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Tickers in this Article: KOMG, WDC, STX, HIT, MSFT
Shares of Komag Inc. (Nasdaq: KOMG) suffered a 15% one-day pasting last week when company management issued a tersely worded press release hinting that the company needed a drastic downward revision in its sales and earnings outlook for the upcoming quarter, and possibly the rest of the year.

The news blindsided many analysts covering stock as the company had only just provided a detailed set of guidance numbers at the end of April.

The previous outlook had called for sales to be down 8% to 10% in the second quarter, which is generally inline with the seasonal slowdown during that time, and net margins to also be down in the 8% to 10% range. Now, it looks like those numbers were too optimistic.

So, why the about-face by management? The hastily drafted press release cited "market pressures" as the cause of the revision in outlook. Translated into layman's terms, that suggests that both unit volumes and average selling prices are going to be lower than expected.

Komag is in the business of making one of the principal components (the thin film disks) that go into making hard drives. Its sales are almost equally split between the three biggest hard drive makers; Western Digital (NYSE: WDC), Seagate Technology (NYSE: STX) and Hitachi (NYSE: HIT).

Tough Times Ahead for Hard Disk Industry
Right now, these finished-product producers are facing sluggish demand, in part due to the slower than expected take-up of new PCs sporting Microsoft's (Nasdaq: MSFT) memory gobbling Vista operating system. This couldn't come at a worse time as the industry is poised to expand production capacity dramatically this year. While production capacity is expected to jump 25% this year, unit sales are only expected to go up 10%.

For operators lower down the supply chain like Komag that spells big trouble. The impending glut of hard disks implies drastically lower selling prices for finished unit makers. The unit makers, in turn, are likely to push back hard on component makers like Komag who'll likely take a double-whammy hit of both lower unit sales and lower prices.


Negative Sentiment Should Keep Shares in Check
As temping as it may be to buy Komag after the sell-off, don't do it. As is typical in situations where management is assumed to have been a bit less than totally forthcoming, and the analysts covering the stock have all registered their disappointment by unanimously knocking back their earnings forecast for this year and next. In the face of such negative sentiment, and the worsening industry conditions, it's unlikely that the stock will be able to recover over the next couple of quarters.

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