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Executives

Bob Blair - Investor Relations

John F. Coyne - President, Chief Executive Officer, Director

Tim Leyden - Chief Financial Officer, Executive Vice President - Finance

Analysts

Richard Kugele - Needham & Company

Keith Bachmann - BMO Capital Markets

Mark Miller - Brean Murray, Carret & Co.

Richard Kaiser - Sanford C. Bernstein

Mark Moskowitz - J.P. Morgan

Steven Fox - Merrill Lynch

David Bailey - Goldman Sachs

Sherri Scribner - Deutsche Bank

Christian Schwab - Craig-Hallum Capital

Matt Nahorski - Wachovia

Scott Craig - Banc of America

Western Digital Corp. (WDC) F4Q08 Earnings Call July 24, 2008 5:00 PM ET

Operator

Good afternoon and thank you for standing by. Welcome to Western Digital's fourth quarter financial results for fiscal year 2008. (Operator Instructions) Now I’ll turn the call over to Mr. Bob Blair. You may begin.

Bob Blair

Thank you. I want to mention that we will be making forward-looking statements in our comments and in response to your questions concerning: our financial and operational performance; our business model, cost structure and customer satisfaction; demand, growth, pricing and inventory in the hard drive industry; our expectations for the September quarter; our growth opportunities, new product designs and our execution capabilities; our expectations regarding our WD VelociRaptor products and GreenPower technology; our investments in technology, capacity and infrastructure; our aspirations to serve every mass storage market segment; the efficiencies of our in-house hard drive controller design and development and how it will enhance the efficiencies of our development process with our existing SOC supply partners; the cost benefits of the integration of our media operations; our effective tax rate; repurchases of our stock; our cash conversion cycle; and our financial outlook for the September quarter and the second-half of calendar year 2008.

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-Q filed with the SEC on May 6, 2008, as well as the additional risk factors reported in the press release included as Exhibit 99.1 to the Form 10-K we furnished to the SEC today.

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 that we make today are still valid.

I also want to note that copies of remarks by WD executive John Coyne and Tim Leyden from today’s call will be available on the investor section of Western Digital’s website immediately following the conclusion of this call.

I’d now like to turn the call over to John Coyne, Chief Executive Officer of Western Digital.

John F. Coyne

Thanks, Bob. Good afternoon and thank you for joining CFO Tim Leyden and myself today. Following my remarks, Tim will review our financial performance in fiscal year 2008 and our fourth quarter, and provide our outlook for the September quarter.

Fiscal ‘08 was an outstanding year for WD, capped off with a solid fourth quarter financial performance reported earlier today. For the year, we grew revenue 48% and earnings 54%, delivering on our primary goal of profitable growth.

We generated $1.5 billion in cash from operations during the year. We also successfully concluded our $1 billion acquisition of Komag and have completed the integration of the new media operation and are already generating solid technology and cost contributions to the overall business.

Our fiscal ‘08 performance provides further evidence of disciplined operational and financial performance and the continued scalability and execution excellence of the

WD team.

Customer satisfaction with WD’s broad product line, high quality and reliability, service excellence, and overall value proposition continues to drive our business growth. We are very pleased with the continued, consistent performance of the efficient business model that we have built and refined over the last several years.

While maintaining focus in the high-volume desktop segment, we have made major strides in diversifying the business by establishing our footprint in newer, faster-growth markets such as the 2.5-inch notebook drives, branded products, consumer electronics, and SATA drives for the enterprise.

As a result of this activity in higher-growth areas, we saw our hard-drive revenues from non-desktop markets expand to 56% of revenue in fiscal ‘08, compared with 43% in fiscal ‘07 and 29% in fiscal ’06, and we exit the year with 63% of Q4 revenues derived from non-desktop, higher-growth applications.

It is worth noting that in the June quarter, WD was less reliant on the desktop business as a share of revenue and units than either Seagate or Samsung.

Now, let me briefly address industry conditions as we ended the June quarter and enter the new fiscal year. My remarks are confined to the markets served by WD for 3.5-inch and 2.5-inch SATA and PATA hard drives.

Despite concerns with macroeconomic conditions, June quarter industry demand was strong relative to seasonal patterns and expectations, coming in flat with the March quarter and increasing 19% year-over-year. 3.5-inch demand in the quarter was down 4% sequentially and up 6% year-over-year, in line with expectation. 2.5-inch demand was stronger than expected, up 7% sequentially and up a very healthy 45% year-over-year.

Strong year-on-year sales growth in Asia for the quarter reflected our success in the 2.5-inch notebook market, offsetting muted demand in the U.S. and Western Europe.

Industry shipments of 21.5 million units in the last week of the quarter represented 18% of total shipments in the quarter, an increase of half-a-week compared to the 14% shipped in the same week last year. This increase was likely due to the fact that certain hard drive companies ended their quarter on June 30th, a Monday this year but a Saturday last year, adding extra days of shipment opportunity.

Industry inventories for manufacturers and distribution exiting the June quarter were down sequentially and compare favorably with the same time last year, up only 10% over last year while supporting a market which grew 19% year-over-year. This represents a reduction of one full week of supply on a year-over-year basis.

Manufacturers’ inventory reduced by some 4 million units sequentially and is at a little over one week of supply. Distribution inventory was also down some 700,000 units sequentially and is in the middle of the normal four- to six-week range.

Pricing in the distribution channel, which accounts for some 20% of the total hard drive revenue stream, is driven more than any other industry segment by short-term supply/demand dynamics. The desktop market is uniquely weighted towards distribution, with a roughly 50-50 split between distribution and OEM customers.

Distribution pricing was especially tough last quarter because of a competitor’s large inventory overhang exiting March, which led to the industry’s highest quarterly price erosion in the desktop distribution channel since 2001, at 16%.

While the inventory overhang was largely eliminated by June quarter-end and current inventory levels are in good shape, this price erosion had a spillover impact on OEM September quarter price negotiations, as well as creating a depressed distribution pricing floor entering the new quarter.

We navigated through these conditions reasonably well, helped by our lesser dependence on desktop business. We also leveraged our responsive manufacturing capability to adjust product and segment mix. We expect that the conditions created in the June quarter will have some residual impact on the industry and our business through the current quarter.

I would now like to describe the recent results of our multi-year diversification effort on a market-by-market basis and tell you why we think we are well-positioned to continue our profitable growth in the year ahead, primarily based on compelling products that are currently shipping.

Continued execution of our demonstrated product design and deployment capability is also important in driving the continued potential of the WD profitable growth story in future years. Looking at our individual markets, we tripled our 2.5-inch drive shipments year-over-year to 36.6 million units, demonstrating technology and product leadership throughout the year. Even with this success, we have yet to ship meaningful volume to three of the world's top 10 notebook OEMs, leaving significant growth opportunities in our mainstream 5400 RPM product line.

In June we began shipping our new line of WD Scorpio Black 7200 RPM 2.5-inch SATA hard drives in capacities up to 320 gigabytes for high performance notebook markets. This important product expansion offers our customers another opportunity to embrace the WD value proposition of quality, reliability and availability in the notebook segment.

We grew revenue in our branded products business by 60% year-over-year to $1.4 billion and we continue to add new products and product features to the line-up, to strengthen our leadership position and expand our available market.

In the June quarter, we completed the rollout of the popular My Passport Essential series with a refreshed design in multiple colors, and over the last several months we began shipping many new and next-generation branded products, including the My Passport Elite fully-featured portable USB hard drive in capacities of 320 and 250 gigabytes; the Mac-formatted My Passport Studio portable hard drive for Apple Mac users, targeting a discerning, fast-growing sub-segment of the branded business; the newest model of our 3.5-inch My Book series, the Mirror Edition dual drive storage system, which automatically stores content not once but twice to maximize safety and security of users’ valuable content; and a USB version of the WD My DVR Expander, significantly expanding the recording capacity of Dish Network HD DVRs.

In Enterprise SATA, a fast-growing segment of enterprise storage, we continued to innovate with the introduction of our 3.5-inch SATA GreenPower drive series and the WD VelociRaptor drive family, the industry’s first 300-gigabyte 10,000 RPM 2.5-inch drive.

Over the last few years, the fastest growing segment in the mainstream enterprise market is 2.5-inch SAS drives for blade servers and storage. This market is now approaching 4 million units per quarter, with annual growth in excess of 40%. We expect the WD VelociRaptor 2.5-inch SATA products to establish a niche for SATA in this market, just as the 3.5-inch WD RE offerings did in the large form factor space, following their introduction in 2004.

The introduction of our power-saving technology to our WD AV hard drives for the CE space, combined with improved costs and our demonstrated field quality performance, have been the catalysts in helping us resume growth in this important segment, leading to enhanced value for our customers and improved contribution to WD’s business.

To underpin our medium to longer term growth, we continue to work and invest to constantly roll out new platforms, capacities and features to timely meet the needs of our existing served market segments. We are also investing in the underlying technology to facilitate entry into our currently un-served market sectors of mainstream enterprise, gaming, and automotive.

We continue to aspire to serve every segment of the mass storage market and will do so as these segments offer adequate return on the investments required to serve them properly. As is traditional with WD, we will announce all new products only when they are available and shipping in volume.

Now I’d like to turn to the longer-term future. The global hard drive industry continues to present great opportunity for those with an appropriate business model. Storage demand and applications for hard drives continue to proliferate in both computing and consumer markets, as both workplace and lifestyle changes continue to generate increasing volumes of content to be stored securely, conveniently and cost effectively on hard drives.

The HDD market in fiscal ‘08 generated revenues in excess of $35 billion, with 540 million hard drives shipped, while forecasted demand for fiscal ‘09 exceeds 620 million units. On a unit basis, the overall hard drive market is looking at a five-year CAGR of approximately 13%, while those markets served by WD are forecast to grow in excess of 16% annually.

We continue to see the strongest growth potential in the notebook PC and Branded Product segments, areas of continued focus for WD. We are encouraged by these opportunities for profitable growth, both for the near-term and as we head into the seasonally strong second-half of the calendar year, and as we address the longer-term prospects represented in these industry forecasts.

I’d like to highlight some of the important actions we’ve taken during fiscal ‘08 to ensure our continued success in addressing these outstanding market opportunities. We have made and continue to make investments in the technologies and infrastructure that will enhance our ability to compete as a full-line industry leader, with the product portfolio required to capitalize on these growth trends and the capacity and cost structure to do so efficiently and profitably.

We added to our design and development capability with significant expansion of our technical workforce in Lake Forest and San Jose and in Asia, and the addition of a new design center in Longmont, Colorado.

In June, in a further strategic step to accelerate our technology development and deployment, we acquired the hard drive controller IP rights, design tools, and design team from ST Microelectronics. This in-house HDC capability will enhance the efficiencies of our development process with our existing SOC supply partners.

Our previously announced plan to upgrade and expand our Fremont wafer facility is on track and we have already produced first wafers from our new 8-inch pilot line, ahead of schedule. As indicated earlier, the integration of media operations has greatly enhanced our technology capability and overall cost structure.

Tim will now review our financial performance and outlook. Tim.

Tim Leyden

Thank you, John. Our fiscal 2008 and June quarter results demonstrate continued strong execution by the WD team. During the year, we improved and refined the basic WD business model in which we profitably satisfy our customers’ demands by efficiently providing a broad range of quality products at competitive costs.

In the seasonally softer June quarter, our results reflect our capability to thrive in a very competitive pricing environment. The growing segment and geographical diversification of our business provided us with the basis to generate strong results, despite the impact of the excess inventory which was carried into the quarter by our competition. This diversification resulted in continued strong revenue growth, operational results that delivered 630 basis points of gross margin improvement over the same quarter last year, and earnings that exceeded expectations.

For our full fiscal year 2008, total revenue was $8.1 billion, hard drive shipments were 133 million units, and hard-drive ASP was $59. The corresponding numbers in fiscal ‘07 were $5.5 billion, 96.5 million units and $57, respectively.

Gross margin in ‘08 was 21.5% versus 16.5% in ‘07.

Operating income for ‘08 was $1 billion versus $415 million in ’07, and net income for ‘08 was $867 million versus $564 million in ‘07.

Fiscal ‘08 EPS was $3.84 versus $2.50 in ‘07.

Net income in ‘08 included the impact of $75 million of tax charges related to the license of intellectual property to subsidiaries, and $49 million of acquired in-process R&D expenses, whereas ‘07’s net income included a favorable tax adjustment of $126 million related to the valuation of our deferred tax assets.

Turning to the fourth quarter results, revenue was $2 billion, up 46% from the prior year, and hard drive shipments totaled 35.2 million units, up 41% from the prior year period.

Average hard drive selling price was approximately $56 per unit, down $3 from the March quarter but up $1 from the year-ago quarter. Our Q4 ASP reflects our response to the pricing environment created by the stress of the excess inventory liquidation push mentioned earlier, as well as expected seasonal pricing factors.

The percentage of our hard drive revenue generated by non-desktop applications was 63% in the June quarter, 54% in the March quarter, and 46% in the year-ago quarter.

We shipped 11.7 million 2.5-inch mobile drives in the June quarter, as compared to 10.2 million in the March quarter and 3.8 million in the year-ago quarter. These increases were driven by continued strength in notebook PCs, coupled with increased customer preference for WD product offerings as we also benefited from the recent refresh of our WD My Passport range of portable storage solutions for people on the move.

In consumer electronics, we shipped 4.1 million 3.5-inch drives for use in digital video recorders in the June quarter, 3.1 million in the March quarter, and 2.7 million in the year-ago quarter. The refined WD value proposition in this space is resonating with a broad set of discerning customers.

Sales of our enterprise products were in line with our expectations. On the desktop side, we increased the percentage of our business going to OEMs. Hard drive channel revenue was 57% OEM, 24% distribution, and 19% branded products in the June quarter, compared with 50%, 34%, and 16% in the March quarter; and 47%, 36%, and 17% in the year-ago quarter respectively. There were two customers, Dell and HP, that each comprised more than 10% of total revenue.

The Q4 geographic split of our hard drive revenue was 29% Americas, 25% Europe, and 46% Asia, as compared to 28%, 31%, and 41% in the March quarter; and 40%, 26%, and 34% in the year-ago quarter.

Our gross margin percentage for the quarter was 21.3% versus 22.6% in the March quarter, and 15% in the year-ago quarter. The decrease in gross margin versus Q3 came primarily from the competitive 3.5-inch desktop channel pricing. We largely offset the normal seasonal pricing trends with a richer product mix, a changing segment mix, a higher OEM mix, increased volume and improved cost.

We have completed our media integration and are on track to meet our previously stated plans of full cost benefit by the December quarter.

Operating expenses totaled $184 million, or 9.2% of revenue, up slightly from the March quarter as a result of increased R&D spending. As compared to the prior year, operating expenses are up as a result of the Media acquisition, higher incentive compensation associated with stronger financial performance, and increased investments in new programs to support technological advancements and our broadening product portfolio.

Operating income was $241 million, or 12.1% of revenue. Interest and other non-operating expenses were approximately $4 million. This includes about $2 million of unrealized losses on our previously disclosed investments in auction-rate securities. These investments totaled $28 million at the end of the quarter.

Tax expense for the June quarter was $24 million and includes a $15 million incremental tax charge related to the license of intellectual property to subsidiaries. For fiscal 2009, we expect our book effective tax rate to range between 7% and 10% as we take into account our expected continuing profitability and the global mix of taxation by geographic location.

Our cash tax rate for fiscal ‘08 was approximately 1%, and fiscal 2009’s cash tax rate is expected to be between 1% and 2%.

Our net income totaled $213 million, or $0.94 per share.

Turning to the balance sheet, our cash and cash equivalents at the end of the quarter totaled $1.1 billion as compared to $917 million at the end of March. These amounts exclude the $28 million in auction-rate securities that were reclassified as long-term investments during the June quarter, as their immediate liquidity continues to be constrained by the market.

During fiscal ‘08, we generated $1.5 billion in cash flow from operations. Cash generated from operations during the June quarter totaled $318 million.

Capital additions for fiscal ‘08 totaled $615 million and included approximately $120 million for our 8-inch wafer-fab conversion. Depreciation and amortization expense for fiscal ‘08 totaled $413 million.

Capital expenditures for the June quarter were $146 million and our non-cash charges for depreciation and amortization expense totaled $113 million.

We expect fiscal 2009 capital expenditures to be about $800 million, including about $150 million for our 8-inch wafer fab conversion.

Depreciation and amortization for fiscal 2009 is expected to be about $475 million.

We did not repurchase any shares of common stock during the June quarter. Since May 2004, we have repurchased 16.6 million shares at a total cost of $248 million, for an average price of about $15 per share. A total of $502 million remains under our existing stock repurchase authorization.

Going forward, we will weigh opportunities to repurchase our stock against other investment opportunities and prepayments of our outstanding debt as we take our typical opportunistic approach to share repurchases.

As of the end of June, we had 46 days of receivables outstanding, 27 days of inventory, or 14 turns, and 69 days of payables. This resulted in a cash conversion cycle of four days. Going forward, we will continue to weigh working capital investments against opportunities for growth and opportunities to reduce shipping costs.

During Q4, we increased our ocean shipments of certain products to help offset price increases from higher fuel costs. Air freight continues to be a key element in our ability to satisfy changes in customer demand for our hard drives.

Before I address Q1 earnings guidance, I want to point out that WD will have a 14-week quarter in this fiscal year and we will include that extra week in our fourth fiscal quarter that will end on July 3, 2009.

Now I will discuss our expectations for the first quarter of our fiscal year 2009 but first let me outline the market situation as we see it. Compared with established historical demand, it is important to note that last year’s September quarter was extraordinary. However, based on the demand patterns that we have seen thus far in this quarter, we expect a return to the more seasonally normal Q1 demand patterns of 8% to 14% sequential unit growth in the markets we serve. In addition, all the HDD companies are now in a position to provide most required capacities across the entire 2.5-inch and 3.5-inch product lines.

As John indicated in his remarks, the higher-than-expected distribution price erosion in Q408 established the starting point for Q109 and also affected OEM pricing negotiations for this quarter. Taking these factors into account, we expect current quarter revenue growth for WD in a range of between 3% and 8%. Consequently, we are forecasting total revenues for the current quarter to be $2.05 billion and $2.15 billion.

We are modeling gross margin at approximately 19.3%. Operating expenses are projected to be approximately $190 million. Our net interest expense is projected to be about $4 million, assuming no further investment losses. We anticipate our tax rate to be 8% of pretax income, and our share count to be approximately flat with the June quarter.

Accordingly, we estimate earnings per share of between $0.81 and $0.89 for the September quarter.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Rich Kugele with Needham & Company.

Richard Kugele - Needham & Company

Thank you. A few questions, I guess first, can you give us a sense on Komag’s contribution in the fiscal fourth quarter, both from a margin and a revenue perspective and whether or not you think as you move forward, you’ll continue to see some further synergies from Komag?

Tim Leyden

Komag, Rich, we got 80 basis points in the December quarter, a further 40 basis points in the March quarter, and an additional 80 basis points in the June quarter, so we are at a cumulative 200 basis points of increased gross margin, or reduced cost, is a better way to put it, as we stand at this point. We are still on track and expect to reach full cost benefit by the end of December of this year and we expect that to happen pretty much linearly between now and then.

Richard Kugele - Needham & Company

So that means 100 basis points at least in the 19.3 is coming from Komag. I guess that begs the question, how much of the business do you normally walk into at the beginning of a quarter through auctions with OEMs? And does that really vary by desktop versus notebook?

John F. Coyne

I think first, the 100 basis points is spread over the next two quarters in terms of contribution from the Komag cost improvement. And the -- typically the vast bulk of our OEM business is decided before we exit the prior quarter.

Richard Kugele - Needham & Company

Okay, so the opportunity for upside to your gross margin guidance then has to largely occur within the channel, and so if channel prices are less aggressive than what you are at least anticipating in your guidance, then that would represent the opportunity for upside, plus mix, I guess?

John F. Coyne

We’re running the business the way we run the business.

Richard Kugele - Needham & Company

Okay, and just lastly on your new enterprise announcement, how much of the market do you think, since it is a new drive, can really be addressed by this 2.5-inch 10K product, which I think most vendors have largely shied away from? And then moving that, if you wanted to migrate that 2.5-inch SAS product, how much engineering and time would that take?

John F. Coyne

I think the good news is that there’s a significant infrastructure now in place, and continuing for 2.5-inch form factor in both the blade server and storage markets. And our desire would be to see similar adoption of SATA in that space that we’ve seen over the past four or five years in the 3.5-inch space, so that’s item one.

To your second question, I think the engineering investment in mainstream enterprise is significant, both in terms of development and support, once serving that market. And as we’ve said, our long-term guidance in the 8% to 10% OpEx range adequately covers what we believe is necessary to participate in that market.

Richard Kugele - Needham & Company

Okay. Thank you very much.

Operator

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

Keith Bachmann - BMO Capital Markets

Thank you. I wanted to ask you about mix, both in Q4 and then embedded in your guidance in Q1. This quarter you had a much higher percent of OEM versus disti and retail, and I just want to try to understand how that mix in particular is incorporated within your guidance -- does the mix stay the same? I assume that disti would tick up as a percent, but I just wanted to get a little color on that, and then I have a follow-up, please.

Tim Leyden

As John indicated, we navigated pretty much away from the distribution in order to have a different channel mix, the different segment mix in Q4, and got the benefit of that. As we go into Q1, again the starting point of the pricing has pretty much been set, so we will have an impact on the OEM pricing, as John also indicated. And we expect to have a 2.5 -- with the 2.5 at this stage, 2.5-inch, we’re seeing that most suppliers at this stage have the capability to provide a broad mix. And so consequently, I think that our mix in Q109 will resemble the broader market, whereas we’ve had a competitively advantaged view of that for the last few quarters.

Keith Bachmann - BMO Capital Markets

So Tim, just to push you a little bit, does that mean that disti goes up as a percent of your total units in Q1?

John F. Coyne

The other thing in relation to that to recognize is that while the desktop disti market if a 50-50 disti and OEM market, the 2.5-inch space is more like 80-20 OEM -- 80% OEM, 20% disti, so our success in the 2.5-inch space in and of itself dilutes our overall distribution content in our business.

Keith Bachmann - BMO Capital Markets

But I was thinking, John, if more people are participating in the 2.5-inch space that might suggest that your disti content would actually go up this quarter.

John F. Coyne

Not necessarily.

Keith Bachmann - BMO Capital Markets

Okay, well, I’ll leave it but then the second question is I just wanted to get some thoughts -- your weighted average price this quarter was $56. Does that go up, down, or flat you think in the September quarter?

Tim Leyden

If we look at historical norms, generally it stays about flat or maybe slightly up.

Keith Bachmann - BMO Capital Markets

Okay. Thank you very much.

Operator

Mark Miller with Brean Murray.

Mark Miller - Brean Murray, Carret & Co.

I was wondering if you could comment -- we’ve seen some data in the channel where we are seeing additional pricing pressure, some added rebates from one of your competitors. Are you seeing any worsening of the channel since the quarter began in terms of pricing?

John F. Coyne

I think nothing unseasonal; I mean, recognize that we came in at a pretty low point and expectations I think were not there that the inventory had actually been worked off during last quarter. I think there was a -- despite the data to the contrary, I think there was an expectation that the -- there was more product around than there needed to be, and so turning that perception around has taken a little bit of time.

Mark Miller - Brean Murray, Carret & Co.

One of your competitors for the first time has indicated, apparently the first time in 10 years indicated the possible intention of buying significant [inaudible] from one of your suppliers, TDK. I realize that’s later this year. Do you anticipate that will have any affect on your in terms of pricing or supply?

John F. Coyne

No, I don’t. We’ve had a very consistent approach to sourcing in the open market since we acquired our internal head capability. We’ve had a very long relationship with TDK SAE, a very positive relationship. They are a great supplier. We believe they perceive us as a great customer and we expect to continue to advantage each other as we move forward.

Mark Miller - Brean Murray, Carret & Co.

Finally, any changes in the percent of heads that you are buying from outside in the June quarter over previous quarters? Has that stayed the same, gone up, gone down?

John F. Coyne

Pretty much the same.

Mark Miller - Brean Murray, Carret & Co.

Thank you.

Operator

Richard Kaiser with Sanford Bernstein.

Richard Kaiser - Sanford C. Bernstein

Could you just talk about how you are seeing development of solid state drives into 2009? Is that primarily still a high-end product? It seems that there are a number of NetBooks that are looking, or incorporating solid states. Can you just give us some idea of how you are perceiving that and its development now?

John F. Coyne

Sure. I think we’re looking at it in three distinct market applications for SSDs, the first of those being in the high-end enterprise, which is an [inaudible] requirement, a performance requirement, not really a large storage requirement. And so we’ve seen announcements in that space. We believe that there’s some compelling value being offered there and there certainly seems to be an economic case, as well as a technical case for deployment of SSDs into that kind of environment.

The second area where SSDs have probably been most heavily marketed and have been lightly distributed is in the high style notebook arena -- full featured, full sized notebook, things like the Macbook Air and several announcements from most of the PC notebook manufacturers. In that space, we believe that the customer experience, those few customers who actually have one, that the customer experience has been essentially negative, relative to the overhyped benefits. And that that potentially puts back -- that and the cost put back the adoption rate probably by 12 months against current forecasts.

And then the third area of application has been in the ultra-mobile PC, or the SUSE EPC type market, which is a market focused on meeting price point and providing a level of functionality at a price point.

What we are seeing there is the first generation of those devices, essentially they were with four, eight, 12-gigabytes of Flash memory, and what we are seeing in this year’s announcements over the last couple of months of the second generation is that that market seems to be bifurcating to on the low end, $399 type price point, a 7-inch screen with a 12-gig of SSD and probably a Linux operating system. And then a more functional, more feature, richer machine at somewhere in the $400 pricing point, which is going to a 10-inch screen, operating an XP-based system, and incorporating a 2.5-inch hard drive. So that’s kind of how we are seeing that shaking out.

And it looks like the low-end machine is beginning to develop some penetration in completely new markets that have lower disposable income levels than the markets currently being served by the entire PC portfolio, and we are seeing the higher featured machine targeted as incremental sales into developed markets, where a second PC or a third PC is being bought in that fashion.

Richard Kaiser - Sanford C. Bernstein

That’s very helpful. Thank you. Could you just perhaps give an estimate of what you though SSD share was in 2008 calendar, or where you think it will be in calendar 2008 and then calendar 2009, just approximately?

John F. Coyne

It’s really hard. I don’t think it gets into more than one decimal place.

Richard Kaiser - Sanford C. Bernstein

Okay. Great, thank you very much.

Operator

Mark Moskowitz with J.P. Morgan.

Mark Moskowitz - J.P. Morgan

Thank you. Good afternoon. A couple of questions, gentlemen; I want to first get back to the rank and file, if you could, in terms of the swing factors for your outlook. Getting back to Mr. Bachmann’s question as far as the OEM mix, can you kind of rank order how much is OEM mix versus maybe potential share loss, as manufacturing parity does increase in terms of your competitors now able to execute? And then thirdly, just general pricing dynamics.

Tim Leyden

On the pricing dynamics, and I’ll leave the other part or portion of the question to John, but on the pricing dynamics, we are modeling towards the higher end of what would be the historical norm, so that’s what we see out in the marketplace.

John F. Coyne

We’re not modeling share loss. We’re modeling that our mix, which has been very rich, from the beginning of last fiscal year and getting a little lighter each quarter as we move through the year, our mix becomes to look much like the market demand, and that’s driven by two dimensions. One is that our growth has basically meant that we need to service a market lookalike demand because of our size at each account, and the other piece of that is that as our competitors have gradually come up with the ability to ship the full range of capacities, that provides more choice to our customers also.

Mark Moskowitz - J.P. Morgan

Okay. Thank you on that part. And then, have you ever given us any context around the notebook class drive shipments that WD exhibits each quarter in terms of how much is going into an actual PC versus external back-up? When you guys say you are shipping notebook, is that all for notebook PCs or is that for other as well?

John F. Coyne

It’s for all 2.5-inch shipments, the 11.7 million is our total 2.5-inch shipments. Some of that went into notebook PCs, some of it went into external storage solutions built by others, and some of it went into our own branded products. We don’t break it out.

Mark Moskowitz - J.P. Morgan

You don’t break it out. Is it fair to say that that piece though, the notebook class is higher than your overall branded business, in terms of 2.5-inch versus 3.5-inch shipping into the retail market?

John F. Coyne

I’m not sure I’m getting the question right. Certainly our shipments into notebook computers are significantly larger than the shipments into the external attached marketplace.

Mark Moskowitz - J.P. Morgan

Okay. And then if we could shift gears, John, could you maybe talk a little about your new product tone in terms of -- obviously you said you won’t pre-announce products until you actually start shipping, but your tone seems to be a little more constructive, I think ever since November of ’06 when you first started talking about the enterprise as a potential market. Can you maybe just talk about what’s changed and should we expect more announcements in the coming months ahead?

John F. Coyne

Well, absolutely. I mean, I certainly hope we’ll be making lots of announcements over the course of the next year in order to maintain our current position in the marketplace and actually improve it, so yes, you may expect a significant stream of product announcements over time.

Mark Moskowitz - J.P. Morgan

I’m talking about new market entry though in terms of markets you are not currently serving, I’m sorry.

John F. Coyne

You’ll just have to watch the specific product announcements.

Mark Moskowitz - J.P. Morgan

Okay, and then maybe you can talk a little more about the ST Micro IP and the team. Can you talk about what that can mean for the model, what that can mean for some of your design or new product development down the road?

John F. Coyne

Certainly. As you’ve seen over the past five years, as we’ve grown the company and grown the financial resources of the company, we have also in parallel been gathering in the fundamental technology capability to drive the business forward and to improve the fundamental efficiency from an engineering perspective. When you own all of the technology pieces, you can better and more efficiently and more timely put together the optimization of the system, and so we did that with Hedge, we did it with Media, and we’ve now brought HDC controller design and development back into the company again. We’ve had it outside for maybe eight years, I guess, something in that range. So we brought that capability back in house and the objective there is to improve the efficiency so that the HDC core, just like all of our competitors have their own HDC capability, we now have that and therefore all of the firmware that we write to operate that core can now be common across our multiple drive platforms, and can be -- we’ll continue to then embed that technology in the SOCs, paired up with the best channel and the best execution with our existing SOC suppliers.

So it helps us on efficiency and it helps us on speed.

Mark Moskowitz - J.P. Morgan

Okay, thank you. If I could just squeeze one more in --

Bob Blair

Next question, Mark. We’ll come back.

Operator

Steven Fox with Merrill Lynch.

Steven Fox - Merrill Lynch

Good afternoon. Just getting back to the revenue guidance and maybe as you look out into the rest of the fiscal year, it sounds like you are not seeing any kind of slowdown in demand from any of the end markets. Is that true? And if there’s any acceleration or anything else that’s going on, could you talk about how you view the end markets, given you have another three months to look at the economy?

Tim Leyden

We are seeing all the commentaries like everybody else is seeing from the reporting companies, talking about headwinds and we’re watching very closely in order to see whether there is anything that would be significantly or statistically significantly different from what we would term normal seasonal patterns. And at this point, there isn’t anything that we are seeing. We are seeing normal seasonal patterns.

Having said that, the WD business model is very well-positioned to deal with anything that appears on the macro level because with our focus on asset velocity and our focus on low cost, we are well-positioned to be able to change and adapt, shift focus if we see anything happening. We watch the demand very closely and we are -- but there isn’t anything that we are seeing so far.

Steven Fox - Merrill Lynch

Okay. And then just on pricing, your comments tend to lead us to believe that once you get this hangover in the September quarter from pricing pressures, that the December quarter may look fairly normal off of whatever base we’re in September. What’s the risk that I guess pricing stays tough as you look out beyond this quarter?

Tim Leyden

Given the normal seasonal accommodations and the expected back-to-school season and the seasonally strong Christmas season, and of course always with the caveat of competitive behavior, we would see that once the inventory overhang is gone that we would get back to fairly normal conditions and be able to have a typical upswing in the back half of the year.

John F. Coyne

And to that point, we saw very disciplined industry production rates last quarter. We were surprised and I believe the industry overall would express surprise with how rapidly the inventory overhang was worked off by moderation of production capacity, and so I think that’s a very, very positive sign for the industry. We’ve just got to see the seasonal demand roll in and maintain that discipline into this quarter, and I think your proposition as you opened your questions that things could get a lot better in the December quarter is pretty sound.

Steven Fox - Merrill Lynch

Okay. Thank you very much.

Operator

David Bailey with Goldman Sachs.

David Bailey - Goldman Sachs

Thank you very much. Your branded business continues to show strong growth, despite some slowing on the consumer side. Can you help us understand how you are maintaining those rates? Is it share gains or retail expansion?

John F. Coyne

All of the above. I mean, the fundamental is that we have really cool products that are really easy to understand and easy to use, and that we have great channel partnerships, and that we continue to expand our reach, particularly in Europe and in Asia-Pacific and other developing economies. I mean, we are very, very well-penetrated in the U.S. market but we have lots of growth opportunity in emerging markets.

David Bailey - Goldman Sachs

Thank you.

Operator

Sherri Scribner with Deutsche Bank.

Sherri Scribner - Deutsche Bank

Thank you. I heard a lot of commentary about the desktop market and I apologize if you already comment on this, but can you give us some commentary about what’s going on in the notebook market in terms of pricing? Is it as bad as the desktop market, or is it a little bit better?

John F. Coyne

Notebook is pretty much running to our expectation. It is exhibiting the characteristics of a six supplier market with all six suppliers having capability to address virtually every segment of the market.

Sherri Scribner - Deutsche Bank

Okay, and then in terms of the CapEx guidance, it looks like CapEx is going up about 30% year over year. It’s a little bit more than I would have expected. Can you maybe help us understand why that’s going up 30%?

Tim Leyden

We had anticipated that we would spend a little bit more during the course of 2008, but as we manage our CapEx to a just-in-time capability, we’ve pushed more out into 2009 and that includes our wafer fab conversion, which you’ll notice that we had anticipated that there was going to be a $200 million expenditure in that in the course of 2008 and we actually came in at about 120, I believe. And in 2009, we were going to have $100 million and the slowdown that we had in 2008 is actually spilling over into 2009, which is responsible for most of the up-tick.

Sherri Scribner - Deutsche Bank

Okay, and then I just have a quick question on the bringing in of the controller design technology -- does that allow you to design a controller for a solid state drive or is that only going to allow you access to design for the HDD controllers?

John F. Coyne

We will have the capability to design a controller for any media and any interface.

Sherri Scribner - Deutsche Bank

Okay. Thank you.

Operator

Christian Schwab with Craig-Hallum Capital Group.

Christian Schwab - Craig-Hallum Capital

Thank you. Just on the -- a follow-up again on the controller question; are you ultimately trying to bring the design of your system on-chip controller entirely in-house?

John F. Coyne

Controller portion, yes.

Christian Schwab - Craig-Hallum Capital

Perfect. And then, if one wanted to be an optimist, if possible, the good news that you highlight is that production and inventory are at last in check. Seagate obviously flushed through their entire inventory by getting their builds wrong. The rest of the industry behaved the best they could and watched them sell all those drives. The good news is that perhaps if seasonality and demand continues in the December quarter, that gross margins could improve.

Tim Leyden

Yeah, I mean, that’s what the expectation would be if we get back to -- if we get back to a normal back-to-school season and normal demand patterns in the Christmas quarter, yes. And with the inventory overhang gone, yes, there should be an improvement in margins.

John F. Coyne

Which would be extremely good, given that current margins that we are forecasting are already higher than last year.

Christian Schwab - Craig-Hallum Capital

Right, exactly. Thank you.

Operator

Matt [Nahorski] with Wachovia.

Matt Nahorski - Wachovia

Just a couple of quick questions about headcount; number one, can you just talk about where you added headcount in the quarter and what your thoughts are around headcount throughout fiscal ’09? Thanks.

John F. Coyne

You’ll see headcount increase substantially in the quarterly report, up to 50,000 from about 42. That’s really a factor of a decision that we made in Thailand to convert a large number of contract workers to full-time WD direct employees. Outside of that reclassification, and that brought them into the WD employee report, outside of that reclassification, our hiring was pretty normal, targeting support of our growth as well as specific investments in engineering and other parts of the support structure of the business to drive our future.

Operator

Our last question comes from Scott Craig with Banc of America.

Scott Craig - Banc of America

Thanks. Good afternoon. Just quickly on the CapEx side of things; if I strip out the wafer expenditures, the CapEx is still going to be up around 30% year over year in fiscal 2009, so can you maybe discuss where the CapEx is going to be spent, in particular focusing on how much capacity, perhaps in percentage or in units that you think that you could add?

Tim Leyden

Our component expenditure and our media expenditure together accounts for close to two-thirds of the total CapEx expenditure. And then, in addition to that we have to deal with the mix of test, as the mix gets larger, the -- we have to spend more time on test and therefore more capital expenditure. So the remainder is in the back-end, which is assembly test and R&D type expenditure.

Scott Craig - Banc of America

Okay, so you don’t have any rough estimate on how much you’ll think you’ll increase the unit capacity capabilities in 2009? And is there any -- how does the linearity of the expenditures occur over the course of the year? How much flexibility do you have there?

Tim Leyden

What we’ve been spending in normal business situation, other than the increment that we are spending for the wafer fab conversion, for several years it was at 6% of revenue, and then with media, added about another percent. So consequently, from a modeling viewpoint, a good model to use excluding the increment for wafer conversion, wafer fab conversion is in the 7% range or so.

Scott Craig - Banc of America

Okay, and if I could just ask one more -- there was a couple of times on the call where you mentioned that you felt that the competitors were capable of providing all products across all the ranges for 2.5 and 3.5-inch, but it’s been clear that you guys have had a nice technological lead in the 2.5-inch notebook space, so can you describe the competitive dynamics there, whether you still think you have a lead, how far that lead is, and how long you think it will last, the gap between yourselves and competitors?

John F. Coyne

Of course, it will be our endeavor to maintain it forever. I think we are still advantaged somewhat in the sense that we’ve built the franchise over the last year and we will certainly endeavor to maintain that. And we’ll make product announcements as we ship product.

Scott Craig - Banc of America

Do you feel the competition is closing that gap at all, or will close it in the back part of calendar 2008?

John F. Coyne

I think we’ll have to wait and see who ships what when, and then we’ll know. We don’t pay much attention to announcements of future intent. We focus more on what actually gets done.

Scott Craig - Banc of America

All right, thanks.

John F. Coyne

So in closing, I would like to thank you again for joining us. We are very encouraged by the overall market opportunities for WD growth in the hard drive markets in the years ahead and I look forward to keeping you informed of our progress. Thank you.

Operator

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

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