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Executives

Bob Blair – Investor Relations

John Coyne – President and CEO

Tim Leyden – Chief Operating Officer

Wolfgang Nickl – Chief Financial Officer

Analysts

Rich Kugele – Needham & Company

Aaron Rakers – Stifel Nicolaus

Sherri Scribner – Deutsche Bank

Keith Bachman – Bank of Montreal

Ben Reitzes – Barclays Capital

Nehal Chokshi – Technology Insights Research

Rob Cihra – Caris & Company

Mark Miller – Noble Financial

Kaushik Roy – Wedbush

Ananda Baruah – Brean Murray

Mark Moskowitz – J.P. Morgan

Western Digital Corp. (WDC) F1Q2011 Earnings Call October 19, 2010 5:00 PM ET

Operator

Good afternoon and thank you for standing by. Welcome to Western Digital’s First Quarter Financial Results for fiscal year 2011. Presently, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

As a reminder, this call is being recorded. Now, I will turn the call over to Mr. Bob Blair. You may begin.

Bob Blair

Thank you. I want to mention as we begin that we will be making forward-looking statements in our comments and in response to your questions concerning the role in growth of digital content, growth opportunities for storage companies and our responses there too, industry inventory, pricing and demand, our business model, our position in the industry, total available market for hard drives in the December quarter, our expected capital expenditures, depreciation and amortization and tax rate for fiscal 2011, our share repurchase plans, and our financial results, expectations for the December quarter, including revenue, expenses, tax rate, share count and earnings per share.

These forward-looking statements are based on management’s current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including those listed in our 10-K filed with the SEC on August 13, 2010. We undertake no obligation to update our forward-looking statements to reflect new information or events and you should not assume later in the quarter that the comments we make today are still valid.

I also want to note that copies of remarks from today’s call will be available on the Investor section of Western Digital’s website immediately following the conclusion of this call.

I would now like to turn the call over to President and Chief Executive Officer of Western Digital, John Coyne.

John Coyne

Thank you, Bob. Good afternoon and thank you for joining us today. With me are Tim Leyden, recently named Chief Operating Officer; and Wolfgang Nickl, our newly appointed Chief Financial Officer. Although my titles of President and CEO are unchanged, my emphasis has shifted to how we can best leverage our resources to accelerate our growth in the years ahead.

As the new leader of all WD operations and keeper of our low cost model, Tim will discuss current industry dynamics and the company’s performance in the September quarter. While Wolfgang will report on our financial results and provide our outlook for the December quarter.

With the advantage of the deeply experienced dedicated and passionate team we are excited as we lead WD into its fifth decade. As we look out over the next 10 years, the role of digital content in our daily lives at home and in the workplace will become increasingly ubiquitous with the explosion of data and video rich applications creating huge amounts of digital content that need to be stored and managed.

This will be driven by both the traditional computing markets and by new or evolutionary platforms such as hand held devices, television and other home entertainment devices for the analog to digital conversion is in its infancy.

In addition to the continuing growth of traditional PC platforms, the growth of cloud computing, tablet computing and the proliferation of smartphones creates myriad opportunities for storage companies and traditional hard drive and emerging solid state drive markets.

We will shape the future of WD by sorting through all of these opportunities and acting decisively in our core business and in our business development efforts to continue delivering value to customers and shareholders. You have seen some early indications of one new strategic direction for WD into the movement of data and content around the home, with our WD TV Live HD Media Players, our WD My Book Live Network Storage Solutions and most recently our WD Livewire Powerline Network offering.

Going forward, we are looking for ways in which to pursue strategic growth initiatives such as these both organically and through acquisition.

Turning to the current hard drive industry environment, we are again reminded that this is a competitive industry of seasons and cycles. The management of supply and demand remains an imperfect science. The moderation and industry demand growth in the last two quarters came on the heels of an unprecedented four quarters of strong sequential growth coming out of the great recession.

As an industry we purely overshot the recent market demand and we’ve spent the last six months correcting for that. We believe this will prove to be an interlude to the resumption of the industries traditional cadence of growth over the last 10 years.

Having said this, it’s important to note that growth has not disappeared in the hard drive industry post-recession. Expected year-on-year volume growth and calendar year 2010 of 15% brings the five-year industry compound growth rate, which includes the recession of late 2008 to about 11%, while the average growth rate over the last 10 years has been 12.5%.

In the last two quarters, some competitors have made aggressive bids to recover market share. This is a scenario we have seen play out from time-to-time over the years in the drive industry. Our observation is that these are temporary skirmishes, which do not derail our fundamental long-term profitable growth story as we address these challenges with a tested business model we have developed and honed overtime.

For the last 10 years, WD has been navigating these industry swings and consistently winning share with our focus on customer value by having the lowest cost model in the industry. We have grown revenues by 18% annually over the past 10 years and by 22% annually for the past five years, by providing exceptional value to our customers through the high quality, reliability and desirability of our products along with predictable availability and competitive prices.

At the same time, we have expanded our full year gross margins from 11% in 2001 to 24% in 2010. This was accomplished primarily through successful vertical integration, expanding our product breath, delighting our customers and execution of our low cost model. We will continue with this approach as we go forward.

Tim Leyden will now comment on how the September quarter played out for WD and the industry.

Tim Leyden

Thank you. As John indicated we have navigated through most of the market driven supply demand imbalances in the hard drive industry and WD remains prepared to address them with what we believe is the industry’s lowest cost market.

Continuing our unwavering focus on low cost leadership is my top priority in my new position. Encompass with a focus on staying on the industry area inventory curve and continued depreciation of customer needs and a broad and diverse set of competitive product offerings in all segments will keep us in an advantage position. This proven approach to the hard drive business has served us, our customers and our shareholders well over the last 10 years.

As John mentioned earlier, we saw an increase into four consecutive quarters of increasing hard drive shipments from April 2009 to March 2010 and it is now apparent that we have been experiencing correction of PC maker inventories beginning in the June quarter of this year. Despite weak demand for the first two months of the September quarter and a quieter than normal back-to-school season, industry shipments nevertheless climb towards the high-end of our 165 million unit forecast for the September quarter. But to accomplish this, shipment volumes in week 13 were over twice the average of previous weeks.

In light of the sluggish demand in July and August, we reduced our bill plans for September, delayed our capital spending and selectively stepped back from participating in some very aggressive pricing at the end of the quarter.

Lower than expected demand early in the quarter led to a buildup of manufactures inventory during the first eight weeks of quarter and contrary to prior fiscal first quarter historical trends, it contributed to aggressive pricing during the remainder of the quarter.

We maintain shares in the 3.5-inch market and uses 1.5 points per share in 2.5-inch as a result of our temporary pullback. We exited the quarter with well controlled inventories in each of our segments. We expect that the instrumental parts of the week 13 shipments will be consumed during the current quarter because customers will not wish to carry this inventory into a seasonally weaker March quarter and we believe this set the stage for a TAM in the December quarter that will be essentially flat with the September quarter.

We believe that HDD hardware and software are pivotal to the data and content management infrastructure ecosystem. The value delivered is not proportional to your reward in the broader marketplace. Particularly in the level of unique skills and investments in technology and capital are taken into consideration.

Consequently, we are in the midst of reviewing the comparative returns on investments that we are currently achieving across our customer and product ranges, with a view to reaching the levels of ROI we need in order to continue investing and provide a product availability that the market demands.

As the industry’s low cost provider, we believe that it is in the best interest of our customers and shareholders that we offer products at a price that cover the cost of doing business and provides the margin and the funding required to continue investing in all that remain a valued HDD supplier on a long-term sustainable basis.

Looking at our third markets in the September quarter, in the compute space we saw continuation of softness in consumer demand in all channels, with somewhat of an offset coming from healthier desktops and commercial notebook demand. We expect desktop demand to be marginally down and notebook demand to be marginally up in the December quarter.

In the enterprise segment, we saw continued demand strength particularly in enterprise data with the traditional enterprise segment been essentially flat sequentially. We expect overall enterprise demand to show us some modest growth in the December quarter.

In a non-compute space, we saw the CE market volumes decline marginally quarter-on-quarter as the market try to start a seasonal demand pattern. At the same time the branded products market showed seasonal demand strength for both 3.5-inch and 2.5-inch categories showing growth.

We expect the non-compute space to be essentially flat in the December quarter. I can see volume increases in branded and CE are offset by the seasonal decline in gaining volume. Geographically, Asia has showed continued strength, Europe showed the best comparative improvement from the previous quarter helped by the currency appreciation, while the U.S. market is up modestly from the prior quarter.

We shipped 50.7 million units in the September quarter up 15% from the year ago period, while the overall market grew by 8%. Revenues totaled $2.4 billion, gross margin was 18.2%, we remain solidly profitable with net income of $197 million. Importantly, we continue to generate strong cash flow from operations of $390 million.

We continue to invest in the business and are doing so by improving and expanding our operations and by enhancing our product line up, both in our industry leading hard drive offerings and in the nascent the promising market for management of content in the home.

In our traditional businesses, we deliver new models of our popular My Book and My Passport external hard drives with USB 3 connectivity and up to the 3 terabytes of storage. Significantly improving content transfer speed and providing our customers with future proofing as newer PCs and other devices begin shipping in volume with USB 3.

And in the component space we began shipping the highest area of entity 3.5-inch hard drive in the industry. The WD Caviar Green 3 terabytes which fits 750 gigabytes on each of its forefathers, reflecting our increasing focus on enabling a comprehensive and easy-to-use experience for management of content in the home, we have added several new products and features, including the WD Livewire Powerline AV Network Kit, a home AV compatible solution that enables consumers to use their existing electrical wiring for extent secure high-speed internet connection throughout the home.

My Book Live Home Network Drive which gives consumers the fastest storage of and access to their content and provide a seamless set up centralizing digital media in the home. The 1 terabyte WD Elements Play Multimedia Drives with high-definition capability onboard and we also recently introduced the newest version of WD Photos, a photo viewer application now optimized for the iPad, the iPhone 4 and iPod touch. WD Photos enables users to use photos stored on their WD Home Network Drive from any location.

I will now turn the call over to Wolfgang Nickl for view of our Q1 financial performance and our outlook for the second quarter.

Wolfgang Nickl

Thank you, Tim. I would like to refer you to a new and expanded summary of financial information that been posted to the Investor Relations section of our website. Much of the data that we have re-sited during past conference calls is included in that spreadsheet.

During my prepared remarks, I will focus on highlights and significant changes in some of our key metrics. At the end of this call the summary of financial information will be updated to include our Q2 guidance which I will discuss in a few moments.

The September quarter was characterized by unusually aggressive pricing that lasted throughout the quarter, with like-to-like prices decline in excess of 8%. Pricing pressure was most prevalent in the 2.5-inch segment. We made a conscious decision to limit our participation in this segment in an effort to optimize profitability. Our operating model allowed us to adjust our operating expenses to offset the impact of pricing on operating markets, in close the quarter near the midpoint of our EPS guidance range.

We actively managed capital receipts and working capital and generated significant free cash flow. Revenues for the first fiscal quarter were $2.4 billion, up 9% from the prior year and 1% sequentially. This included $51 million of sales of media from our newly acquired Singapore media facility to fulfill contractual obligations carrying over from poised existing sales commitment.

We do not expect any external media sales in Q2. Our price shipments totaled 50.7 million units, up 15% from the prior year period and 2% sequentially. Revenue from sales of WD TV Media Players, WD Livewire, Network Kits and solid state drive totaled approximately $33 million. Roughly flat with the prior year and up 22% from the June quarter.

Average hard drive selling price was approximately $46 per unit, down $3 from the year ago quarter and down $1 from the June quarter. Revenue from sales of our branded products including WD TV and WD Livewire products were $425 million, up 11% from $382 million in the year ago quarter and 6% sequentially from $400 million in the June quarter. There was no customer that comprised 10% or more of our total revenue.

Our first margin for the quarter was 18.2%, down from 23.3% in the year ago quarter and down from 22.5% in the June quarter. The lower and expected gross margin percentage was prematurely due to the price decline, I spoke to you earlier. Product and segment mix as well as product cost decline were largely in line with expectations.

Total R&D and SG&A spending was $226 million or 9.4% of revenue. This compares with $195 million or 8.8% of revenue in the year ago quarter and $242 million or 10.2% of revenue in the June quarter. As a reminder, total operating expenses for the June quarter include a $27 million of litigation settlement.

Operating income was $211 million or 8.8% of revenue. This compares with $319 million or 14.4% of revenue in the year ago quarter and $293 million or 12.3% of revenue in the June quarter.

Net interest and other non-operating expenses were less than $1 million. Tax expense for the September quarter was $14 million or 6.6% of the pre-tax income. Our net incomes totaled $197 million or $0.84 per share. This compares with $288 million or $1.25 per share and $265 million or $1.13 per share in the year ago and June quarter’s, respectively.

Turning to the balance sheet, we generated $390 million in cash flow from operations during the September quarter. Our cash conversion cycle for the first quarter was a negative three-day. It consisted of 50 days of residual outstanding, 26 days of inventory or 14 turns and 79 days of payables.

Capital additions for the September quarter totaled $200 million, lower than our July projections of $275 million as we scale back in line with lower shipments. Depreciation and amortization expense for the first quarter totaled $150 million.

We continue to expect our capital expenditure for fiscal 2011 to be between 7% and 8% of revenue with an additional $200 million related to our 6-inch to 8-inch wafer conversion and some expenditure to optimize the output from our recently acquired media facility in Singapore. Depreciation and amortization is expected to be at about $630 million for the fiscal year.

We made $25 million of debt repayment installments during the first quarter and thereby reduced our debt balance to $375 million. We exited fiscal Q1 with cash and cash equivalents of $2.9 billion, an increase of $124 million from the June quarter.

During the quarter we repurchased 1.8 million shares at a total cost of $60 million. The balance remaining on our stock repurchase authorization is $460 million. From a balance sheet credit perspective our first priority is to create shareholder value through strategic investments both in markets currently served and adjacent markets. Any larger scale share buyback would be considered only after we have started our strategic option.

Now turning to our expectations for Q2. Historically, industry shipment increased by 5% to 7% from the September through the December quarter. As Tim mentioned, we have seen approximately twice the shipments volume in the last week of last quarter than in average of the preceding 12 weeks of the quarter.

We believe that customers will not want to carry extra inventory into the March quarter and therefore expect some inventory correction. We consequently assume that the December quarter industry TAM will be roughly flat with the September quarter at around 165 million units.

Some of the aggressive pricing we have seen last quarter has carried over into this quarter and our guidance includes like-to-like price decline of approximately 5%. We are actively reviewing our plan shipment portfolio to identify business that is not meeting our business model requirements.

We have contractual obligations do not exist we may review our shipments to low contribution products and seek to ship sales to more profitable segments. As previously indicated, we are currently calibrating our new Singapore media facility to our own recipes and as a result, we are experiencing dilution of first margin of 50 basis points during this quarter.

Accordingly, our guidance for fiscal Q2 is as follows. We expect revenue to be in the range from $2.3 billion to $2.4 billion. R&D and SG&A spending is expected to total approximately $230 million. Our net interest expense is projected to be about $1 million, expect our tax rate to be within our business model of 6% to 9%. We anticipate our share count to be approximately 235 million. We estimate earnings per share of between $0.50 and $0.60 for the December quarter.

Operator, we are now ready to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Rich Kugele with Needham & Company. Your line is open.

Rich Kugele – Needham & Company

Thank you. Good afternoon. A few questions. I guess, first, regarding the 13th week extra shipments that you are referring to, did those shipments go to OEMs or did they go to the channel? Any color on the types of products lines we’re really talking about?

John Coyne

Hi, Rich. Those shipments went mainly to OEM.

Rich Kugele – Needham & Company

Okay. With a desktop or notebook?

John Coyne

Mainly notebook because notebook is as you know has got a heavy OEM level.

Rich Kugele – Needham & Company

Okay. And then, in terms of the raw materials and Tim this is probably best for you. I’m sure you’ve seen the news about the raw materials, the rare earth metals coming out of China. Do you have any thoughts on serum shortages affecting the substrate world and are you protected against that because of the Hoya relationship, any comments?

Tim Leyden

We don’t really have much insight into that at this particular point, Richard. And but we are looking at how it might impact us and we’ve got pretty good relationships with our vendors, so we are looking to leverage those and I’ll make sure that we are minimally impacted.

Rich Kugele – Needham & Company

Okay. Then, just lastly, traditionally the industry has been able to offset price declines by moving to new product lines. There has been largely in absence of new products here in the second half of calendar ‘10. There supposed to be some new products coming out in the first half of ‘11, do you think that that’s the opportunity to go and maybe reset this cost price situation or any thought that we might be able to see a stabilization of the praising environment?

Tim Leyden

What we have seen previously from history is that the stabilization of the pricing environment comes when demand exceeds supply and that has generally been going through seasonal cadences, generally been in the September and December quarter.

And so with the working off the inventory that has occurred during the course of the September quarter and with the HDD market being up about 5% versus what would normally be a much stronger position, somewhere in the 10% to 12% I would imagine.

And going into a December quarter that’s essentially flat we think that the opportunity will come more from supply, demand – in supply case and demand again. So we think that it will and the industry will have to manage the inventory supply demand equilibrium and stabilize that situation and that will have more of an impact on us than any of the new products exception.

Rich Kugele – Needham & Company

Okay. Thank you very much.

Operator

Aaron Rakers with Stifel Nicolaus. Your line is open.

Aaron Rakers – Stifel Nicolaus

Yeah. Thanks guys. So just a backwards math given what you guys just said about the guidance, it would appear to me that you’re guiding a gross margin number somewhere that 60% range. So, I think, in the context of pricing, in the context of the TAM assumption. If I’m correct, can you help me bridge the gap on top of that 50 basis point impact from kind of ramping the Hoya facility and then I have a follow-up?

Wolfgang Nickl

Yeah. Aaron, this is Wolfgang. Your math is obviously correct. Gross margin is a function of business segment mix cost declines and price declines. And the 5% like-to-like price decline that I quoted compares to a regular price decline in this quarter, historically that we have seen in the 1.5% to 2% range and I would say this is the main contributor to the decline quarter-over-quarter.

Aaron Rakers – Stifel Nicolaus

And then the follow-up questions, first of all, on the $27 million of litigation expense, are you assuming that that continues here going forward. And finally, I appreciate the more detailed breakdown that you guys are giving, actually breaking out an enterprise shipment number. Is that inclusive of both SATA and SAS drive into enterprise? I’m just trying to understand maybe the ramp in the traditional enterprise that you guys are seeing when we might be able to point to kind of inflection point some appreciable market share gains there? Thank you.

Tim Leyden

Yeah. Aaron, I think the enterprise question, yeah, that’s correct, the enterprise number would be comprised of all of our enterprise shipments, including traditional and our products and I’ll let John speak the litigation question.

John Coyne

Yeah. The litigation is a one-off.

Aaron Rakers – Stifel Nicolaus

Okay. So with $27 million out, why is the expense than on a normalized basis going up?

Wolfgang Nickl

The expense going up if you take the $242 from the June quarter and normalize all the $27 and then the increase in expense comes mainly from an adjustment in our incentive growth and then from investments in our research and development teams and in our sales teams to increase our market reach.

Aaron Rakers – Stifel Nicolaus

Okay. Thank you.

Operator

Sherri Scribner with Deutsche Bank, your line is open.

Sherri Scribner – Deutsche Bank

Hi. Thank you. I was curious if you would want to make comments on the recent news that Seagate announced that they might be going private and would it be something that you guys would consider doing?

John Coyne

Hi, Sherri. This is John. We’ve seen Seagate as a formidable and respected competitor both in public and private ownership previously. And so we have no reason to believe that that will change whether they are public or private. They will remain a respected and formidable competitor.

Sherri Scribner – Deutsche Bank

Is that something you would consider doing if they were private?

John Coyne

We don’t think the ownership structure is significant. The business model is what we are focused on. And we believe our business model that we’ve been refining for the last 10 years is the appropriate one for its effect in the market.

Sherri Scribner – Deutsche Bank

Okay. And then in terms of the gross margin now being down below your targeted range, we’re heading into -- after December, we are into the margin that June quarters went and due to its demand, it’s typically down. I am trying to get a sense of how long do you think it will take before we get back into your targeted ranges for gross margins. It seems like that won’t happen until the second half of 2011 at the earliest?

Wolfgang Nickl

Wolfgang again. As I mentioned, price decline is a very important contributor to this equation. We’re in control of our cost declines and we are working on our channel mix. So it will come down to win the supply demand situation and will allow pricing to stabilize. And we are not making any predictions when that would happen but we know that the margins for the June quarter usually are seasonally soft.

Sherri Scribner – Deutsche Bank

Do you -- I guess, just quickly do you have any sense of what the industry capacity is right now? Would you say that it’s 10% higher than the TAM or 20% higher than the TAM? Just trying to get a sense.

Wolfgang Nickl

We are just going on with what expectations are like to say as things coming into the year. There was expectations that the industry demand would be somewhere in the 170 million units or 180 million units, that type of number. And so consequently we’re a running at about 165 and if you take the midpoint of the 170 to 180 million units, you are probably looking at being somewhere between 90 and 95%. You just take the straight map 165 to 175, it’s about 94%. So you’re probably somewhere in there 90 to 95% range.

Sherri Scribner – Deutsche Bank

Okay. Great. Thank you.

Operator

Keith Bachman with Bank of Montreal, your line is open.

Keith Bachman – Bank of Montreal

Hi. Tim. I guess this is for you. On the TAM, I just want to make sure I am doing the numbers right. It sounds like September came in kind of 164 million and normally, I think you indicated that the bump in units would be three to 5%, so maybe it’s a low 170 million. So does that suggest that that map that you have about seven to 8 million units out there as the extra inventory that needs to get worked of?

Tim Leyden

Yeah. Probably it’s right around that number, maybe marginally higher than that.

Keith Bachman – Bank of Montreal

Okay. And is it -- I think you said it was more notebooks but what is it collective so to speak? I know you guys said you elected not to participate but were there many fingerprints on the drives?

Tim Leyden

We didn’t actually mention that we elected not to participate. We mentioned that we selectively set back. So in addition to that you know, even though it is a higher number than what we would normally see, there is always some extra amount that gets shift in at the end of each quarter. So the excess over and above, what would normally happen is probably somewhere in the region of about 5 million units or so. And so that has to get worked off obviously going into a quarter which is front-ended loaded as oppose to the previous two quarters, which have been heavily back-end loaded. And so there is an opportunity for that inventory to get burned off early. We’ll just have to wait to see what happens.

Keith Bachman – Bank of Montreal

Okay. Well, then my follow-up then Tim is just curious, your discussions with the OEMs as it relates to the demand on the notebook side versus the potential conflict or demand conflict with tablets. How are the OEMs characterizing and how does that make you think about the seasonality in notebook drives in the March quarter? And that’s it from me. Thanks.

John Coyne

This is John. I will take this tablet question. You know, from everything we can gather with multiple different source reporting on, on tablets, I mean we see the first two quarters of the iPad had about 8 million units.

Keith Bachman – Bank of Montreal

Right.

John Coyne

Compares -- to, to put it in context, that compares with the first two quarters of the EPC netbook emergence, which was 5 million in its first, first two quarters? So everything we hear indicates that roughly half of the iPad sales are to existing Apple households and that somewhere in the region of 13% to 15% of the folks buying iPads admit to substituting the iPad for a previously planned PC purchase and some 23% of purchasers indicate that they are buying an iPad as an alternative to a Kindle or other eReader. So, what we see, I think, is a complementary additional device sale to the overall ecosystem of content consumption.

We think that when you look at the numbers, certainly there has been some fall off in netbook over the last couple quarters. They’re also -- you have to take the price point of the iPad into account. It’s likely that over the next several quarters as other tablets emerge, they will address lower price points than the iPad currently occupies. But on overall assessment, we’re seeing, maybe somewhere in the 10% to 20% impact range on the growth of low end notebook/netbook products.

Keith Bachman – Bank of Montreal

Okay. Fair enough. Thank you very much.

Operator

Ben Reitzes with Barclays Capital, your line is open.

Ben Reitzes – Barclays Capital

Hi. Thank you very much. I wanted to ask about going beyond the December quarter, if you could, just about some dynamics that are setting up. There’s Intel’s Sandy Bridge, which may affect some of the builds from OEM customers and then there is the emergence of China, which is kind of changing the seasonality of the whole world. So is there a chance that TAM is, is flattish like it was again, you know, like it was last year in the March quarter? And is, is -- does the March quarter potentially represents some light at the end of the tunnel here after this big quarter of adjustment in December?

Tim Leyden

Yeah. I think there is a chance. I mean, March quarter traditionally, if we go back to the more pre-recession cadence, was flat to slightly down, somewhere in the 3% region. And from a going forward seasonal viewpoint, it does look as if the strength of China is changing that dynamic. So there is opportunity there for the -- for the situation to improve. So we’ll wait and see but, I mean, there is -- it’s all dependent on the working through the inventory that the PC -- that the OEMs have, the PC OEM’s have built up and how they manage that and then how the different fares in the disk drive industry and manage the shipments going into the market.

So there is a lot of dynamics on it. But the -- but there is an opportunity considering the changing variables that are going in such as the Intel Sandy Bridge, the Chinese New Year and the strength of post-Christmas sales as well. So there is opportunity and we will have to wait and see.

Ben Reitzes – Barclays Capital

Okay. And then I wanted to just address the demand issue again, perhaps with Apple having an event tomorrow where they might introduce more NAND into the MacBook Air and what not. Just -- is there, is there, has there anything changed more in the mainstream PC market or is there any worries about what Apple may do actually more the mainstream PC market with NAND? Or is that a status quo still right now, where it’s too expensive and it’s not going to happen and it’s just going to be in the iPad market or the tablet market?

John Coyne

Yeah. We believe that the solid-state solutions are not competitive in the mainstream PC market, whether laptop or desktop, the economics just don’t work out. Where the storage element is constrained by form factor than on high price point devices, solid state is an appropriate solution. And where, in the very small form factor devices, like PDAs and MP3 players and so on, it’s clear that small amounts of solid-state memory are the solution to fit in the form factor and fit in the budget.

Ben Reitzes – Barclays Capital

Okay. Thank you very much.

Operator

Nehal Chokshi with Technology Insights Research, your line is open.

Nehal Chokshi – Technology Insights Research

Yeah. I got two questions actually. Your enterprise units are down Q2 compared to what is typically and up Q. Can you talk about what drove that?

John Coyne

Yeah. We are going through some product transitions in there. We had a very strong product lineup and we are now moving into a period in which we would have some product transitions. We expect to work through those in two or three quarters.

Nehal Chokshi – Technology Insights Research

Okay. Is that a SAT space transition or is that a base transition?

John Coyne

It’s a SATA base transition.

Nehal Chokshi – Technology Insights Research

Okay. All right. And then at the beginning of the call, John, you talked about how you’re putting a little bit larger focus on some strategic direction. It seems like you’re trying to talk about more focus on the users that implies greater focus on software. Can you discuss some metrics that verify that this is being the case, possibly maybe number of software engineers at WD, how that’s growing or maybe R&D spend dedicated software. Can you talk a little bit to that?

John Coyne

I’ll not give you specifics on that for competitive reasons but I -- if you look at the thrust of our product offerings in our branded business, you’ll note that we have – we’ve migrated the backup software on all of our drive products, the MyBook and My Passport lines, which used to be a purchase software solution, we have migrated to an internally developed solution so that we can better own the total customer experience there and the interaction of the customer with the device.

If you look at our complete range of WD media players, the TV Live line and the Elements Play line, there again you will see significant software content in those products. And then you look at the -- our recent launch of the WD photo app for the iPad, iPhone 4 and iPod Touch, again an in-house developed software product. So, also some years ago, you recall we bought a company called [Meomat], which was a software play that we have developed into the major engine that creates the connectivity and accessibility for all of our products as the interplay for remote access. So, yeah, we are putting significant emphasis on software these days.

Nehal Chokshi – Technology Insights Research

Okay. Thank you for that.

Operator

Rob Cihra with Caris & Company, your line is open.

Rob Cihra – Caris & Company

Hi, thanks very much. Two questions, if I could. One, just on CapEx. It did come in a little lower in dollar terms and you had mentioned that you are still looking at the same target as a percentage of revenue and including the eight-inch wafer conversion. But can you, can you tell us what you’ve seen, maybe from sort of across the industry in terms of other players? If you’re seeing people already cutting CapEx measurably or just starting to a little bit including for example, Asian media suppliers. Do you think that’s going to help anytime soon or are we too early for CapEx cuts to help?

And then separate from that, if I could just push maybe a little more, you did touch on the almost the $11 in cash per share that you have. I am just wondering if you could push a little more in terms of what your priorities are in terms of buyback versus potential dividend versus acquisitions? Thank you.

John Coyne

Okay. From a CapEx viewpoint, we don’t really have much in for competitors or we would imagine that by past history that people are -- since the volumes are coming in lower than what people had anticipated in September and December quarters, if our projections for ‘10 being flattish from September is correct. We would imagine that everybody is moving to postpone and cancel where possible and capital editions and managing it as prudently as they possibly can. In our case, we are -- we have demonstrated that capability over long period of time. We add capacity just in time and we have managed the capacity on an ongoing basis in order to cover the demand at that point in time.

Tim Leyden

In terms of the balance sheet and stuff, we built a strategy, as John mentioned in his remarks, our prime focus right now is to evaluate strategic opportunities both in the HED as well as in adjacent markets. And we will use our cash and our borrowing capacity to accomplish that. And once we have previewed all of these opportunities and solution that we can find anything appropriate, we will evaluate the best way of returning money to the shareholder and that could be in home or share buyback. And we will decide whether we do that in a unlevered or a levered fashion at the appropriate point in time.

Rob Cihra – Caris & Company

All right. Thank you very much.

Operator

Mark Miller with Noble Financial, your line is open.

Mark Miller – Noble Financial

I want to go back and talk about pricing again because these margins were, I think, below most -- what most people thought you indicate in inventory. How much -- you are roughly split 50/50 between the OEM and channel and retail. How much of the pricing pressure or the decrease margins is due to pricing from the OEM options? And how much of it is your anticipated pricing pressures in the channel?

Tim Leyden

I think there will be more pricing pressure coming from OEMs because during the four quarters of unprecedented demand outstripping supply, the OEMs got nervous about supply -- built up some inventory positions within their, their own internal inventory. And then we came on a little consumer softness, they let the inventory correct and then sat back and got some improved pricing conditions as a result of that.

And, so that dynamic is, is the more important one in the overall pricing movement. There has been some pressure in the channel as well as in the last couple of quarters we’ve had different competitors trying to gain back market shares that they had lost in earlier quarters. And it’s put some pressure on the channel but I think the OEM pricing pressure has been more significant.

Mark Miller – Noble Financial

Okay. Just one final question. You are going through a major ramp in your HID fabs and also I think expanding into a new fab in the old Thermoway facility. Have you had to buy more components externally then you have in previous quarters or you are still supplying at roughly the same mix internally and externally, especially for HIDs and as well as media, by the way?

Tim Leyden

Yeah. I mean we have a very good relationships with the external merchant vendors. And we’ve got our own internal components operating rather well. So we operate in order to -- we mix both in order to optimize the power profit objective. And that fluctuates around, you know, from somewhere around 75% to 85% internal. And so we continue to work that, that’s not a, a perfect science as you can imagine. So, it’s -- we are continuing to work it as we always do.

Mark Miller – Noble Financial

So there is no major, no change in your mix? Just relatively small change in your mix between internal and external component supply expected for the December quarter as what you’ve seen in the recent quarters?

Tim Leyden

No.

Mark Miller – Noble Financial

Thank you.

Tim Leyden

Other than, of course, the impact of the Singapore Hoya facility that will change the dynamic and increase the internal for media.

Mark Miller – Noble Financial

Thank you.

Operator

Kaushik Roy with Wedbush, your line is open.

Kaushik Roy – Wedbush

Thanks. So going back to the question of Seagate, how do you see the markets evolving if Seagate goes private? I mean, do you expect less pricing pressure or not really?

John Coyne

Based on history, we don’t perceive that private or public ownership had any significant impact on how Seagate addressed the market and how we addressed the market. So we’re -- I mean we’re focused on how we continue to find a recipe that delights customers and does so based off having the lowest costs in the industry so that we can convert that customer delight, despite competitive environment into significant profitability and growth. And so we don’t see the company ownership fees as a significant -- very significant element in all of that.

Kaushik Roy – Wedbush

And then you said that SSDs are not competitive on desktop and notebook, but can you comment on your progress on SSDs? Are you willing to participate in the enterprise segment, or the small form factor segment? Thank you.

John Coyne

Yeah. We are -- the company we acquired a couple of years ago, we have worked on that embedded market for Netcom and industrial controls and so on and we have grown that business since acquisition. We are committed to that space. We have produced products for the client space that is very low volume.

And we are working diligently on product for the enterprise space, which we believe is the most attractive application for solid-state drives, attractive to the customer because of the value it brings, attractive to us because of the value that we bring to the knowledge in the area of applications and management of media. And so that is our primary focus for now is on the development trail to broaden our enterprise portfolio offering.

Kaushik Roy – Wedbush

Can you quantify the units or revenues in any way?

John Coyne

We think that the enterprise, solid-state enterprise market today is somewhere in the $800 million to $1 billion range. And as we assess the various forecasts that are out there for multiple sources and our own take on that, you know, we are looking at that market as being a $3 to $5 billion market in three to five years.

Kaushik Roy – Wedbush

Okay. Thank you.

Operator

Next comes from Ananda Baruah with Brean Murray, your line is open.

Ananda Baruah – Brean Murray

Thank you for taking the question. Hi, John, just wanted to ask your opinion on -- given that after this quarter, sounds like there’s still going to be, I don’t know, you say seven to 10 million drives of excess inventory out there for the industry. Might it, might it be, I guess, more prudent to ship, I guess, sort of a TAM down the December quarter versus September just to get that out of the way more quickly or is there something structural just about the way, you know, that you take down -- the industry collectively takes down the bill price of the quarter that precludes that from being done?

Tim Leyden

You know, our take on the TAM and calling the TAM flat quarter to quarter here, we believe the underlying demand is up quarter to quarter. We think there’s -- it is seasonal and will likely be up in the 5% range on a quarter-over-quarter basis. And we’re, we’re calling the drive industry TAM flat so that the inventory that has been built up can be absorbed the market demand.

Ananda Baruah – Brean Murray

Got it. Thanks. And I guess just a quick follow-up on that. Any sense -- is it too early to get a sense -- if taking out, you know, through the inventory that will be taken out during the December quarter by shipping the flat TAM, will that make a meaningful difference in the promotion of, you know, more normal seasonal pricing in the March quarter?

Tim Leyden

I think March quarter, you know, the thesis is yet to be proven. But we do believe that there is some shift to the overall traditional seasonality of the industry and unfortunately the timing of the big recession makes it -- and the recovery out of that -- makes it very difficult to clearly discern shifts in the multi-year seasonal patterns. But we do believe that there is a (inaudible) of the rise of China as an important market, creating demand in the first calendar quarter of the year.

We believe there is a shift from air freight to sea freight from Asia to the U.S. and Europe causing a shift, a pull forward of back to school builds into the second calendar quarter of the year. And that we’re, over time, the seasonality of the business will flatten out. But it’s, it’s difficult to get a precise handle on that because of the massive disruption that the recession put on top of those patterns.

Ananda Baruah – Brean Murray

Got it. Okay. Thanks a lot. Appreciate it.

Operator

Mark Moskowitz with J.P. Morgan, your line is open.

Mark Moskowitz – J.P. Morgan

Yeah. Thank you. Good afternoon. Two questions if I could. I want to come back to just what has been going on here over the past six months or so. John and Tim, if you could kind of weigh in here. Is there something that’s structurally wrong right now with the overall disk drive industry in terms of how the industry interfaces with both the OEMs and the distributors?

And I think back to 2004 how there was a lot of challenges and the industry participants worked to have greater transparency and greater dialogue to manage the inventories and supply demand and balances. Because I just get confused when you can have this huge 13th week and then suddenly the spigot gets turned off again by the OEMs. I mean, are they having these quick solid demand cycles? Who’s kind of at fault here in terms of what is going on?

John Coyne

I mean, what you’re seeing is competitive behavior in a slightly -- just slightly unbalanced supply demand situation. It is very typical. We saw -- we have never before seen in the industry four sequential quarters where the demand presented to the industry outstripped the industry’s demand for supply -- ability to supply. And it’s pretty natural coming out of that that the pendulum is going to swing back a little the other way. It is very difficult to land without a little over shoot.

And so I think what you have seen in the last six months has been, you know, the wealth created in the four quarter runoff allowed people to -- encourage everybody to get more invested in the industry. And initially, as the demand softened, people have tried to maintain their momentum. And it takes a little while for folks to realize that the -- if everybody overbuilds then there’s going to be pressure and then there is going to be -- you know, our customers are smart people. They are going to take advantage of that. And we need to get things back in balance and move on with life. And that is the cycle that has been played through.

I think if you analyze the numbers however, you will see that -- you know things are not a disaster right now. Where we finished last quarter above the bottom of our model, you can go back many years into the last 10 years and find periods where we dropped out of the model for periods of time. And I would remind you that the model was a significantly lower bottom to it that it has today.

So the industry and WD have expanded gross margin model consistently over the last 10 years. And we are still -- you know, yeah, we do not like being under the bottom of the model. And we are going to work to move ourselves back into it as soon as we can but we are also going to work to ensure that we have the right product set and the right availability and the right approach with our customers to have them prefer WD product over others and continue to grow our business profitably.

Mark Moskowitz – J.P. Morgan

I guess as a follow-up then, so should, should the message be then to investors that we could see a Bell curve where you had four kind of medioric quarters and now you’re going to have four quarters of some pretty challenging times? And I say that because if I think about the industry, to the industry’s credit, you have a lot more efficient and effective participants now than we did say five years or six years ago. And as Rich alluded to earlier, it is going to difficult to kind of reset the price curve, I think, for the time being. So are we…

John Coyne

What I would say to investors is to look at the long-term demand for storage. The fact that the most appropriate solution for mass volume storage is hard drives. And to look at the long-term progress the industry has made in the last 10 years and I believe we will continue on that fundamental trend line over the next 10 years.

Mark Moskowitz – J.P. Morgan

Okay.

John Coyne

So, in closing, I’d like to thank all of you for joining us today. We appreciate your questions and your interest in the company and in the industry. We look forward to seeing you again in another quarter.

Operator

Thank you. This does conclude today’s conference. You may disconnect at this time.

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