions of Applicable Laws may, in the Administrator’s sole discretion, be granted limited Stock Appreciation Rights in tandem with their outstanding Options. Upon the occurrence of a Hostile Take-Over, each outstanding Option with such a limited stock appreciation right in effect for at least six (6) months shall automatically be cancelled and the recipient shall in be entitled to a cash distribution from the Company in an amount equal to the excess of (a) the Take-Over Price of the Shares subject to the cancelled Option (whether or not such Shares are exercisable) over (b) the aggregate exercise price payable for such Shares. The cash distribution payable upon such cancellation shall be made within five (5) days following the consummation of the Hostile Take-Over. Neither the approval of the Administrator nor the consent of the Board shall be required in connection with such Option cancellation and cash distribution. The Shares subject to any Option cancelled for an appreciation distribution pursuant to this Section shall not be available for subsequent grant under the Plan.

               (iii) Hostile Take-Over. A Hostile Take-Over shall be deemed to occur in the event (a) any person or related group of persons (other than the Company or a person that directly or indirectly controls, is controlled by, or is under common control with, the Company) directly or indirectly acquires beneficial ownership (within the meaning of Rule 13d-3 of the Exchange Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Company’s outstanding securities pursuant to a tender or exchange offer which the Board does not recommend the Company’s stockholders to accept, and (b) more than fifty percent (50%) of the securities so acquired in such tender or exchange offer are accepted from holders other than Company Officers and Directors subject to the short-swing profit restrictions of Applicable Laws.

     The Take-Over Price per share shall be deemed to be equal to the greater of (a) the Fair Market Value per share on the date of cancellation, or (b) the highest reported price per share paid in effecting such Hostile Take-Over; provided, however, that if the cancelled option is an Incentive Stock Option, the Take-Over Price shall not exceed the Fair Market Value per share on the date of cancellation.

               (iv) Restricted Stock, Performance Shares, Performance Units and Deferred Stock Units. In the event of a merger or Change in Control, each outstanding Restricted Stock, Performance Share, Performance Unit and Deferred Stock Unit award shall be assumed or an equivalent Restricted Stock, Performance Share, Performance Unit and Deferred Stock Unit award substituted by the successor corporation or a Parent or Subsidiary of the successor corporation. In the event that the successor corporation refuses to assume or substitute for the Restricted Stock, Performance Share, Performance Unit or Deferred Stock Unit award, the Participant shall fully vest in the Restricted Stock, Performance Share, Performance Unit or Deferred Stock Unit including as to Shares (or with respect to Performance Units, the cash equivalent thereof) which would not otherwise be vested. For the purposes of this paragraph, a Restricted Stock, Performance Share, Performance Unit and Deferred Stock Unit award shall be considered assumed if, following the

16

merger or Change in Control, the award confers the right to purchase or receive, for each Share (or with respect to Performance Units, the cash equivalent thereof) subject to the Award immediately prior to the merger or Change in Control, the consideration (whether stock, cash, or other securities or property) received in the merger or Change in Control by holders of Common Stock for each Share held on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding Shares); provided, however, that if such consideration received in the merger or Change in Control is not solely common stock of the successor corporation or its Parent, the Administrator may, with the consent of the successor corporation, provide for the consideration to be received, for each Share and each unit/right to acquire a Share subject to the Award, to be solely common stock of the successor corporation or its Parent equal in fair market value to the per share consideration received by holders of Common Stock in the merger or Change in Control.

     17. Date of Grant. The date of grant of an Award shall be, for all purposes, the date on which the Administrator makes the determination granting such Award, or such other later date as is determined by the Administrator. Notice of the determination shall be provided to each recipient within a reasonable time after the date of such grant.

     18. Amendment and Termination of the Plan.

          (a) Amendment and Termination. The Board may at any time amend, alter, suspend or terminate the Plan.

          (b) Stockholder Approval. The Company shall obtain stockholder approval of any Plan amendment to the extent necessary and desirable to comply with Applicable Laws.

          (c) Effect of Amendment or Termination. No amendment, alteration, suspension or termination of the Plan shall impair the rights of any Participant, unless mutually agreed otherwise between the Participant and the Administrator, which agreement must be in writing and signed by the Participant and the Company. Termination of the Plan shall not affect the Administrator’s ability to exercise the powers granted to it hereunder with respect to Awards granted under the Plan prior to the date of such termination.

     19. Conditions Upon Issuance of Shares.

          (a) Legal Compliance. Shares shall not be issued pursuant to the exercise of an Award unless the exercise of the Award or the issuance and delivery of such Shares (or with respect to Performance Units, the cash equivalent thereof) shall comply with Applicable Laws and shall be further subject to the approval of counsel for the Company with respect to such compliance.

          (b) Investment Representations. As a condition to the exercise or receipt of an Award, the Company may require the person exercising or receiving such Award to represent and warrant at the time of any such exercise or receipt that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required.

     20. Inability to Obtain Authority. The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company’s counsel to be

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necessary to the lawful issuance and sale of any Shares hereunder (or with respect to Performance Units, the cash equivalent thereof), shall relieve the Company of any liability in respect of the failure to issue or sell such Shares (or with respect to Performance Units, the cash equivalent thereof) as to which such requisite authority shall not have been obtained.

     21. Reservation of Shares. The Company, during the term of this Plan, will at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan.

     22. Stockholder Approval. The Plan shall be subject to approval by the stockholders of the Company within twelve (12) months after the date the Plan is adopted by the Board. Such stockholder approval shall be obtained in the manner and to the degree required under Applicable Laws.

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EX-10.2

EXHIBIT 10.2

KOMAG, INCORPORATED

2005 TARGET INCENTIVE PLAN

TABLE OF CONTENTS

		Page
SECTION 1	BACKGROUND, PURPOSE AND DURATION		1
1.1	Effective Date		1
1.2	Purpose of the Plan		1
SECTION 2	DEFINITIONS		1
2.1	Affiliate		1
2.2	Award		1
2.3	Base Pay		1
2.4	Board		1
2.5	Committee		1
2.6	Company		1
2.7	Corporate Operating Income		1
2.8	Disability		2
2.9	Individual Modifier		2
2.10	Manager		2
2.11	Participant		2
2.12	Payout Percentage		2
2.13	Performance Period		2
2.14	Plan		2
2.15	Target Percentage		2
2.16	Termination of Service		2
SECTION 3	DETERMINATION OF AWARDS		3
3.1	Determination of Target Awards		3
3.2	Employment Status Affect on Award		4
SECTION 4	PAYMENT OF AWARDS		4
4.1	Funding of Plan		4
4.2	Timing of Payment		4
4.3	Form of Payment		4
SECTION 5	ADMINISTRATION		4
5.1	Committee		4
5.2	Committee Authority		5
5.3	Decisions Binding		5
5.4	Delegation by the Committee		5
SECTION 6	GENERAL PROVISIONS		5
6.1	Tax Withholding		5
6.2	No Effect on Employment or Service		5

-i-

TABLE OF CONTENTS
(Continued)

		Page
6.3	Successors		6
6.4	Nontransferability of Awards		6
SECTION 7	AMENDMENT, TERMINATION AND DURATION		6
7.1	Amendment, Suspension or Termination		6
7.2	Duration of the Plan		6
SECTION 8	LEGAL CONSTRUCTION		6
8.1	Gender and Number		6
8.2	Severability		7
8.3	Requirements of Law		7
8.4	Governing Law		7
8.5	Captions		7

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KOMAG, INCORPORATED
2005 TARGET INCENTIVE PLAN

SECTION 1
BACKGROUND, PURPOSE AND DURATION

1.1 Effective Date

     The Compensation Committee of the Board adopted the Plan effective as of January 31, 2005.

1.2 Purpose of the Plan

     The Plan is intended to align each management employee of the Company towards a single financial target which will result in a competitive cash bonus payment for each such employee as a reward for each employee’s personal contributions to the Company’s consolidated financial performance.

SECTION 2
DEFINITIONS

     The following words and phrases shall have the following meanings unless a different meaning is plainly required by the context:

2.1 “Affiliate” means any corporation or other entity (including, but not limited to, partnerships and joint ventures) controlled by the Company.

2.2 “Award” means the actual award (if any) payable to a Participant as determined pursuant to Section 3.

2.3 “Base Pay” means base straight time gross earnings earned by the Participant for the Performance Period but exclusive of overtime, premium pay, stock compensation, relocation payments, or any other bonus or incentive awards or payments.

2.4 “Board” means the Board of Directors of the Company.

2.5 “Committee” means the committee appointed by the Board to administer the Plan. Until otherwise determined by the Board, the Compensation Committee of the Board shall constitute the Committee.

2.6 “Company” means Komag Incorporated, a Delaware corporation, or any successor thereto.

2.7 “Corporate Operating Income” means the annual net sales of the Company during the Performance Period, less (A)(i) the cost of goods sold, (ii) research and development expenses, (iii) selling, general and administrative expenses. The Committee will determine annually any adjustments, plus (or minus), to Corporate Operating Income including, but not limited to, any gains

(or losses) with respect to the disposal of assets, non-cash employee stock compensation expense, restructuring, impairment, and foreign currency adjustments.

2.8 “Disability” means a permanent and total disability determined in accordance with uniform and nondiscriminatory standards adopted by the Committee from time to time.

2.9 “Individual Modifier” means the Participant’s actual individual performance as measured against certain objectives, as established for a Participant by his or her Manager, as well as the demonstration of key job attributes and competencies in achieving those objectives. Eighty percent (80%) of the Individual Modifier will be based on the achievement of a Participant’s performance objectives for a Performance Period and twenty percent (20%) of the Individual Modifier will be based on the demonstration of key attributes and competencies in achieving those objectives as determined by a Participant’s Manager. The Individual Modifier may range between 0% and 150%.

2.10 “Manager” means a Participant’s manager or the person whom the Participant reports for the Performance Period. For these purposes, the Company’s Chief Executive Officer (“CEO”) reports to the Committee.

2.11 “Participant” means as to any Performance Period, all exempt employees in grade E06 and above who are employed by the Company on the date Awards are paid and are in good standing with the Company (i.e., not on a performance management plan).

2.12 “Payout Percentage” means the percentage of actual Corporate Operating Income versus the target Corporate Operating Income for Performance Period as determined by the Committee. In no event may the Payout Percentage exceed 149%. The target Corporate Operating Income for the Performance Period will be approved annually by the Company’s Board of Directors.

2.13 “Performance Period” means the Company’s annual fiscal periods commencing after December 31, 2004 during which the measurement of the Corporate Operating Income targets and Individual Modifiers must be met as set forth herein to receive an Award.

2.14 “Plan” means the Komag, Incorporated 2005 Target Incentive Plan, as set forth in this instrument and as hereafter amended from time to time.

2.15 “Target Percentage” means a Participant’s incentive target as a percentage of Base Pay as follows: CEO (80%), officers (40% — 50%, as determined by the Committee), other Participants (15% - 25%, as determined by the Committee).

2.16 “Termination of Service” means a cessation of the employee-employer relationship between a Participant and the Company or an Affiliate for any reason, including, but not by way of limitation, a termination by resignation, discharge, death, Disability, retirement, or the disaffiliation of an Affiliate, but excluding any such termination where there is a simultaneous reemployment by the Company or an Affiliate.

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SECTION 3
DETERMINATION OF AWARDS

3.1 Determination of Target Awards

     At the end of the Performance Period, the Corporate Operating Income will be reviewed and used to determine the aggregate bonus pool from which Awards will be made as set forth in Section 4.1. The total amount of all Awards may not exceed the total bonus pool.

     Subject to the provisions of Section 3, Participants are eligible to receive an Award for the Performance Period equal to such Participant’s Base Pay for the Performance Period multiplied by the Payout Percentage multiplied by the Participant’s Individual Modifier multiplied by the Participant’s Target Percentage (the “Annual Award”). The Annual Award for a Participant who receives a Mid-Year Award (discussed below) will be reduced by the amount of such Mid-Year Award.

     In the event the Payout Percentage is less than 60%, no Annual Award shall be paid to any Participants under this Plan. If the Payout Percentage for the Performance Period is equal to or greater than 60% but less than 80%, then Annual Awards will not be provided pursuant to the formula in the preceding paragraph, but will instead be allocated on a discretionary basis to certain top performers of the Company as determined by the Committee.

     During the Performance Period, the Committee will determine whether to pay a portion of the Annual Award (the “Mid-Year Award”). The Committee will determine the financial target necessary to receive the Mid-Year Award, the Participants eligible to receive a Mid-Year Award, and the level of the Mid-Year Award compared to the Annual Award.

     Final Annual Award recommendations may be modified by a Participant’s Manager to reflect the bonus pool allocated to such Participant’s department within the Company. A Manager must submit a final Award recommendation for each Participant under such Manager’s supervision based on his or her Individual Modifier within the limit of the total bonus pool. A Manager may petition the CEO, or, if applicable, the Committee, for extra funds in the event the bonus pool allocated to such Manager’s department is insufficient to reward the extraordinary performance of a Participant.

     If a Participant transfers or is assigned to a different position during the Performance Period, which would result in the application of a different Target Percentage, the Participant’s Target Percentage will be pro-rated based on the number of full months a particular Target Percentage applied to such Participant. If a Target Percentage applies to a Participant for a partial month, the higher Target Percentage will apply for the entire month.

     If a Participant enters the Plan from the Company’s 2005 Bonus Plan or enters this Plan as a new hire after the beginning of the Performance Period, his or her Award will be pro-rated based on the number of full months such Participant became eligible to receive an Award under the Plan. If a Participant becomes eligible to receive an Award under this Plan for a partial month, he or she will be credited for the entire month.

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3.2 Employment Status Affect on Award

     Except as provided below, if a Participant’s Termination of Service occurs prior to the payment of an Award, no Award shall be made to such Participant. In the event of a Participant’s leave of absence from the Company during the Performance Period, or upon an involuntary termination of the Participant due to death, Disability or the elimination of the Participant’s position, the Participant shall receive a prorated Award for the period of employment during the Performance Period.

     If following a Participant’s Termination of Service for any reason it is determined by the Company that the Participant acted in a manner which is or was detrimental to the business of the Company within the six-months period following the Participant’s termination date, the Participant may be required to refund any Awards paid to such Participant during the six-month period prior to such termination.

SECTION 4
PAYMENT OF AWARDS

4.1 Funding of Plan

     At the beginning of the Performance Period, the CEO will recommend to the Committee the measures and goals to be used in determining the amount of money to be reserved for the payment of Awards under the Plan.

     Each Award shall be paid solely from the general assets of the Company. Nothing in this Plan shall be construed to create a trust or to establish or evidence any Participant’s claim of any right other than as an unsecured general creditor with respect to any payment to which he or she may be entitled.

4.2 Timing of Payment

     Payment of each Mid-Year Award or Annual Award, as applicable, shall be made as soon as practicable as determined by the Committee after the end of the period during which the Award was earned. Unless otherwise determined by the Committee, a Participant must be employed by the Company or any Affiliate on the date an Award is actually paid to receive such Award.

4.3 Form of Payment

     Each Award shall be paid in cash (or its equivalent) in a single lump sum.

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SECTION 5
ADMINISTRATION

5.1 Committee

     The Plan shall be administered under the authority and subject to the approval of the Committee. The Committee shall approve the total of all Awards made under the Plan. The Vice President of Human Resources of the Company (or such other person as designated by the Committee) shall be responsible for the preparation and coordination of all pertinent Performance Period and Award information.

5.2 Committee Authority

     It shall be the duty of the Committee to administer the Plan in accordance with the Plan’s provisions. The Committee shall have all powers and discretion necessary or appropriate to administer the Plan and to control its operation, including, but not limited to, the power to (a) prescribe the terms and conditions of awards, (b) interpret the Plan and the Awards, (c) adopt rules for the administration, interpretation and application of the Plan as are consistent therewith, and (d) interpret, amend or revoke any such rules.

5.3 Decisions Binding

     All determinations and decisions made by the Committee and any delegate of the Committee pursuant to the provisions of the Plan shall be final, conclusive, and binding on all persons, and shall be given the maximum deference permitted by law.

5.4 Delegation by the Committee

     The Committee, in its sole discretion and on such terms and conditions as it may provide, may delegate all or part of its authority and powers under the Plan to one or more directors and/or officers of the Company.

SECTION 6
GENERAL PROVISIONS

6.1 Tax Withholding

     The Company shall withhold all applicable taxes from any Award, including any federal, state and local taxes (including, but not limited to, the Participant’s FICA and SDI obligations).

6.2 No Effect on Employment or Service

     Nothing in the Plan shall interfere with or limit in any way the right of the Company to terminate any Participant’s employment or service at any time, with or without cause. For purposes of the Plan, transfer of employment of a Participant between the Company and any one of its Affiliates (or between Affiliates) shall not be deemed a Termination of Service. Employment with

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the Company and its Affiliates is on an at-will basis only. The Company expressly reserves the right, which may be exercised at any time and without regard to when during a Performance Period such exercise occurs, to terminate any individual’s employment with or without cause, and to treat him or her without regard to the effect that such treatment might have upon him or her as a Participant.

6.3 Successors

     All obligations of the Company under the Plan, with respect to awards granted hereunder, shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation, or otherwise, of all or substantially all of the business or assets of the Company.

6.4 Nontransferability of Awards

     No Award granted under the Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will, by the laws of descent and distribution, or to the limited extent provided in Section 4.4. All rights with respect to an Award granted to a Participant shall be available during his or her lifetime only to the Participant.

SECTION 7
AMENDMENT, TERMINATION AND DURATION

7.1 Amendment, Suspension or Termination

     The Company may amend or terminate the Plan, or any part thereof, at any time and for any reason.

7.2 Duration of the Plan

     The Plan shall commence on the date herein, and subject to Section 7.1 (regarding the Company’s right to amend or terminate the Plan), shall remain in effect thereafter.

SECTION 8
LEGAL CONSTRUCTION

8.1 Gender and Number

     Except where otherwise indicated by the context, any masculine term used herein also shall include the feminine; the plural shall include the singular and the singular shall include the plural.

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8.2 Severability

     In the event any provision of the Plan shall be held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included.

8.3 Requirements of Law

     The granting of awards under the Plan shall be subject to all applicable laws, rules and regulations, and to such approvals by any governmental agencies or national securities exchanges as may be required.

8.4 Governing Law

     The Plan and all awards shall be construed in accordance with and governed by the laws of the State of California, but without regard to its conflict of law provisions.

8.5 Captions

     Captions are provided herein for convenience only, and shall not serve as a basis for interpretation or construction of the Plan.

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EX-10.3

EXHIBIT 10.3

EXECUTIVE RETENTION AGREEMENT

     On May 14, 2002, the United States Bankruptcy Court for the Northern District of California entered an order confirming the “Debtor’s Further Modified First Amended Plan of Reorganization, Dated May 7, 2002” (the “Plan”), which provides for a reorganization (the “Reorganization”) of Komag, Inc., a Delaware corporation (the “Company”). The Plan became effective by its terms on June 30, 2002. This Agreement was originally entered into as of July 17, 2002 and is currently being reinstated as of May 4, 2005 (the “Effective Date”) by and between the Company and William Hammack (“Executive”). The purpose of this Agreement is to provide Executive with an incentive to remain employed as a key executive of the Company following the Reorganization.

     1. Duties and Scope of Employment.

          (a) Positions and Duties. As of the Effective Date, Executive will continue to serve as Vice President, Human Resources of the Company. Executive will render such business and professional services in the performance of his duties, consistent with Executive’s position within the Company, as shall reasonably be assigned to him by the Company’s Board of Directors (the “Board”). The period of Executive’s employment under this Agreement is referred to herein as the “Employment Term.”

          (b) Obligations. During the Employment Term, Executive will perform his duties faithfully and to the best of his ability and will devote his full business efforts and time to the Company. For the duration of the Employment Term, Executive agrees not to actively engage in any other employment, occupation or consulting activity for any direct or indirect remuneration without the prior approval of the Board.

          (c) Conflicting Employment. Executive agrees that, while employed by the Company, he will not engage in any other employment, occupation, consulting or other business activity directly related to the business in which the Company is now involved or becomes involved during the term of Executive’s employment, nor will Executive engage in any other activities that conflict with Executive’s obligations to the Company.

     2. Term. Executive’s employment with the Company commenced on March 14, 2005, and shall continue, unless otherwise terminated earlier pursuant to the terms of this Agreement, through July 16, 2005. After July 16, 2005, the parties agree that Executive’s employment with the Company will be “at-will” employment and may be terminated at any time with or without cause or notice.

     3. Compensation.

          (a) Base Salary. During the Employment Term, the Company will pay Executive as compensation for his services a base salary at the annualized rate of $187,554 (the “Base Salary”). The Base Salary will be paid periodically in accordance with the Company’s normal payroll practices and may be subject to annual adjustments by the Company after comparison of market data with similarly-situated companies.

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          (b) Retention Bonus Plan. Following Executive’s employment date, Executive will be eligible to participate in the Company’s Retention Bonus Plan.

     4. Employee Benefits. During the Employment Term, Executive will continue to be entitled to participate in the employee benefit plans currently and hereafter maintained by the Company of general applicability to other senior executives of the Company, including, without limitation, the Company’s group medical, dental, vision, disability, life insurance, vacation and flexible-spending account plans and programs. The Company reserves the right to cancel or change the benefit plans and programs it offers to its employees at any time.

     5. Severance.

          (a) Involuntary Termination. If Executive’s employment with the Company terminates other than voluntarily or for “Cause” (as defined herein), and Executive signs and does not revoke a standard release of claims with the Company, then Executive shall be entitled to receive a lump-sum severance payment (the “Severance Payment”) equal to (A) x (B), where (A) = 2.99 and (B) = the sum of (i) Executive’s annualized Base Salary rate, as then in effect, (ii) all of Executive’s expected bonus payments to be made during the year in which the termination occurs, if any, and (iii) the annualized value of Executive’s benefits package with the Company as determined by the Company in its reasonable discretion. The Severance Payment shall be made in a single lump sum within thirty (30) days of termination. Notwithstanding the foregoing, the Company shall not be obligated to make any payments pursuant to this Section 5(a) unless and until Executive has delivered to the Company an executed release of all claims he or she has or may have against the Company, in form and substance satisfactory to the Company.

          (b) Voluntary Termination; Termination for Cause. If Executive’s employment with the Company terminates voluntarily by Executive or for Cause by the Company, then (i) all vesting of any options to purchase shares of the Company’s common stock held by Executive will terminate immediately and all payments of compensation by the Company to Executive hereunder will terminate immediately (except as to amounts already earned), and (ii) Executive will only be eligible for severance or other benefits in accordance with the Company’s established plans or policies as then in effect.

     6. Change of Control Benefits. In the event of a “Change of Control” (as defined herein) followed by Executive’s termination other than voluntarily or for “Cause” within six (6) months of the consummation of a Change of Control Transaction, Executive shall be entitled to receive the Severance Payment within thirty (30) days of such termination. For the purpose of this Section 6, Executive shall be deemed to have been terminated other than for “Cause” if Executive is not provided with an offer of comparable employment with the Company or successor entity following the Change of Control with comparable duties, position and responsibilities relative to the Executive’s duties, position and responsibilities in effect immediately prior to such Change of Control. Notwithstanding the foregoing, if Executive receives the Severance Payment pursuant to this Section, he shall not be entitled to receive an additional Severance Payment pursuant to Section 5 hereof.

     7. Non-Solicitation. For a period of twelve (12) months following Executive’s termination of employment, Executive shall not, directly or

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indirectly, without the prior written consent of Parent, solicit, encourage or take any other action which is intended to induce or encourage any employee or customer of Parent or its subsidiaries to terminate his or her employment with or customer relationship to Parent or its subsidiaries.

     8. Definitions.

          (a) Cause. For purposes of this Agreement, “Cause” is defined as (i) an act of dishonesty made by Executive in connection with Executive’s responsibilities as an employee, (ii) Executive’s conviction of, or plea of nolo contendere to, a felony, (iii) Executive’s gross misconduct, or (iv) Executive’s continued substantial violations of his employment duties after Executive has received a written demand for performance from the Company which specifically sets forth the factual basis for the Company’s belief that Executive has not substantially performed his duties.

          (b) Change of Control. For purposes of this Agreement, “Change of Control” of the Company is defined as: (i) any “person” (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) is or becomes the “beneficial owner” (as defined in Rule 13d-3 under said Act), directly or indirectly, of securities of the Company representing 50% or more of the total voting power represented by the Company’s then outstanding voting securities; or (ii) the date of the consummation of a merger or consolidation of the Company with any other corporation that has been approved by the stockholders of the Company, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or the stockholders of the Company approve a plan of complete liquidation of the Company; or (iii) the date of the consummation of the sale or disposition by the Company of all or substantially all the Company’s assets.

     9. Assignment. This Agreement will be binding upon and inure to the benefit of (a) the heirs, executors and legal representatives of Executive upon Executive’s death and (b) any successor of the Company. Any such successor of the Company will be deemed substituted for the Company under the terms of this Agreement for all purposes. For this purpose, “successor” means any person, firm, corporation or other business entity which at any time, whether by purchase, merger or otherwise, directly or indirectly acquires all or substantially all of the assets or business of the Company. None of the rights of Executive to receive any form of compensation payable pursuant to this Agreement may be assigned or transferred except by will or the laws of descent and distribution. Any other attempted assignment, transfer, conveyance or other disposition of Executive’s right to compensation or other benefits will be null and void.

     10. Notices. All notices, requests, demands and other communications called for hereunder shall be in writing and shall be deemed given (i) on the date of delivery if delivered personally, (ii) one (1) day after being sent by a well established commercial overnight service, or (iii) four (4) days after being mailed by registered or certified mail, return receipt requested, prepaid and addressed to the parties or their successors at the following addresses, or at such other addresses as the parties may later designate in writing:

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If to the Company:
Komag, Inc.
1710 Automation Parkway
San Jose, California 95131
Attn: Chief Financial Officer

If to Executive:
William Hammack

     11. Severability. In the event that any provision hereof becomes or is declared by a court of competent jurisdiction to be illegal, unenforceable or void, this Agreement will continue in full force and effect without said provision.

     12. Arbitration.

          (a) General. In consideration of Executive’s service to the Company, its promise to arbitrate all employment related disputes and Executive’s receipt of the compensation, pay raises and other benefits paid to Executive by the Company, at present and in the future, Executive agrees that any and all controversies, claims, or disputes with anyone (including the Company and any employee, officer, director, shareholder or benefit plan of the Company in their capacity as such or otherwise) arising out of, relating to, or resulting from Executive’s service to the Company under this Agreement or otherwise or the termination of Executive’s service with the Company, including any breach of this Agreement, shall be subject to binding arbitration under the Arbitration Rules set forth in California Code of Civil Procedure Section 1280 through 1294.2, including Section 1283.05 (the “RULES”) and pursuant to California law. Disputes which Executive agrees to arbitrate, and thereby agrees to waive any right to a trial by jury, include any statutory claims under state or federal law, including, but not limited to, claims under Title VII of the Civil Rights Act of 1964, the Americans with Disabilities Act of 1990, the Age Discrimination in Employment Act of 1967, the Older Workers Benefit Protection Act, the California Fair Employment and Housing Act, the California Labor Code, claims of harassment, discrimination or wrongful termination and any statutory claims. Executive further understands that this Agreement to arbitrate also applies to any disputes that the Company may have with Executive.

          (b) Procedure. Executive agrees that any arbitration will be administered by the American Arbitration Association (“AAA”) and that a neutral arbitrator will be selected in a manner consistent with its National Rules for the Resolution of Employment Disputes. The arbitration proceedings will allow for discovery according to the rules set forth in the National Rules for the Resolution of Employment Disputes or California Code of Civil Procedure. Executive agrees that the arbitrator shall have the power to decide any motions brought by any party to the arbitration, including motions for summary judgment and/or adjudication and motions to dismiss and demurrers, prior to any arbitration hearing. Executive agrees that the arbitrator shall issue a written decision on the merits. Executive also agrees that the arbitrator shall have the power to award any remedies, including attorneys’ fees and costs, available under applicable law. Executive understands the Company will pay for any administrative or hearing fees charged by the arbitrator or AAA except that Executive shall pay the first $200.00 of any filing fees associated with any arbitration Executive initiates. Executive agrees that the arbitrator shall administer and conduct any arbitration in a manner consistent with the Rules

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and that to the extent that the AAA’s National Rules for the Resolution of Employment Disputes conflict with the Rules, the Rules shall take precedence.

          (c) Remedy. Except as provided by the Rules, arbitration shall be the sole, exclusive and final remedy for any dispute between Executive and the Company. Accordingly, except as provided for by the Rules, neither Executive nor the Company will be permitted to pursue court action regarding claims that are subject to arbitration. Notwithstanding, the arbitrator will not have the authority to disregard or refuse to enforce any lawful Company policy, and the arbitrator shall not order or require the Company to adopt a policy not otherwise required by law which the Company has not adopted.

          (d) Availability of Injunctive Relief. In addition to the right under the Rules to petition the court for provisional relief, Executive agrees that any party may also petition the court for injunctive relief where either party alleges or claims a violation of this Agreement or the Confidentiality Agreement or any other agreement regarding trade secrets, confidential information, nonsolicitation or Labor Code Section 2870. In the event either party seeks injunctive relief, the prevailing party shall be entitled to recover reasonable costs and attorneys fees.

          (e) Administrative Relief. Executive understands that this Agreement does not prohibit Executive from pursuing an administrative claim with a local, state or federal administrative body such as the Department of Fair Employment and Housing, the Equal Employment Opportunity Commission or the workers’ compensation board. This Agreement does, however, preclude Executive from pursuing court action regarding any such claim.

          (f) Voluntary Nature of Agreement. Executive acknowledges and agrees that Executive is executing this Agreement voluntarily and without any duress or undue influence by the Company or anyone else. Executive further acknowledges and agrees that Executive has carefully read this Agreement and that Executive has asked any questions needed for Executive to understand the terms, consequences and binding effect of this Agreement and fully understand it, including that Executive is waiving Executive’s right to a jury trial. Finally, Executive agrees that Executive has been provided an opportunity to seek the advice of an attorney of Executive’s choice before signing this Agreement.

     13. Existing Agreements. This Agreement does not supersede and replace any prior severance or retention plans or agreements that Executive may have entered into with the Company prior to the Effective Date (the “Existing Agreements”).

     14. Integration. This Agreement, together with any Existing Agreements, represents the entire agreement and understanding between the parties as to the subject matter herein and supersedes all prior or contemporaneous agreements whether written or oral. No waiver, alteration, or modification of any of the provisions of this Agreement will be binding unless in writing and signed by duly authorized representatives of the parties hereto.

     15. Tax Withholding. All payments made pursuant to this Agreement will be subject to withholding of applicable taxes.

     16. Governing Law. This Agreement will be governed by the laws of the State of California (with the exception of its conflict of laws provisions).

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     17. Acknowledgment. Executive acknowledges that he has had the opportunity to discuss this matter with and obtain advice from his private attorney, has had sufficient time to, and has carefully read and fully understands all the provisions of this Agreement, and is knowingly and voluntarily entering into this Agreement.

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     IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the case of the Company by their duly authorized officers, as of the day and year first above written.

COMPANY:

KOMAG, INC.
By:	Date:
Title: Chief Executive Officer
EXECUTIVE:
	Date:
William Hammack

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EX-31.1

Exhibit 31.1

RULE 13a – 14 (a) CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Thian Hoo Tan, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Komag, Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements and other financial information included in this report fairly present, in all material respects, the financial condition and results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15(e) and 15d - 15(e)) and internal control over financial reporting (as defined in Exchange Act rules 13a – 15 (f) and 15d – 15 (f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

DATE: May 6, 2005	BY: /s/ Thian Hoo Tan
	Thian Hoo Tan
	Chief Executive Officer

EX-31.2

Exhibit 31.2

RULE 13a – 14 (a) CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Kathleen A. Bayless, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Komag, Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements and other financial information included in this report fairly present, in all material respects, the financial condition and results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15(e) and 15d - 15(e)) and internal control over financial reporting (as defined in Exchange Act rules 13a – 15 (f) and 15d – 15 (f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

DATE: May 6, 2005	BY: /s/ Kathleen A. Bayless
	Kathleen A. Bayless
	Chief Financial Officer

EX-32

Exhibit 32

SECTION 1350 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

     I, Thian Hoo Tan, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Komag, Incorporated on Form 10-Q for the quarterly period ended April 3, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Form 10-Q fairly presents in all material respects the financial condition and results of operations of Komag, Incorporated.

BY: /s/ Thian Hoo Tan  

Thian Hoo Tan 

Chief Executive Officer 

     I, Kathleen A. Bayless, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Komag, Incorporated on Form 10-Q for the quarterly period ended April 3, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such 10-Q fairly presents in all material respects the financial condition and results of operations of Komag, Incorporated.

BY: /s/ Kathleen A. Bayless  

Kathleen A. Bayless 

Chief Financial Officer 

     This certification accompanies this Report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by such Act, be deemed filed by Komag, Incorporated for purposes of Section 18 of the Security Exchange Act of 1934, as amended. A signed original of this written statement required by Section 906 has been provided to Komag, Incorporated and will be retained by Komag, Incorporated and furnished to the Securities and Exchange Commission or its staff upon request.