Maxtor Corp. Q4 2005 Earnings Conference Call Transcript (MXO)

| About: Maxtor Corp. (MXO)

Maxtor Corporation (MXO)

Q4 2005 Earnings Conference Call

January 31st 2006, 5:00 PM.

Executives

Jenifer Kirtland, Investor Relations

Mike Wingert, President and Chief Operating Officer

Duston Williams, Chief Financial Officer

C.S. Park, Chairman and Chief Executive Officer

Unidentified Corporate Speaker, Maxtor Corp

Analysts

Rich Kugele, Needham & Company

Andrew Neff, Bear Stearns

Paul Mansky, Citigroup

Mark Moskowitz, J.P. Morgan

Stephen Weiss, Analyst

Keith Bachman, Banc of America Securities

Harry Blount, Lehman Brothers

Naveen Bobba, Bear Stearns

Mark Miller, Hoefer & Arnett

Phillip Roe, Susquehanna

Andrew Neff, Bear Stearns

Shelby Seyrafi, Kaufman Brothers

Paul Manski, Citigroup

Operator

Good afternoon. At this time I would like to welcome everyone to the Maxtor Corporation Fourth Quarter Earnings Conference Call. Operator Instructions I would now like to turn the call over to Miss Jenifer Kirtland. Please go ahead, ma’am.

Jenifer Kirtland, Investor Relations

Before we begin, I would like to remind you that we will be making forward-looking statements in both prepared remarks and in answers to questions. These remarks will include comments on product development, media procurement and manufacturing strategy and outlook on our first quarter financial results and comments related to our proposed acquisition by Seagate Technology. These statements are based on current expectations and are subject to risks and uncertainties, which could materially affect the company's results.

These risks include but are not limited to market demand for hard disk drives, the company's ability to execute future production ramps and product qualifications, changes in product and customer mix, the availability of components, actions of competitors, the overall pricing environment, the company's ability to utilize its manufacturing assets efficiently, changes in the competitive position of the company's key customers, general economic and industry conditions, the impact of the announced transaction between Maxtor and Seagate on current customer demand prior to the closing of the transaction, the possibility that Seagate's pending acquisition of Maxtor will not be consummated on a timely basis or at all, and the possibility of the combination of Seagate and Maxtor will not provide the anticipated benefits to the combined company.

More details on these factors and other factors, which could cause actual results to differ materially are contained in registration statements and reports that the company has filed with the SEC, including Maxtor's most recent Forms 10-K, 10-Q's and S-3 as well as the joint proxy statement prospectus on Form S-4 that Seagate will be filing with the SEC. We undertake no obligation to update our forward-looking statements to reflect subsequent events or circumstances. Portions of the subject matter discussed in the call to follow, related to the proposed transactions between Seagate and Maxtor will be addressed in the joint proxy statement prospectus.

Investors and stockholders will be able to obtain free copies of the joint proxy statement prospectus when available and other documents filed with the SEC by Seagate and Maxtor through the website maintained by the SEC at www.sec.gov. We urge you to read it when it becomes available because it will contain important information. Seagate and Maxtor and their respective directors and executive officers maybe deemed to be participants in the solicitation of proxies with respect to the proposed transaction. Information regarding participants in the solicitation of stockholders will be set forth in the joint proxy statement prospectus.

Now I'd like to turn the call over to Mike Wingert, President and Chief Operating Office of Maxtor.

Mike Wingert, President and Chief Operating Officer

Thanks, Jenifer. Good afternoon. Thanks for joining us for Maxtor's fourth quarter conference call. With me today are C.S. Park, Chairman, and Chief Executive Officer; and Duston Williams, Chief Financial Officer. This afternoon we announced our fourth quarter results.

We reported a net loss of 15.7 million, which was inline with guidance we provided during our third quarter conference call in October. As expected, our results reflected seasonally strong demand and a slightly improved desktop product mix, partially offset by lower prices on our SCSI drives. On the desktop, we saw good demand in the fourth quarter. We shipped 12.6 million desktop drives in the quarter, an increase of approximately 3.2% from the third quarter. Supply and demand remained in balance. Both Maxtor and the industry exited the fourth quarter with inventory in the channel at under five weeks, pricing was within expectation.

We've been very pleased with the recognition from our global OEM customers of the significant quality improvements that we've made on our desktop drives. As a result, we expect to gain some share of OEMs in the first quarter. We shipped 1.3 million drives to consumer electronic customers, compared with 1.1 million in the third quarter. The increase is driven primarily by participation in additional programs with a couple of key customers. Looking ahead to Q1, we expect a typical seasonal down slowdown in demand. This would translate to our CE OEM volume being flat to down, compared to fourth quarter shipments.

Our brand new products grew nicely in the fourth quarter with units, revenue, ESPs and gross profit margins all increasing from the third quarter. We continue to benefit from our OneTouch brand external storage drive, which remains the market leader. We began shipments of our 500 gigabyte and one terabyte external storage drives. While it is too soon to draw conclusions, we've been very pleased with the early customer acceptance of these high capacity devices. Shipments of MaXLine drives were unchanged from the third quarter. One major OEM is Quad, and is shipping our 500 gigabyte drive. It is in qualification with several other OEMs, and we anticipate that volume of our 500 gigabyte MaXLine product will grow substantially beginning in the second quarter and ramping through 2006. Before I leave this topic of our desktop business I would like to provide an update on the 160 gig per platter drive. We are on track to introduce this product in the second quarter of 2006, and expect it will ramp quickly through the second half of the year.

Now turning to our Enterprise business. Our SCSI shipments increased slightly to 992,000 in the fourth quarter compared with 975,000 in the third. Price declines were within our expectations. As we've discussed previously, until the products gets scheduled for the second half of this year, we are constrained in our ability to reduce cost to the extent necessary to offset price reduction. However, while our gross profit margins on our SCSI drive declined from the third quarter level, they remained well above our 25% target. Shipments of our serial attached SCSI drives continue to grow, especially our 10,000 RPM SAS product line, where we continue to be the sole supplier. In the first quarter, we expect to see the usual seasonal slowdown in the Enterprise market and price declines within historical ranges.

Finally, I’d like to provide a couple of updates on our manufacturing. First, our team in Asia has done an excellent job of ramping volume at the China facility. Approximately two-thirds of our desktop drives shipped in the fourth quarter were produced in Suzhou. We anticipate that the facility will continue to represent roughly two-thirds of our desktop volume, depending on demand. Our internal media operation produced approximately 16 million units in the fourth quarter, and is on track to increase volume in the first quarter of 2006. In light of our pending acquisition by Seagate, we are to reevaluating our plans to move media operation to Thailand. However, the California operation remains wholly committed to its plan to increase production in the U.S. over the next couple of quarters.

Now I'd liked to call over to Duston for a review of our financial performance. Duston?

Duston Williams, Chief Financial Officer

Thank you, Mike. I'll start with the details of our fourth quarter financial results, then I'll provide an outlook for the first quarter of 2006. So let's begin with the income statement. Revenue in the fourth quarter was 969 million, slightly above our previous guidance of 940 and 960 million. Sales to OEM customers were 49% of the total, distributors represented 41%, retail was 10%, Dell and HP were both 10% or greater customers.

Geographic breakdown is as follows: Sales to America 32%; EMEA, 38%: sales to Asia Pacific and Japan were 30%. Gross profit margin was 9.3% in the fourth quarter versus our previous guidance of approximately 10%. Fourth quarter operating expenses were 109 million, inline with guidance of approximately 110 million. We reported a net loss of 15.7 million or $0.06 per share for the fourth quarter. This loss included the following items: a gain of 5.8 million on the sale of a building in Lewisville, Colorado; a 2.2 million gain from the sale of an equity security investment; and a 2.9 million charge for the cancellation of our one-inch product program. Our previous guidance, which had included the gain on the building sale was for a loss of between 10 and 20 million.

Now turning to the balance sheet, we ended the fourth quarter with 581 million in cash and marketable securities, compared with 560 million at the end of the third quarter. We generated 35 million of cash from operations. Accounts receivable at the end of Q4 was 418 million, a decrease of $33 million from the 451 million at the end of Q3. DSOs in the fourth quarter were 39, compared with 44 in the third quarter. Inventories decreased 17 million to 240 million, compared with 257 million in Q3, and inventory turns improved to 15 versus 13 in Q3. The breakdown for the fourth quarter versus the third quarter is as follows: Raw materials 55 million versus 91 million; WIPs 56 versus 51 million; and finished goods 129 million versus 113 million. Capital expenditures total 51 million in the fourth quarter. Depreciation and amortization was 42 million. The cash conversion cycle was negative six days, consisting of 39 days of accounts receivable, 25 days of inventory and 70 days of accounts payable.

I'd also like to provide an update on a couple other financial activities. We have finalized the agreement to sublease 350,000 square feet of office space in our Milpitas, California site, and we have also entered into a sales and purchase agreement to sell our vacant Singapore manufacturing building for approximately 11 million. We anticipate this closing in early Q2.

Now the outlook for the first quarter. Our outlook will continue to reflect the following themes and trends, which we have consistently communicated over the last several quarters. The desktop performance will continue to be challenged until we ramp to volume on our 160 gigabyte per platter platform. Our product costs remain high and ASP declines will continue to outstrip cost declines and mix improvements. Additional shipments of our 500 gigabyte drive will somewhat help offset ASP declines; however, we will not recognize its full profit potential until we reach a higher level of unit shipments.

In Q3 and Q4, we made substantial cost improvements to our repair operations, and also reduced our average return rates. In Q4 alone, these improvements aided our P&L performance by approximately 18 million. Now that we have achieved competitive quality levels, the improvements will be more gradual and have a smaller financial impact in any one quarter. Although our enterprise operations will continue to perform well, and within our business model range, until our product line is refreshed in the second half of 2006, we will continue to experience declining gross margins and profitability.

With this background, I'd like to offer the following guidance for the first quarter. Although it is early, at this point in the quarter we do not see any negative merger-related impact to unit shipments in Q1. In fact, we believe we have the ability to slightly increase our strategic desktop OEM market share in Q1 and, therefore, see revenue levels in the 950 to 975 million range. Gross profit margins will be impacted by the items I mentioned earlier and should be in the 6 to 7% range.

Operating expenses are projected at approximately 110 million. This would translate into a loss of between 45 and 55 million. With approximately 258 million shares outstanding, the loss would be $0.17 to $0.21 per share. It is important to note that the loss includes the following items: Charges of 3.1 million related to stock option expenses to be incurred for FAS 123R; the vast majority of these expenses will be reflected in extra expenses. A 10 million charge for our employee retention bonuses related to our merger with Seagate; these would also be reflected in operating expenses. And a 10.8 million gain from the sublease of our office space in Milpitas that I previously mentioned; this will be reflected as a reduction of restructuring charges. And lastly, a gain of 2 million from sales, sale of shares in the equity security investment, and this again will be reflected in other income. The net impact of all the items listed above is less than 300,000.

I'd now like to turn the call over to C.S.

C.S. Park, Chairman and Chief Executive Officer

Thank you, Duston. In December we announced that we had entered into a definite agreement to be acquired by Seagate Technology. As we have mentioned, we are very excited about this opportunity. We believe Maxtor will benefit by combining with the industry technology leader, allowing us to offer a broader, more competitive set of products to our customers more quickly and more cost effectively. And it will strengthen our financial and competitive position within the overall storage market. Since the proposed acquisition was announced, my executive team and I have spent a lot of time in face-to-face meetings with our customers and suppliers. I am pleased to report that nearly everyone we have met with understands the rational behind the transaction, and has expressed an interest in working with us over the next few quarters as we go through the transition.

I’d like to provide a brief update on the timeline of the acquisition. The U.S. anti-trust filing was submitted on January 13. The Federal Trade Commission has 30 days from that submission date to complete its review or request additional information. Over the next several weeks, we will be working to file our 10-K for fiscal 2005. The statutory deadline is March 16, but we will try very hard to file before that date. Seagate will then file a preliminary joint proxy statement prospectus with the SEC. We are tentatively targeting a shareholder meeting for June, with a closing date for the transaction in the second half of 2006.

Before I turn the call over to Q&A, I’d like to express my sincere thanks to all customers, suppliers and especially to the Maxtor employees worldwide for their support during this time of transition. I'm especially proud of our employees who through this challenging period have continued to demonstrate the highest standards of professionalism and dedication. Operator, we will take questions now.

Questions-and-Answer Session

Operator

Operator Instructions Your first question comes from Rich Kugele.

Q - Rich Kugele

Thank you. I guess first, when you look at your Enterprise line, you are the only one who has a 10K SAS product. You've commented in the past that this has had some interest among the customers, yet Seagate, for example, does not have that product and does not seem to really intend on having one of their own. Do you believe that product will survive as a Maxtor brand for a period of time? Any thoughts on how this in particular could fit into the combined company?

A - C.S. Park

Mike?

A - Mike Wingert

Sure. I think you're absolutely correct. The 10K SAS is a unique product for Maxtor. We've had a lot of interest from another, a number of global OEMs along with a number of regional OEMs in that product. It's probably too early to say where Seagate will go with their product roadmap going forward, but they expressed a real interest in the 10K SAS product and continuing it through 2006 and into 2007. So, we'll see how that goes going forward, but I definitely think they're interested in it going forward.

Q - Rich Kugele

And then I guess, secondly, in terms of the channel, obviously you and the others have had considerable success in maintaining inventory levels and keeping a channel discipline. Should we assume that that would be the status quo throughout the 2006 timeframe until the merger?

A - Mike Wingert

Yeah, there is absolutely no reason, you know, this is, we're running it as obviously a standalone independent company, and we'll continue our past practices into the future and we'll go from there.

Q - Rich Kugele

And then I guess, in terms of more the near-line market, the 500 gig, you’ve commented I believe, you had one quale so far. Can you repeat that and where do you think that's going to fit in against Seagate's 500 gig, which will be based more on, ultimately I guess, the 160? Today it's probably the four platter 125s, but the - overtime, which would defer to the other?

A - Mike Wingert

Yes, we're making good progress on the 500 gigabyte product. We started shipments in Q4. We'll ramp the shipments pretty dramatically here in Q1. And that's going well. The customer qualifications are going well. I think we're actually at one up to two, and there's several more coming online here in the near future. As far as the roadmap for the future on the 500 gig, it's really too early to tell where that's going to go. I think that remains to be seen, as we work together.

Q - Rich Kugele

Okay, and I guess just Duston, the last question. You know, with the dynamics that you mentioned about the gross margin unlikely to really change until the Q2, Q3 timeframe, should we assume that this is kind of what your gross margins going to be for, you know, the next three to six months?

A - Duston Williams

Certainly for the next three months. For this quarter, yes. But you're right, there's not a whole lot of changes as you go into the Q2 timeframe. We'll start to ship some of the 160 platform but it won't be a significant piece of the volume.

Q - Rich Kugele

Okay. Thank you very much.

Operator

Your next question comes from Andrew Neff with Bear Stearns.

Q - Andrew Neff

Two things. What are you doing to keep the people incentivized during this period? Second, I guess same thing in terms of customers. What are you, can you talk about things you're doing to maintain customer relationships?

A - C.S. Park

Well, we have instituted a major retention plan for our key employees, which is very extensive, and we feel very good about it. I hope that employees seize the benefits, though. And this is a period that we all trying to work together. Regarding customers, we have significant encouragement from our customers to continue to deliver our current set of products. Our 2006 plan remains unchanged, we continue to commit to meet the requirements and needs of our customers, such as some of you mentioned about 10K SAS products. So, we feel very good about customer retention at this point in time.

Operator

Your next question comes from Paul Mansky with Citigroup.

Q - Paul Mansky

I guess kind of related to some of the other points you made, at what point during the process leading up to the close of the acquisition can you actually start conducting some level of joint planning with Seagate? And has that occurred at any level?

A - C.S. Park

Again, at this point it's Paul, a little bit early in terms of integration process. Clearly we have a few opportunities, particularly post-closing planning in terms of manufacturing and other related matters. So, yes, there will be a series of process actions that will go on. And each company has just established integration office and we are about to launch that process.

Q - Paul Mansky

Okay. So, no discussions as of yet, that's about to be launched?

A - C.S. Park

Exactly.

Q - Paul Mansky

And then Duston, just on a housekeeping basis, what was your FAS 123 charge in the December quarter?

A - Duston Williams

We'll start actually in the March quarter, Paul.

Q - Paul Mansky

Okay. Do you have a rough idea of what it would have been in?

A - Duston Williams

It'll be close to the 3 million.

Q - Paul Mansky

Okay, great. Thank you.

Operator

Your next question comes from Mark Moskowitz with J.P. Morgan.

Q - Mark Moskowitz

Yes, hi. Thank you. A few questions if I may. The first question gets back to the 160 gig transition for you guys. Obviously, Seagate is quite far ahead by most estimates here or actuality. I want to see when do you say the June quarter, does that mean you're going to be shipping for qualification on 160, or is that going to be starting to ship for actual major revenues?

A - Mike Wingert

We'll be shipping significant volumes in Q2.

Q - Mark Moskowitz

Significant volumes. Is that more on the distribution side or across…

A - Mike Wingert

Probably starts in distribution, while the calls are going on, and then the costs come on later in the quarter.

Q - Mark Moskowitz

Okay. And then secondly, I wanted to get back to the China facility. I think you guys said two-thirds of your desktop went through that facility. Correct me if I'm wrong, but I thought you were anticipating getting close to 100% of your desktop drive is going forward. And I just want to get a sense, are you kind of changing that plan now, in light of the potential merger, and that the two-thirds maybe static, given a little flexibility post merger?

A - Mike Wingert

Actually, over the last year we've been very consistent about – talking about two-thirds of our desktop volume going into China, and we're real proud of the fact that we've been able to do that over the last year. We'll continue with that plan, as we go forward. We'll continue to put volume at about that rate into China.

Q - Mark Moskowitz

Okay. And then just lastly, on the finished goods ramp, in terms of your inventories in the December quarter, can you kind of walk us through at what were the drivers there in terms of why that kind of spiked?

A - Duston Williams

Little bit more in Enterprise. We had brought down some level of JIT inventory in the prior quarter. Some of this is building up some of that stuff.

Q - Mark Moskowitz

Okay. Thank you.

Operator

Your next question comes from Keith Bachman with Banc of America Securities.

Q - Stephen Weiss

Hello. Actually, this is Stephen Weiss for Keith. A couple questions to ask. For the next six months what would you say are your risks moving forward for your major raw materials?

A - Mike Wingert

I think we've done a good job working and communicating with our supply base, and they've been quite supportive. There's been a lot of good meetings here over the last few weeks to get the supply base on and supporting us. So I think that's working well. Obviously, we are all concerned about their wanting to be a part of the combined company going forward, and that opportunity is allowing them to continue to support Maxtor well. So, I think that the key risks are, you know, for much more future projects and getting investment on those future projects.

Q - Stephen Weiss

What would you say the raw, or the raw materials are concerning you, though?

A - Mike Wingert

Well with substraights continue to be in tight supply, we feel like we're okay for Q1 but we'll continue to watch that but it is tight. And as we’ve said before media continues to be constrained. I feel good about the head situation.

Q - Stephen Weiss

Right now your suppliers are real informed with the merger, and they think they're going to have a win-win for both sides?

A - C.S. Park

Yes. I think generally as Mike said, this is C.S. They clearly have expressed an interest in continuing to serve the combined company. So particularly, as long as they are competitive, I think clearly I understand Seagate also publicly stated they are open to looking at other sources and in relationship. So, this is potentially a great opportunity and we are trying to give a fair opportunity.

Q - Stephen Weiss

And final question, other than where are you working the gross supplies, what are some other types of supply-side initiatives that you're putting in place to offset high material cost and the economy that we're experiencing right now?

A - Mike Wingert

We don't have any specific initiatives. We've got, we're just working with our existing suppliers and we feel pretty good about the progress that we're making.

Q - Stephen Weiss

Then, C.S. last thing. Over the next six months, before you guys merge, what would you like to accomplish as CEO?

A - C.S. Park

Well, that's a very good question. I'm trying to hold together our team, and I think we have a good basis in terms of support from the employees and customers and suppliers. But yes, that's my, the clearest objective is to bring the best part of the Maxtor performance to the combined company, so that combined company has a good basis to move on. Thank you.

Q - Stephen Weiss

All right. Thank you very much.

Operator

Your next question comes from Keith Bachman with Banc of America Securities.

Q - Keith Bachman

Hi, guys. Two questions, if I could. You talked about share loss or potential share loss, you really haven't seen any. I was wondering if you would give us more flavor on your conversations with your OEMs, in particular, and/or the disk drive side, and would you expect if there were share loss, would that just be focused on the desktop side? That's question number one, and I'll hold off on question number two, please.

A - Duston Williams

It's really too early to tell on share loss. We haven't seen it at all, and as we've stated today, we actually feel like we've got some upside here in Q1, primarily in the global and regional areas on the desktop. So, we would need to continue to execute, and I believe that we can continue to hold our share as we go forward, and that's our plan.

Q - Keith Bachman

Right, but, sorry, let me just test that thesis. I was assuming that in your conversations if you did see share loss, it would be closer to a time of merger close, is that not a reasonable assumption?

A - C.S. Park

I think my assumption is obviously for the latter part of this year. Clearly depends on, also how the merger closing time happens. So I would say that this is a much more relevant subject probably in the second half of the year depending on the closing time.

Q - Keith Bachman

Okay. Fair enough. Let me try my second question, then. If Maxtor were to remain an independent company, how would you think about the ability of media to obtain the necessary media to deliver against your expectations for the balance of the year, whether it be the substraight start or finished media?

A - C.S. Park

Go ahead.

A - Mike Wingert

We feel like we're well positioned this year for media. We've got the right relationships substraights with our key suppliers, going forward. We feel like we're set up well, got a great relationship with Kite, excuse me, with Comag to supply its media this year. And we've been increasing the media supply internally to Maxtor here with adding additional lines. So we feel like we're well positioned.

Q - Keith Bachman

Okay. Thank you.

Operator

Your next question comes from Harry Blount with Lehman Brothers.

Q - Harry Blount

Hi, guys. Couple of questions. First of all on the OEM mix, I heard your comments on the call about being pleased with the progress and reception from the OEMs. And then I look at the OEM business sequentially, and it was actually down a little bit. I was wondering if you could comment on that first of all?

A - Mike Wingert

Yes. Our comments really, Harry, on market share and potential gains here going into Q1 that’s what we were referencing there. So, hopefully you'll see a little pickup in that percentage in Q1.

Q - Harry Blount

Okay. And then if I kind of parse through your comments on the various segments, if memory serves, you talking about CE being down a little bit sequentially in the March quarter, and Enterprise being down a little bit sequentially in the March quarter, so what gives you the confidence that you'll see that much of a share increase in a seasonally weaker quarter, given some of the uncertainty in the overall market dynamics?

A - Duston Williams

I think what you'll see is volume will be flat on the Enterprise quarter-over-quarter; maybe right around flat. You'll see the consumer electronics business running about flat for us from a volume perspective. And you'll see a tick-up as we stated, on the global and regional side of our desktop business, which will account for the revenue numbers we talked about.

A - Mike Wingert

And, obviously, we've had those discussions, and those plans are put in place with the strategic guys for Q1.

Q - Harry Blount

Okay. And then one final question on this side is, Duston, looking at the balance sheet looks like the prepaids kicked up quite a bit. What does that relate to?

A - Duston Williams

Should be the Comag payment.

Q - Harry Blount

Got it. Actually there is one other question. You mentioned an $18 million benefit this past quarter from the improved quality, did that impact entirely in the cost of sales line or was there some below the line, as well?

A - Duston Williams

It was all in cost of sales.

Q - Harry Blount

Okay. Thank you.

Operator

Your next question is from Naveen Bobba.

Q - Naveen Bobba

Thanks. Just a couple of clarifications, I guess, really on the entry on the inventory I mean balance sheet, Duston, finished goods picked up a bit from Q3 to Q4. I would think they'd go down. Any reasons why they went up as opposed to going down?

A - Duston Williams

Yeah, we had some, there were a scattering around, but there was some places that we refreshed some JIT inventory at certain locations.

Q - Naveen Bobba

And raw material came down quite a bit?

A - Duston Williams

Yes. Trying to focus on bringing that down and we did, we had a couple things that we pulled in Q3, and we didn't do that in Q4.

Q - Naveen Bobba

Okay. And looking at the first quarter, I would like to, what are you expecting in terms of pricing trends for desktop into 1Q. You will gain some share, that's kind of what you're saying, but what do you expect for pricing?

A - Mike Wingert

Yeah pretty much normal from a trend perspective. We're trying to win this business as the quality comes back and people get more comfortable with the quality aspects of our products. That's what we're focusing on but it will be a normal seasonal Q1ish-type decline.

Q - Naveen Bobba

Yes. Thank you.

Operator

Your next question comes from Mark Miller with Hoefer & Arnett.

Q - Mark Miller

First question, I'd like to ask a little bit more. I guess I'm a little more alarmed than some about the margin decrease, especially since revenues are going to stay high. It seems like you're flat on Enterprise and consumer-ships, and it seems like it's beyond what the other companies are saying. And can you tell us anything more? It just seems high to me, even though it's a March quarter in terms of the decrease in margins you're seeing.

A - Mike Wingert

Yes, fair question. You know, we've said all along that our desktop business is cost-challenged, and it will continue to be cost-challenged until we ramp the 160 quite honestly, and we are seeing margin decrease in the desktop. We also are seeing margin decrease in the Enterprise business. As far as a pretty big chunk, that was still above our business model in Enterprise, but you're going to continue to see those margins come down also.

Q - Mark Miller

Okay, my final question is that there's a significant difference between you and Seagate in terms of component purchases whether it's head, suspension or media. What do you feel, or where are we going, are we going to revert back in terms of how we buy and build suspensions, do you feel eventually we will translate back to what Seagate typically does? I know TDK said yesterday in their announcement that they expect a significant decrease next year in the number of heads they're going to sell you. I'm just wondering anybody else will, do we see any major shifts back more to the Seagate way of building versus buying components outside?

A - Mike Wingert

I think, you know, it remains to be seen as we go through the merger process in 2006. We'll continue to operate with our current suppliers, using TDK and LPS, and we'll continue to execute to our plan through the end of the merger. I would anticipate that being able to use the power of its vertical integration going forward, but I still think there's great opportunity for some of our key suppliers in the combined company as well.

Q - Mark Miller

What about suspensions? It's my understanding that Seagate does quite a bit more business with Hutchinson's competitors than you do. Is that true and do you think that'll, we'll revert to that stall?

A - Mike Wingert

I don't think we can speculate on that at this point.

Q - Mark Miller

Thank you.

Operator

Your next question comes from Phillip Roe with Susquehanna.

Q - Phillip Roe

Thank you. Good evening. Duston, can you give us a range or an idea of what percentage of revenue was from the different product to enterprise, desktop. Granted, I know you've given that range in the past?

A - Duston Williams

Well, we've given models our percent ranges, and we've typically don't give finite percentage breakouts of the product lines.

Q - Phillip Roe

Okay. So was Enterprise down below the model range?

A - Duston Williams

No, it was above. It was above in revenue percentage, and it was above in gross margin percentage.

Q - Phillip Roe

Okay. And for the components of gross margin on the Enterprise side, it was within normal expected ranges, that wasn't sort of any sort of liquidating of inventory on the Enterprise side?

A - Duston Williams

No. No. I mean, the Enterprise margins, they were above our 25, quite a bit above our 25% target.

Q - Phillip Roe

And do you have an idea of where your cash flow from operations will be going forward?

A - Duston Williams

It's going to come, cash flow from operations depends on the linearity for the quarter, quite honestly, so we'll see how that plays out.

Q - Phillip Roe

Okay. And do you see any unmet demand in high capacity Enterprise drives in Q4 or for this month and in your customers?

A - Duston Williams

I think it's a pretty balanced situation right now. If you look at the inventory in the channel, it looks very balanced.

Q - Phillip Roe

Okay. Thank you.

Operator

We will go on to the next question. Your next question comes from Andrew Neff.

A - Mike Wingert

Andy?

Operator

Mr. Neff, your line is open. Mr. Neff?

Q - Andrew Neff

Yes, can you hear me okay?

A - Mike Wingert

Yes.

Q - Andrew Neff

Given that your gross margins probably below where expectations are and the earnings are also, is there anything in the Seagate agreement that would lead to a re-pricing of the agreement or changing of the terms at this point?

A - C.S. Park

There is no such a thing in terms of changing the pricing. There is a very fixed exchange ratio, not contingent upon short-term circumstances or changes. So the answer is no.

Q - Andrew Neff

Okay. Thank you.

Operator

Your next question comes from Shelby Seyrafi with Kaufmann Brothers.

Q - Shelby Seyrafi

Yes, thank you very much. A few questions. One is are you changing any of the terms of the prior agreements you have with any of your chip suppliers now that Seagate's acquiring you? Or will you keep those agreements unchanged until the deal closes?

A - C.S. Park

The answer is that, yes, we keep those agreements, prior agreements unchanged.

Q - Andrew Neff

Unchanged. Okay. And secondly, what was your like-for-like and blended average ASP declines for your Enterprise drives?

A - Duston Williams

We don't give that out.

Q - Shelby Seyrafi

Can you say if they were more than 5%?

A - Duston Williams

No, because we'll go down a road we don't want to go down, so we just don't give that level…

Q - Shelby Seyrafi

I'm trying to figure out your gross margin decline versus your expectations. Was that due to media constraints more or from Enterprise-derived pricing falling down more than you were expecting?

A - Duston Williams

I wouldn't attribute it to any specific thing. There were a couple little things in there that added about 0.7% difference from the guidance.

Q - Shelby Seyrafi

Okay. Thank you.

A - C.S. Park

Operator, we have time for probably one more question.

Operator

Okay. Your final question comes from Paul Manske with Citigroup.

Q - Paul Manski

In under the wire. Great, thank you. Just a clarification with respect to your internal media supply. Did I hear you correctly you and you said 16 million during the quarter? And can you tell us where you see that headed over the next quarter to two?

A - Duston Williams

Yes. We got 16 million this past last quarter. It'll continue to increase, as we bring on our new lines, and so you'll see that go up to over, to little over 17 million this next quarter.

Q - Paul Manski

Great. Thank you very much.

C.S. Park, Chairman and Chief Executive Officer

Well, thank you very much for your interest. We will look forward to speaking to you again soon. Thank you.

Operator

This concludes today's Maxtor Corporation fourth quarter conference call. You may now disconnect.

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