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Bob Blair - Investor Relations, VP
Thank you and welcome to the Western Digital Corp, conference call, for our fourth quarter result.
This is Bob Blair, Vice President of Investor Relations.
Before we begin, I want to remind you that during the course of this call, we will be making forward-looking statements in our comments and in response to your questions concerning the growth of a hard drive industry and the desktop PC market, our transition to 80 gigabyte technology including our yield and the anticipated impact of such transitions, expected supply and recording our acquisition of the assets of Read-Rite Corp, the expected operation and benefits of such business that we expect to have accretive effect on our earnings, effective gross margin impact, capital expenditures and financing, the expansion of Serial ATA technology in the enterprise market, our expansion into the mobile hardware market, and our business and financial outlook for the next quarter.
These forward-looking statements are based on current expectations and actual results could differ materially as result of several factors, including the company's ability to execute future production road maps, uncertainties related to the development and introduction of products based on new technology, difficulties and reducing yield losses from complex manufacturing processes, pricing trends, and other competitive factors, changes in product and customer mix, business conditions and growth in the PC industry, the availability of product components and other factors listed in our recent SEC filing and in our fourth quarter press release issued today.
We undertake no obligation to update our forward-looking statements to reflect subsequent events or circumstances.
I would now like to turn the call over to Matt Massengill, Chairman and Chief Executive Officer of Western Digital.
Matthew Massengill - Chairman and CEO
Thanks Rob.
Good afternoon and thank you for joining us.
With me today are our President and Chief Operating Officer and Scott Mercer, our Chief Financial Officer.
During my remarks, I will provide some brief commentary on our quarterly results and then some perspective on both our transition to 80-gigabyte per-platter technology and our winning bid to acquire the assets of Read-Rite Corp, announced earlier today.
Western Digital team continued to execute very well in the fourth quarter, delivering another solid set of financial results.
I want to highlight a few noteworthy numbers on a year-over-year basis that demonstrates what we have communicating for two years - that we have a business model that is highly leveraged to grow.
In fiscal 2003, we achieved 26% year-over-year growth in revenue with $2.7b.
We grew operating income more than 300% to $205m.
We increased net income more than 200% to $200m and we ended the year with a cash balance of $393m having generated 281m in cash from operations during fiscal 2003.
This performance was the result of our relentless day-to-day focus on running a highly efficient and flexible business that has consistently produced high quality hard drives.
We have earned a strong position with leading PC makers, distributors and retailers in our core 3.5-inch desktop hard drive market.
We have grown our business in Asia Pacific, one of the fastest growing and most under penetrated markets of the world and we have successfully entered new markets for Western Digital such as consumer electronics and enterprise storage.
Specifically in the new enterprise Serial ATA market, we expanded our product line in the June quarter with a WD Caviar 7200 RPM, Serial ATA drive, to complement our WD Raptor 10,000 RPM model, both of which have grown strong customer interest.
The industry has witnessed steady momentum building in the enterprise space ranging from workstations to high performance, highly reliable storage subsystems.
While much of the focus for the past year has been on a dismal IT spending environment, the hard drive industry has been growing.
Despite the June quarter's typical seasonality, the hard drive market held up quite well in terms of unit growth on a year-over-year basis.
Based on preliminary estimates we have seen the 3.5 inch EIDE hard drive market grew 7.5% year-over-year in the June quarter and increased 9.8% for the first six months of calendar 2003 versus the first half of calendar 2002.
Throughout the last few years, the major hard drive players have been independently demonstrating rationality and discipline in meeting customer needs and generating profits and cash for their shareholders.
On the pricing front, our preliminary analysis based on recorded June quarter results indicates that the average selling price has remained essentially flat for the last five quarters.
On the inventory level side we have seen consistent management within target ranges of four to six weeks throughout the last year.
I would now like to turn to some topics that have received a lot of attention lately in the investment community and the press, namely our transition to 80-gigabyte technology, our strategy for supply of recording heads, and our winning bid for the assets of Read-Rite Corporation.
I can report to you today that Western Digital's transition to 80-gigabyte per-platter technology is essentially complete.
Our yield with this technology have met or exceeded our expectations.
We have qualified 80-gigabyte technology with all leading OEM customers and we are shipping the technology to each of these customers.
We have maintained our leadership position at the very high-end of the desktop market with the fastest, highest capacity drive based on 80-gigabyte technology, the WD Caviar 7200 RPM 250-gigabyte model in both serial and parallel interfaces.
In the September quarter, the vast majority of drives that we ship above the 40-gigabyte capacity point will be based off the 80-gigabyte technology, which translates into a significant portion of our total output.
We will continue to address the capacities at 40 gigabyte and below low, primarily with the 40-gigabyte technology for the same compelling economic reasons we have cited before.
As previously indicated, we have not seen, nor do we anticipate any share losses associated with our more deliberate ramp of this program.
Turning to the supply of recording heads.
Read-Rite bankruptcy raised questions about near- term and long-term supply in the merchant market for non-vertically integrated players like Western Digital.
Our supply of recording heads for the foreseeable future is locked in and secure including 80-gigabyte per-platter technology.
Our decisions to acquire substantially all of the assets of Read-Rite Corporation is an important step to assure our long-term access to recording head technologies and to increase our operational flexibility.
We are delighted that the bankruptcy court reopened the bidding yesterday and as a result we were able to secure the winning bid for these asset.
As indicated in our announcement, the acquisition is subject to certain closing conditions.
While I am not underestimating the significant challenges associated with this undertaking, it is our intention to combine our operational expertise with the strong technology heritage and expertise of Read-Rite to run the most efficient head business in the industry.
Many have challenged the capability of Read-Rite as they struggled through the 40-gigabyte technology transition.
But make no mistake.
They have otherwise been among the industry technology leaders in the last decade, often times outperforming the captive head suppliers.
In fact, Western Digital has never failed to qualify a Read-Rite head in that time period.
They have very good technology, but they have been challenged operationally.
We plan to fix that, as operational focus on excellence is the core strength at Western Digital.
Furthermore and we can speak from personal experience on this front, the most motivated workforce in the world is one that has once been successful, but recently written-off as a failure.
I can assure you that the Read-Rite employees and their future colleagues at Western Digital are anxious to demonstrate once again that this crew can be an industry leader.
The Western Digital Management team has demonstrated the ability to lead this kind of recovery in the past and it is eager to demonstrate that capability again.
As indicated in our press release, we will finance the acquisition from working capital.
We expect the operation to be accretive to earnings by the September quarter of calendar 2004.
This is a shift in strategy at Western Digital, a change that was prompted by Read-Rite's bankruptcy.
It was also prompted by our desire to improve our access to recording head technology, our flexibility, and our cycle time as well as to achieving more competitive cost structure.
We have already been successful in integrating processes such as head stacking and printed circuit board assembly, all of which has increased our flexibility and reduced our cycle time.
I would also note that we have demonstrated the ability to acquire and make productive quickly a purchased operation when we ramped the former Fujitsu drive operation in Thailand within several weeks after closing the transaction.
I do want to emphasize that just as we rely on a merchant supply base for a meaningly - meaningful percentage of our vertically integrated assembly processes, we expect to rely on our existing independent head suppliers in similar fashion maintaining our strong commitment to the external supply base and these long-standing relationships.
As for our outlook, in the near term, we continue to believe that the PC market will have growth of about 8% for calendar 2003 reflecting our confidence and a steady improvement in this market between now and the end of the calendar year.
As we begin the September quarter, we have seen strong sell-through rates, good polls from OEM customers, and continued pricing moderation.
In addition to a large and growing PC market, we see significant growth drivers in the enterprise market for Serial ATA drive, and in the consumer electronics market, these markets continue to gain traction.
The Mobil hard drive market is another growth opportunity for us and we have recently moved from technology staging to active design work on a 2.5-inch product [family.
I will now turn the call over to Scott Mercer for review of the Q4 results and do our outlook for the September quarter.
Scott?
Scott Mercer - CFO
Good afternoon everyone.
As Mat indicated, the June quarter exhibited fairly normal seasonal pattern.
Reasonable industry demand coupled with another quarter of superb execution by the Western Digital team enabled us to deliver outstanding financial results.
These results continue to provide proof of the earnings leverage and financial discipline inherent in Western Digital's business model.
After providing the details of the fourth quarter, I will run an outlook for our 2004 fiscal first quarter.
Revenue for the quarter was $680m, up $140m or 26% from the prior year and down $26m or 4% from the seasonally stronger March quarter.
Unit shipments of 10.5m were up 2.5m units from the prior year or 31% and up 200,000 units from the March quarter.
Average selling prices were approximately $65 per unit, down $3 per unit in both the March quarter and the year-ago quarter.
Shipments to consumer electronics customers were approximately 6% of our unit volume for the quarter.
Revenue by channel was 52% OEM, 41% distribution, and 7% retail versus 53% OEM, 39% distribution, and 8% retail for the March quarter.
Once again, we had two greater than 10% customers during the quarter, Dell and HP.
The Q4 geographic split of the business was 46% North America, 26% Europe, and 28% Asia as compared to 48%, 31%, and 21% respectively in the March quarter.
At 28% of revenues, our Asian business is at its highest level ever and reflects the positive results of our focus on that market.
Our gross margin percentage was 16.4%, up 270 basis points from the prior year and down 90 basis points from the March quarter.
Operating expenses were 65m or 9.5% of revenue, up 30 basis points from the March quarter but flat from a dollar perspective.
Operating income was 47m for the quarter, up 30m from the prior year and down 10m from the March quarter.
As a percentage of revenue, operating income was 6.9% in the current quarter versus 3.2% in the prior year.
Interest and other income totaled 3.9m including 3.4m of investment gain.
Income tax expense was 2m for the quarter.
Net income was 48.8m or $0.23 a share as compared to the net income for the year-ago quarter of 13.1m or $0.07 per share.
Fully diluted shares outstanding were approximately 213m, up 6m from the March quarter because of increased option exercises and stock option equivalents associated with our higher stock price.
Turning into the balance sheet, our cash balance at the end of the quarter was 393m, up 46m from the March quarter.
Cash generated from operations was 44m for the quarter, up 34m from the prior year quarter.
Capital expenditures were approximately 18mfor the quarter and our non-cash charges for depreciation and amortization totaled approximately 14m.
Proceeds from option exercises provided an additional 23m.
Other investing and financing activities included proceeds of 3.4m from the sales of investment securities offset by a $5.9m payment related to discontinued operation.
Our cash conversion cycle for the quarter was a negative eight days.
The current quarter conversion cycle consists of 33 days of receivables, 16 days of inventory or 23 times, and 57 days of payables outstanding.
Like Matt, I'd like to spend a few minutes talking about our fiscal year results, with the focus on some additional comparison.
We're all very proud of what we've accomplished in fiscal 2003.
Here are some of the high points.
We ended the year with total revenue of 2.7b, an increase of 567m or 26% from fiscal 2002.
Total unit shipments were 39.7m, an increase of 37% from 2002.
Gross margin for the fiscal year was 17%, an increase of 390 basis points from 2002.
Total operating expenses were 256m for the year.
As a percentage of revenue, operating expenses declined to 9.4% from 10.7% in 2002.
Operating income was 205m for the year versus 51m for 2002.
As a percentage of revenue, operating income increased to 7.6% from 2.4% in 2002.
And Net income was 200m for 2003 versus 65m for 2002, over 200% improvement.
Earnings per share of $0.97, increase of 188% from 2002.
On the balance sheet side, we generated cash from operations of over 280m for the fiscal year and our earning cash balance of 393m is up 170m from the prior year despite having paid off our entire debenture balance of 88m.
That was a look at our fourth quarter and our fiscal year.
Now, I'll move on to our expectations for our first fiscal quarter.
Note that this outlook for our business in the September quarter does not consider the impact of our acquisition of Read-Rite announced today.
We will provide more detail later in the quarter to review the changes to our business model as a result of this acquisition.
For the September quarter, we expect revenue to be between 680m - 750m and shipments between 10.7m and 11.2m units.
Our gross margin is expected to be approximately 16%.
Operating income is expected to be between $48m and $52m.
The net of interest income and tax expense should be an expense of about $1m.
Accordingly, we expect net income between $47m and $51m or earnings per share of $0.22 to $0.24.
Our share count is expected to increase slightly, as more options are exercised or make their way into diluted calculation.
In closing I would like to make few remarks regarding our acquisition of Read-Rite.
I want to emphasize, that we expect our recording head manufacturing operations, will be accretive to earnings by the first quarter of fiscal 2005, if not sooner.
Also we do not currently anticipate doing any financing transaction, to fund the acquisition.
Regarding the long-term impact of the acquisition on Western Digital business model, clearly our capital expenditures will increase on an annual basis.
As a data point, Read-Rite in serving multiple customers, averaged about $80m per year in capital expenditures over it's last three reported fiscal years.
Our expenses for research and development will of course increase in support of these operations.
Prior to its pre-bankruptcy downsizing, Read-Rite was spending about $10m per quarter in R&D.
Clearly we believe our gross margin expansion because of lower component cost, will more than offset these expenses.
Although we have not yet quantified the near term impact of the acquisition on our operating results, we believe that the cost and expenses to restart the Read-Rite operations are modest, and we hope to be up and running within a matter of weeks, after the close of the transaction.
With that I think we are ready to open up for questions.
Thank you Operator, if you can please open the call up for Q&A.
Operator
Thank you.
Ladies and gentlemen, we will now begin the question and answer portion of today's call.
As a reminder today's call is being recorded, if you have any objections you may disconnect at this time.
If you have a question, please press star one on your touchtone phone and questions will be answered in the order they are received.
If you would like to withdraw your question, please star two.
Again to ask a question, press star one on your touchtone phone.
One moment please, for the first question.
Operator
And the first question comes from Harry Blount, and you may state your company name.
Harry Blount - Analyst
Hi, thanks.
Lehman Brothers.
Several questions.
First on the core operations.
Scott, you talked a little bit about the strength in the Asian Geo, some of the actions you took.
Can you be a little more specific as to why you saw it as a pretty dramatic increase sequentially?
Arif Shakeel - Pres. and COO
Yeah, this is Arif.
We had talked about this several times.
Our penetration in the Asia market was not what we wanted to be and with our focus, we've just increased our sales by more focus in the Asia market.
It's not the statement of the market, it's a statement of our share in the Asia market.
Harry Blount - Analyst
Okay, is there any particular country that -
Arif Shakeel - Pres. and COO
Across the board from Japan to Singapore, we increased our penetration in all the countries.
Harry Blount - Analyst
Okay.
Next question is, obviously there has been a tremendous amount of concern over, once the transition to 80 is complete, the impact on some of your 10% customers and your market share within, can you maybe discuss some of the traction that you may be getting with some other OEMs to offset, if there are any market share losses there.
And why you don't think you are going to lose share within some of your top 10 OEMs?
Scott Mercer - CFO
Sure, Harry.
First of all, you know, the 80 Gig transitions will have absolutely nothing to do with any share gain or loss, relative to our performance at our top OEM customers, and we are going to do everything possible to maintain very strong positions with all the customers that we are doing business with today.
And expand those relationships where we can do so, any given quarter, any given account, share moves around a little bit, but with that said, we feel pretty comfortable in our current aggregate top 10 share position around the world and are going to everything possible to hold down to our positions where we have and then improve positions where we can.
Harry Blount - Analyst
Okay, and then the last question is here on the potential read/write transaction.
Have you - can you give us a little bit of thought process around, what is likely to happen with the Thailand facility and your option there.
Scott Mercer - CFO
Yes Harry, this is Scott.
We will be exercising that option for a very nominal amount.
Harry Blount - Analyst
Okay, and any sense on what you can ultimately get the capacity on the heads up to - I notice that they are running about 50% below where they were, even a year ago.
So where do you think you can get the capacity on the heads up to?
Scott Mercer - CFO
Well it'll vary.
It'll depend on the yield obviously.
We have not completely evaluated what they have to be, but suffice to say that, with the increase in the yield, the capacity will go up dramatically in the next six months.
Harry Blount - Analyst
Will it be to a position where you might even consider selling heads to third parties?
Scott Mercer - CFO
Well, we - our first and primary focus is to get this Wafer Fab up and running, so we can start to have something for the back-end to do.
Once we are convinced that we are doing that reasonably well, we will absolutely consider making heads available to anybody who would like to purchase them.
Harry Blount - Analyst
Great.
Thanks.
Operator
Thank you.
Your next question comes from Mark Miller.
Please state your company name.
Mark Miller - Analyst
Hoefer & Arnett.
Congratulations on a great job, guys.
Matthew Massengill - Chairman and CEO
Thanks Mark.
Mark Miller - Analyst
Question, Read-Rite did ship some ADA heads, I assume some of them to you.
Will you be able to qualify any of the ADA heads Read-Rite supplies with any of your customers?
Arif Shakeel - Pres. and COO
We have - we did qualify the Read-Rite heads within our disk drives and we were [Inaudible] quite a few, but we have not completed the qualification at any major OEM at this particular moment.
Mark Miller - Analyst
Okay.
The $100m of Read-Rite listed in other liabilities, is that basically right now because of the bankruptcies or do you have to assume any of that?
Scott Mercer - CFO
Well, as the press release said, with the exercise of the Thai option, there is - it is debt related in Thailand that we will be assuming with the acquisition.
Mark Miller - Analyst
What about the suppliers over the US, was there a lot of outstanding debt unpaid bills there?
Scott Mercer - CFO
No, we are only buying assets in the United States.
Mark Miller - Analyst
Could you estimate what percentage of ADA ships will be up total in the September quarter?
Scott Mercer - CFO
It's really hard to say, Mark.
It depends on how many 40 gigabyte drives are demanded by the market.
Clearly a large percentage of our output will be ADA [Inaudible] guided primarily by the mix between all things 40 and below versus all things above 40.
Mark Miller - Analyst
Seagate is pushing perpendicular and as you know that requires a different head technology.
I am just wondering will that have a major impact at redirecting CAPEX spending or you're just seeing that transition further up in Seagate?
Arif Shakeel - Pres. and COO
We have looked at the perpendicular recording.
I don't believe that it is going to be that huge ahead.
However, you know, as we get into the business we'll provide you a better guidance at a later time.
Matthew Massengill - Chairman and CEO
I think that it's too early for us to tell you just how rapidly we would or wouldn't capitalize for perpendicular recording with these assets and you know suffice to say that, certainly Read-Rite does appear to have some very compelling technology in the area of perpendicular recording that we are pretty excited about and whether or not, you know, spending more sooner or later is the right thing to do to have it at the right time when it's commercially viable are the decisions that we have to make between, you know, now and the time we get there.
Arif Shakeel - Pres. and COO
But technically we have looked at that before the acquisition and we feel they have got pretty good technology.
Mark Miller - Analyst
Just one final question.
Was there any anticipation or have you seen anything on your part that the Japanese head suppliers were ready to increase prices significantly and if not, with kind of your gut feeling, you know, how much higher prices would be a year from now, if any?
Arif Shakeel - Pres. and COO
Well, you know, we have had very good relationship with both the suppliers, [Inaudible] and they have supported us for many years.
I couldn't speculate what the prices are going to be a year from now, I'll just leave it at that.
All I can you tell you is, so far they have supported us very well in the last 10 or 15 years and they are smart business people.
I don't think they will ever raise prices to the point where they start losing their time.
They want to make sure that their available marketplace, which is the commercial buyers, stay in business and thrive.
Matthew Massengill - Chairman and CEO
I think that what Arif said is absolutely true and in addition to that, there is no question, however, with a third supplier out of the picture and the reduction of those volumes that would have to have an implication to supply and demand and therefore pricing, and to reach a point whether the pricing went up or didn't go down as fast, we don't know, but there would have to be some kind of implication and it's just impossible for us to measure that right now.
Mark Miller - Analyst
Thank you.
Operator
Thank you.
Rich Kugele, you may ask your question and please state your company name.
Richard Kugele - Analyst
Yes, Needham & Co, thank you.
I guess first - to the extent you can talk about it.
From the cost saving standpoint, what assumes just for a second - you know the head operations, we are running at full capacity, whatever capacity there is you wanted to be top yield.
And from the qualitative or quantitative standpoint, whatever savings you think you save or achieve versus buying it on the merchant market.
What is the real gain there?
Do you think from the cost standpoint, and then would you be able to go and achieve that cost savings, even if you would only manufacture even a portion of the head operation rate, for example, if you are only to go into the wafer up and then go and have - did you care how to supply the flatter portion, any ideas there would be interesting?
Arif Shakeel - Pres. and COO
Let me tell Rich Kugele, you have a [Inaudible] venture.
Richard Kugele - Analyst
Do you like to make things competitive?
Arif Shakeel - Pres. and COO
There we go.
Rich, again the only comments we make about on the cost side will be that - we certainly believe this will be a creative by the first fiscal quarter of our 2005 fiscal year, if not sooner.
So by saying it's going to be a creative that means that we have achieved head savings and component cost savings, forget about the other way whatever that be [Inaudible].
And clearly that will - can be achieved and we are not - as a result will be achieved without - but we're still maintaining our strong relationships with outside suppliers].
Richard Kugele - Analyst
So, can you just - is there anyway you can qualify or quantify how much you think you're going to be supplied from the external?
Do you think that even at that small capacity you would be able to supply in the past three quarter of your needs?
Scott Mercer - CFO
I think it's a more a caution of - let me just spend a moment on this.
You know, as Matt talked about earlier of philosophy in the past, has been an - the state today is whether it's head staffing or BTBA (ph), we'll supply a portion of the [Inaudible].
And we will continue to buy a meaningful quarter, be it from the outside of loss.
We have very good relationships with them and whether we could produce 100% of [Inaudible] or not, we need to win, when we are going to keep a relationship pretty outside the block.
Richard Kugele - Analyst
And then I guess previously, you know, there's been a talk about during that the client rewrite that - TDK and I'll say over the past three years really it all relates capacity anyway.
What did you really see in the bankruptcy, is that - either made you concerned or what really push you into such a dramatic shift in business model to think that may be you wouldn't be able to either get 80 gigahertz or 40 gigahertz for that matter or have access - the same type of access to that technology, since they won't really introduce it very much anyway?
Matthew Massengill - Chairman and CEO
Well, I think it; you know a couple of things.
It clearly as I said before with the 103 merchant suppliers in industry disappearing, there's no question that would have - let's spend desirable effect on the supply demand dynamics in business and has to have an implication to purchase price.
Whether it is a large amount or small amount to be determined, we don't yet know that.
But that have to have an impact, number one.
Number two, our access to head technology is crucial for Western Digital to guarantee that it can be a reliable supplier for years to come in this business and not having some little or some significant level of control over that technology, I think it's going to become a bigger issue as we move forward in time.
And thirdly, there are fewer and fewer of these opportunities to take advantage of, as there are fewer and fewer [Inaudible] available to either partner [Inaudible] acquire.
And so the combination of all those led us to believe that our best course of action given the rewrite option, bankruptcy was new incurred under reasonable terms to acquire their assets.
Richard Kugele - Analyst
Hi, it's just last way.
The other areas now you've gone down the partial vertical integration path further, are there other areas where you think there might be synergies of [Inaudible] ratio, do you think, it's compelling to go and get into video program or something else?
Matthew Massengill - Chairman and CEO
We'd always open and looking at it again on the whole philosophy is that has to be more than the [Inaudible] and that has to improve at vital time, it has to improve with reliability and the quality of the product.
And therefore, we are constantly looking at process integration and we continue to look even up.
Richard Kugele - Analyst
Okay, thank you very much.
Operator
Thank you.
Our next question comes from Bill Lewis; please state your company name.
William Lewis - Analyst
JP Morgan thanks.
A couple of questions if I could.
First on the core business really on your guidance, it looks like your unit guidance shows 2-7% unit growth in the September quarter, which looks to be a little bit lower than the guidance from your competitors that reported already in their commentary about the desktop market.
So, could you talk about may be some of the moving parts are within that guidance.
In addition, on that it looks like the September quarter gross margin, you're guiding to 16% down from the 16.4 you did in June.
So, despite the seasonal improvement in demand and higher volumes thus far could you talk about the gross margins and guidance as well?
Thanks.
Scott Mercer - CFO
Bill this is Scott.
Just to be clear, our guidance is the gross margins are expected to be approximately 16%, approximate number.
Matthew Massengill - Chairman and CEO
And on the unit side, Bill this is actually Matt.
The 3-7% seems to be a typical seasonal trend from Q2 to Q3 number one.
Number two, we performed fairly well last quarter.
We had a fairly strong quarter in otherwise down period and to expect to continue to add to that may be difficult but certainly wouldn't want to put any undue pressure on the business that did need to be put there.
And, we'll hope that the market delivers better results than our expectation and if so, that'll be great.
But, right now that's the way see it and whether or not that's consistent or inconsistent with our competitors, I guess we are not terribly concerned. 680 m and 700
William Lewis - Analyst
Okay.
And then on the Read-Rite acquisition if I could ask you question about that.
Scott, you mentioned R&D level in the March quarter around $10m, but I guess tired of Read-Rite's recent difficulties, R&D had been in the range of 19m to 20m a quarter when they were executing better so.
My question is at what level of R&D spending, do you think is going to be required to be competitive in this business and then in addition, can you I guess relative to gross margins what percentage of heads do you need to make internal to make this accretive.
So, I guess, I'm asking what are the assumptions in that September quarter for this to be accretive to earnings.
Scott Mercer - CFO
Let me start with the R&D question first Bill and if he wants to jump in, he will.
Again, they were spending that $10m amount I referred to was their kind of quarterly run rates for their fiscal 2002.
So, that was over a year ago, they were kind of at that level.
We do not know what the number is and we are not going to be able to discuss that with you today.
We'll provide some information later in the quarter.
But, there were will be couple of dynamics going on there certainly.
One dynamic will be that initially in any event, that R&D will be in support of one customer, that will, we believe will be a little more efficient and having support multiple customers in the program offset the way that, that the Read-Rite had to in their business model.
So, we will have some hiring ramps to look at, focus on a single customer, we think will give us some efficiency there.
But, we will talk about it later.
In terms of the model assumption in terms of what we have to do internally to achieve those accretive goals, we have looked at a level that is right around 50% of our demand, internal demand for that calculation.
William Lewis - Analyst
Okay, great.
Thank you.
Operator
Thank you.
The next question comes from Matt Bryson.
You may ask your question and please state your company name.
Matt Bryson - Analyst
Avion Research.
Just kind of continuing on the wave of the last questions.
You're using Read-Rite's capacity to roughly fill half your demand, I mean; it looks like you are going to have some excess there.
Do you have any plans or agreements in place to markets the heads to other dye (ph) makers or do you envision using, head this away for internal supply.
Matthew Massengill - Chairman and CEO
I think as we said earlier in the call, our primary objective will be to get the facility up in writing and building heads for our own consumption.
However, we will absolutely consider making those heads available for the merchant market if that is requested of us, and if we can do so in a commercially viable way.
Matt Bryson - Analyst
Thank you.
Operator
Thank you.
The next question comes from Christian Schwab.
You may ask your question and please state your company name.
Christian Schwab - Analyst
Craig Hallum.
Did you guys mention the capacities that you believe that Read-Rite can produce on a quarterly basis or Read-Rite that [Inaudible] digital head?
Did you know?
Matthew Massengill - Chairman and CEO
No we didn't mention the capacity, Christian.
Christian Schwab - Analyst
Can you?
Matthew Massengill - Chairman and CEO
Not today Christian.
Christian Schwab - Analyst
When we move to whatever next aerial density we move to, it's my understanding that some of the equipment that Read-Rite has may be a little old.
Do you have any idea of when we make the next aerial density jump, how much it's going to cost you in capital equipment?
Arif Shakeel - Pres. and COO
I'll address the technology part.
Yes we have looked at their equipment, yes we realize that the next technology aerial density capital point could be and yes it will require a little bit more equipment but then again that will be required by all head manufacturers.
And I don't think that Read-Rite with any more units than anybody else, keep in mind they were producing 80 gigabyte heads when they ran out of money.
So they were up to snuff on the 80-gigabyte and last time, you can expect it again.
It is a very unique situation for us now where one head is designed for a single disc drive.
There are a lot of efficiencies you can get by designing it for a single drive, and as far as the dollars are concerned, I believe latter part of this quarter when we get together, we'll give you a better feeling on how much we have to spend.
Scott you want to.
Scott Mercer - CFO
I will just make some generic comments, Christian, I think a part of the challenge that Read-Rite had is - you spend capital for two reasons.
You spend it for technology and you spend it for capacity.
And from a capacity standpoint certainly, as we said, they were up and running on the 80.
From a capacity standpoint, we will, since we are not going to be supplying all of our own, we will not have to be adding as much capacity in those areas they might have otherwise had to going forward.
But clearly our business model from a CAPEX standpoint will change with greater capital expenditures associated with this operation.
Christian Schwab - Analyst
Absolutely.
When do you think progress here on the notebook market, can you give us an idea of timing that you would anticipate entering that market, is that something we should expect, can occur sometime in the next year?
Matthew Massengill - Chairman and CEO
We don't want to comment on our specific product plans for competitive reasons, but I think that what key is in my comments, I suggested that we have moved out of this technology staging, and have moved into active design.
And so, we'll obviously want to target the right product at the right time and be cognizant of what's happening in the market place, in the meantime a lot can happen, so just watch the space.
Christian Schwab - Analyst
Great.
Thanks Matt.
Matthew Massengill - Chairman and CEO
You're welcome.
Operator
Thank you, the next question comes from Kevin Hunt, you may state your company name.
Kevin Hunt - Analyst
Hi, thank you.
Actually the first question was surrounding the, going back to the 40 and 80 gig enter a duel after [Inaudible] you are taking here now and wondering if you, you said your yields are up to full on the 80 and may be you can walk us through again the economic rational behind why that would make sense to keep growing both those lines if the yields were up to the full snuff?
Matthew Massengill - Chairman and CEO
Well the yields may be up to our expectation of where we thought that they would be at this point in the technology development, but they are no where near as good as what the 40 gigabyte yield is.
We've been building 40 gigabyte, this drive is now for quite some time and so single-platter device that is one disc two heads [].
For us total cost of ownership is still more attractive on the 40 gig mature technology, when you consider everything yield, quality, reliability, customer satisfaction, on time delivery, rejection rate, utilization of facilities, scrap, everything.
At least, a loss is not better and so the furthermore we've a lot of customers who have products who have qualified the 40, the products not necessarily want to qualify new technology as those products, those platforms become NOI as they launch new [Inaudible] C at the back half of this year and so our customers are happy, we are happy.
There doesn't seem to be an overwhelming motivational reason to do so.
Obviously if we can build an 80-gigabyte version of that drive less expensively we'll do that.
Just a difference - this is the key difference in strategy between [Inaudible] , Macstore (ph) , and Western Digital.
We have different approaches to this particular drive.
All of them can be successful and I think our gross margin demonstrates that we are not disadvantaged.
Kevin Hunt - Analyst
Okay then some more questions on the acquisition as well.
Any sense of the employee count, where that's going to and also any sense of what the magnitude or dilution would be for the fiscal '04 year?
Scott Mercer - CFO
This is Scott, Kevin Hunt.
I can't give you prediction right now on what total employee count is because we've to ramp and get people, regarding the US, but before at the time they went into bankruptcy they had approximately 600 to 700 employees, I believe in the United States that leaving in other states and between 6000 and 7000 employees in the Thailand operation.
And there has been also presumably at near to same levels of production we would have, near those levels.
Kevin Hunt - Analyst
Okay then you can comment on the dilution effect?
Matthew Massengill - Chairman and CEO
Dilution effect of what Kevin?
Kevin Hunt - Analyst
Of the acquisition on the fiscal '04 numbers?
Matthew Massengill - Chairman and CEO
Kevin, we'll as I said in my comments, we're hoping to driving some information later in the quarter as we are going to wait till we actually own this and to solidify some plans before we talk to you about that.
Kevin Hunt - Analyst
Okay, thanks.
Operator
Thank you the next question comes from David Roy (ph).
You may ask your question and please state your company name.
David Roy - Analyst
Very quickly, can you move from 40 gig to 80 gig this quarter, does it have much of an impact on the gross margin, on the mix?
What percentage would grow from one type to the other?
I guess you are still fairly high on the learning curve on the new technology, I was wondering what is the impact on the gross margin?
Scott Mercer - CFO
There is no impact to gross margin on our mix of 40 and 80-gigabyte technologies and we are fully down the learning curve on 80 gigs.
David Roy - Analyst
The other thing I was wondering is that when I listened to the Intel call in the - their second quarter call, they said they had a record PC server business in June quarter, is there any correlation between these two-way server and your demand for your I guess, enterprise drives at all?
Matthew Massengill - Chairman and CEO
Well, clearly having - we believe the fastest growing market segment for servers and the latest storage is in the very entry level.
That has been proving to be true for quite some time now and so whether or not it's a serial 88, 10,000 rpm product, 7200 rpm product or an existing VID product, I think the answer is yes, it is a combination of all three, but very clearly serial 88 type products where the parallel or serial are making their way into these types of servers and these types of servers are the fastest growing segment in the market.
David Roy - Analyst
Thank you.
Operator
Thank you and the next question comes from Naveen Bhaba.
You may ask you question and please state your company name.
Naveen Bhaba - Analyst
Thank you, Bear Stearns, and good job, another nice quarter guys.
Scott Mercer - CFO
Thank you, Naveen.
Naveen Bhaba - Analyst
Two questions.
First, just in terms of the demand conditions, Matt.
You talked about some pickup in demand so far in July and we heard fairly similar comments from Max about a couple of days ago.
I'm wondering if there is any kind of speed buying from the distribution channel in anticipation of further price increases.
I'd like to hear your thoughts on that.
And second, Scott, what kind of linearity are you expecting for the September quarter?
Matthew Massengill - Chairman and CEO
You know, Naveen, I guess there's some possibility that a bit of that is gone [] although we can normalize that and that's why we use a trailing four-week calculation for sell-through purposes.
And so I think that while, you know, you might see that one week, you wouldn't see it consecutively.
The folks that buy disc drives from] our distributors are not in the habit of holding on to large caches of supply for obvious reasons, and so I don't think that's a factor here.
I think that we're rolling out of a slower part of the year into a stronger part of the year and this is not an unusual thing to see as we get into July.
And so I think it has more to do with that than any other artifact in the data due to yield appear or price change.
Scott, you want to handle the
Scott Mercer - CFO
Yes, on linearity, we think it looks so far that this will be, the September quarter will look a lot like the June quarter, back-end loaded.
Naveen Bhaba - Analyst
Okay, and Scott I didn't catch the weeks of channel inventory for where you stand right now on that?
And finally on the gross margins, I mean you just got 16.4 and you have had sequentially up units and revenues, why would gross margins be down, Scott?
Scott Mercer - CFO
We said approximately 16 % Naveen, so we're looking at a very similar kind of situation we were at this time last quarter.
Matthew Massengill - Chairman and CEO
I wouldn't read anything into that the differences being significant. and as far as weeks, it's about four weeks and it's been four weeks for a while.
All I will note that four weeks of inventory for ourselves and probably for the industry is best we can tell.
And the number of drives on the shelves at least for us today is lower than the number of drives that were on the shelf at this time in April.
Naveen Bhaba - Analyst
Great, thank you.
Operator
Thank you.
The next question comes from Rob Cihra.
You may ask your question and please state your company name.
Robert Cihra
Hi, thanks very much, I'm from Fulcrum.
A few questions, if that's right.
One on the enterprise drivers, can you tell us if those had any sort of unit or revenue contribution yet or is it still too early and if that's the case any kind of targets over the next couple of quarters and then as well just a fine point, I wasn't sure on the other income and expense just in the quarter you have that 3m plus investment gain and then something about 5m discontinued, they sort of canceled each other out, you would use that as an operating number as is...?
Scott Mercer - CFO
Must be, Rob let me just address that.
This is Scott.
I was talking - I must have been talking about the cash flow characteristics, not the P&L.
So, as a source of cash from 3.4m with a source of cash in the sale of an investment, we had a liability that was already on our balance sheet related to small discontinued operations that we paid off and that was the 5.9m.
Robert Cihra
So, on the P&L then, the $3.9m interest and other is really more like...
Scott Mercer - CFO
The vast majority of that is the $3.4m of investment gains.
Robert Cihra
Okay and also the enterprise question, but then one more if I could as well, not just in the quarter any key thoughts of, any kind of even ballpark what your desktop mix was by sort of 20GB or 40GB and 80GB and above?
Your ballpark.
Matthew Massengill - Chairman and CEO
Just, the one number I'll give you Rob is that almost two-third of our unit volume was at 40GB capacity points and below.
Arif Shakeel - Pres. and COO
And the enterprise question, this is Arif, we are in production making very good progress, but again you know the 10,000-RPM drivers, the volume is not there yet, but we are making extremely good progress.
Robert Cihra
Okay, great, thank you very much.
Operator
Thank you.
The next question comes from Harry Blount.
You may ask your question and please state your company name.
Harry Blount - Analyst
Hi, Lehman Brothers.
Just can't get enough with the questions, real quick, just in terms of the timing you are closing in remaining hurdles.
Is there going to be a [Inaudible] or do you know the process (ph).
Is their other things that have to be cleared.
Scott Mercer - CFO
Harry, the court order will become fully effective on July 31, at 12:00 AM or 1:00 AM, subject to that court order, we believe, we will take the keys to the shops at that time.
Harry Blount - Analyst
Okay, so from a financial consolidation standpoint, we will see this, assuming that goes as planned.
We'll see this that your financials is effective August 1 then, and when you report the September quarter.
Scott Mercer - CFO
Actually, technically July 31.
Yes, it will be on in the September quarter, operating results in the balance sheet.
Harry Blount - Analyst
Okay, and are there any other contingencies that need to occur in terms of either credit or negotiations, either outside the US assets or elsewhere.
Scott Mercer - CFO
No.
Harry Blount - Analyst
Okay, and then two quick housekeeping items.
Percentage that was 7200 businesses.
Scott Mercer - CFO
We'll check on that.
Harry Blount - Analyst
Okay, and then the consumer.
It ticked up a little bit in unit volume.
I was wondering if you give any kind of commentary regarding the gaming versus PVR in a little application mix.
Scott Mercer - CFO
Sure.
I'll just say Harry that 6% of unit shipments was pretty much dominated by gaming.
Harry Blount - Analyst
Okay, great.
Thank you, and on the 7200 RPM plant.
Scott Mercer - CFO
Right and we shift 29% of our units with 5400 RPM and everything else with 72,with exception of a wrapped with the 10-K.
Harry Blount - Analyst
Great, thank you.
Operator
Thank you, again.
If you'd like to ask a question, press star followed by the one on your touch-tone phone.
Our next question comes from Christian Schwab.
You may ask your question and please state your company name.
Christian Schwab - Analyst
Just a quick follow-up.
Did I hear you right that two-thirds of the temporary 5m units you shipped were at 40-gigabytes or well?
Scott Mercer - CFO
40 gigabytes and below and obviously dominated by the 40 gigabyte ]yes .
Christian Schwab - Analyst
Yeah and then, one last question.
When do you believe that should be efficient enough on the 80 to go to a one-headed solution or do you not plan on doing that?
Scott Mercer - CFO
Well again, and we could do that tomorrow, but because of better economics for us on the [Inaudible] we probably won't.
If the world watched by 40-gigabyte drives for a long time and then obviously that will happen, and I can't tell you sitting here today whether that, next quarter, next month or next year that will happen.
At some point it will be more cost effective to do it on a single surface.
The question will be, will the market move to an 80 gigabyte capacity point, before it makes sense to do a 40 gigabyte with a single head, and we'll be flexible and solve that problem when we get there.
We have the capability.
When it makes sense to do so.
We'll do it.
Christian Schwab - Analyst
Great, thanks.
Scott Mercer - CFO
Good bye.
Operator
Thank you.
The next question comes from Bill Lewis.
You may ask your question and please state your company name.
William Lewis - Analyst
JP Morgan.
Thanks for the follow-up.
If you didn't mention which I don't think you did.
What percentage of your drives are single platter drives in the quarter that you just completed, and then getting back to your statement about the 80-gig per platter() .
You said the transition is complete as and when then should I understand what sense and if you could give a percentage shipment that are 80 gig per platter and I guess tight to that, this one to clarify, you said all or most of the 40-gigabyte capacity is, we are going to be 80-Gig.
Scott Mercer - CFO
Bill, this is Scott and on the business mix questions we are not - we didn't say and we're not going to say what that mix of single versus double platter or a three platter was, and also the mix between technologies, this is not something we disclose.
Yeah what we said is in this quarter that we are commencing in September quarter, that we'd expect to shift the predominant, that majority of all things over 40 gigabyte, using 80-Gig per-platter technology, and for anything 40 gigabyte and below capacities we would use predominantly, 40 gigabyte per-platter technology.
William Lewis - Analyst
Okay, so just make sure to understand quickly, for example you said in the just completed quarter a third of your unit shipments were about 40, assuming a similar percentage in the September quarter, those would all be served by 80GB, is that correct?
Matthew Massengill - Chairman and CEO
Yeah, it was actually a third were up, that's right it.
That is presuming the same mix, but obviously it wont be the same mix because as time goes on people buy more gigabytes and so I will be very surprised if the mix were the same.
Scott Mercer - CFO
Yeah, that mix has been shifting and will continue to shift, as the 80Gig technology ramps.
William Lewis - Analyst
Right, I just wanted to make sure I was correct.
Thanks.
Scott Mercer - CFO
Thank you, Bill.
William Lewis - Analyst
Your welcome.
Operator
Thank you, the next question comes from Rich Kugele, you may ask a question and please state you company name.
Richard Kugele - Analyst
Needham & Co, thank you for the follow up, just on a quick question on Read-Rite has some cross-licensing agreements, I understand, between some of the Asian head suppliers, can you just talk a little bit about what's going to happen with those type of relationships?
Matthew Massengill - Chairman and CEO
Rich, we really can't comment on those relationships at this point.
Richard Kugele - Analyst
Okay thank you.
Matthew Massengill - Chairman and CEO
Your welcome.
Operator
Thank you, the next question comes from Mark O'Jardy (ph), you may ask your question and please state your company name.
Mark O'Jardy - Analyst
Pacific Crest Securities, a clarification in your prepared remarks, you referred to continued pricing moderation.
Were you there referring to the September quarter?
Scott Mercer - CFO
We were referring certainly throughout the last fiscal year and our expectation is, we've said several times in the past, is that for the presumable future we would expect that pricing would be far more moderate than it has been traditionally in this industry.
And as you could see from our forward-looking guidance for our fiscal Q1, I think those ranges would box in at somewhere between $62 and $64 per drive, which is a $1 or $2 below our average of $65 in fiscal Q4.
Mark O'Jardy - Analyst
Thank you.
Operator
Thank you, the next question comes from Brian Haynes (ph), you may ask your question and please state your company name.
Brian Hayne - Analyst
Hi, Equity Growth Management.
Matt you said that you saw that, going forward it would be important or helpful to have control of the head technology going forward, was that strictly due to the higher supply demand situation as a result of Read-Rite going out of business, or is there something about a technology shift or some other change in the business and technology that makes that important as well?
Matthew Massengill - Chairman and CEO
I think it's just the reflection of the landscape of the supply base, I mean with fewer and fewer choices there are as more and more risk in having such an important component in the hands of a very small number of people, albeit they are very capable set of small-a small group of people.
So, I think it reflects more of the landscape and the nature of the supply base, not as much to do with the supply demand in it.
And then with that, that will be our last call today.
Thank you very much for listening in today we appreciate, we look forward to bringing you up to date later in the quarter on a more definitive set of information with regard to our Read-Rite acquisition and after that looking forward to updating you at the end of this fiscal quarter.
Operator
Today's conference has concluded, thank you for joining.