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Operator
Good afternoon and thank you for standing by.
Welcome to Western Digital's second quarter financial results for fiscal year 2007.
Presently, all participants are in a listen-only mode.
Later we will conduct a question-and-answer session.
At that time, if you would like to ask a question, (OPERATOR INSTRUCTIONS).
As a reminder, this call is being recorded.
Now I will turn the call over to Mr. Bob Blair.
Thank you, sir, you may begin.
Bob Blair - VP of IR
Thank you.
As we begin, I would like to remind you that during the course of this conference call, we will be making forward-looking statements in our comments and in response to your questions concerning our business and market expansion strategies, our beliefs regarding growth opportunities for hard drives associated with the digitization of video and audio contents, and our expectations regarding growth in supply and demand conditions in the hard drive industry; the progress of our technology programs and our plans to continue investing in future technologies, our belief that we will continue to deliver consistent outstanding financial performance, the effects of seasonality in the March quarter, our capital expenditure plans for fiscal 2007, and our current financial outlook for revenue gross margin operating expenses, earnings per share, and key geometrics.
These statements are based on management's current expectations and are subject to risks and uncertainties that could cause actual results to differ materially.
We encourage you to read the risk factors in our Form 10-Q filed with the SEC on November 24, 2006, as well as the additional risk factors reported in the press release included as Exhibit 99.1 to the Form 8-K we furnished to the SEC today for an understanding of these risks and uncertainties.
We undertake no obligation to update our forward-looking statements to reflect new information or events and you should not assume later in the quarter that the comments we make today are still valid.
I would now like to turn the call over to Chief Executive Officer and President of Western Digital, John Coyne.
John Coyne - President, CEO and COO
Thank you, Bob.
Good afternoon, everyone.
Joining me today is Steve Milligan, Chief Financial Officer.
After my remarks and Steve's financial report and outlook, we will be happy to answer your questions.
On behalf of the WD team, we are pleased to report the continuing strong financial performance reflected in our second quarter results.
Our revenue, unit shipments, and net income all showed significant progress year-over-year.
The comparisons with last year are especially noteworthy in three of our faster growing markets, demonstrating the success of our strategy of reinvesting the strong cash flows from the business into the most promising real growth opportunities for hard drives.
This long-term investment philosophy is paying off and we believe it will continue to do so in the years ahead.
Unit shipments of 2.5 inch mobile drives reached 2.7 million, up 90% year-over-year.
Hard drives for the PVR market totaled 2.7 million units, up 80%, and our branded products business increased by more than four times from the prior year to $238 million or 17% of overall Q2 revenue.
This compares with $56 million or 5% of revenue in the December quarter of 2005.
Our success in this business is attributable to the growing worldwide acceptance of our My Book and WD Passport portable external digital appliances.
These are ideal solutions to securely store and transport important contents such as video, photos, music, and work-related files.
The My Book and WD Passport products are noted for their design flare and for being very simple and intuitive for mainstream users.
Our broadbased success in faster growth markets resulted in continuing progress in the diversification of our business space, with 42% of overall revenue in Q2 coming from newer markets compared with 26% in the year-ago quarter.
On the technology front, we continue to deploy our 80 gig per platter 2.5 inch PMR, and our 160 GB per platter 3.5 inch programs in steady and satisfactory fashion, while operating well within our business model metrics.
We are continuing to invest in future technologies that will provide the building blocks to grow the product portfolio and enable us to become an even more broad-based hard drive supplier in the years ahead.
The future growth in our business is clearly tied to our execution in addressing the major positive opportunities associated with the digitization of video and audio content.
Many of these trends were evident at CES and MacWorld earlier this month, where we saw larger and more sophisticated TV screens displaying more and richer video content; more sophisticated mobile devices taking delivery of diverse content from hard drive intensive hosts; and increasing consumer awareness of the need and value of securely storing personal digital content through backup services and devices; and the gradual convergence of television, computing and storage in the home.
Not surprisingly, one major retailer singled out the proliferation of hard drives as the single biggest trend at CES.
In the CE space, we are most excited about the opportunities for hard drives to play a critical role in storing and distributing the vast amounts of content required to ensure that the growing surge of handheld devices is properly served, and securely storing lots of video, photo, and audio content in reliable, home-based appliances.
For WD, the beauty of these trends is that they play to the strength of our Company and our business model, which include the ability to leverage our resources efficiently, to consistently supply high quality, high reliability hard drives in the sweet spot of high volume markets, and to focus on satisfying the customer as well or better than others.
Entering calendar 2007, the hard drive industry is on solid, albeit always competitive footing with healthy forecasted growth and with supply and demand being well-managed.
Total hard drive units are forecasted to grow between 12% and 15%, while the industry's fastest-growing high-volume market, mobile drives, is forecasted to grow between 25% and 30%.
As I assume leadership of the Western Digital team, we will continue to seize these present and future opportunities with passion, with a strong bias towards effective action, a focus on productivity, and with perseverance and integrity.
We have the team, the talent, the technology, product set, execution capability, customer relationships, and financial strength to continue on our established path of consistent outstanding financial performance.
I would now like to ask Steve to provide the financial report and our outlook for the March quarter.
Steve Milligan - CFO, SVP
Thanks, John.
Continued strong execution, coupled with our revenue diversification strategy, enabled WD to deliver another strong solid quarter.
Revenue for our second fiscal quarter was $1.4 billion and unit shipments totaled 24.5 million, increasing by 28% and 35% respectively from the prior year.
Average selling prices were approximately $58 per unit, up $2 from the September quarter.
Price declines for the quarter were within our expectations, while product mix was slightly better than expected given the strong branded products performance.
We shipped 2.7 million 2.5 inch mobile drives in the December quarter as compared to 2.2 million in the September quarter and 1.4 million a year-ago quarter.
Our growth in this important high-volume market demonstrates a continued acceptance of our products with leading notebook PC OEMs.
Turning to consumer electronics, we shipped approximately 2.7 million units for use in digital video recorders in the December quarter versus 2.5 million in the September quarter, and 1.5 million in the year-ago quarter.
Revenue by channel was 46% OEM, 37% distribution, and 17% branded products versus 52% OEM, 37% distribution, and 11% branded products for the September quarter.
We had one greater than 10% customer and that was Dell.
The Q2 geographic split of our business was 38% Americas, 32% Europe, and 30% Asia as compared to 35% Americas, 28% Europe, and 37% Asia in the September quarter.
Our gross margin percentage for the quarter was 17.9% versus 17.3% in the September quarter, primarily reflecting a more favorable product segment mix.
Operating expenses totaled $133 million, of which approximately $13 million relates to a reserve for a potentially uncollectible receivable.
Operating income was $122 million or 8.5% of revenue.
Net interest and other income totaled approximately $6 million.
Income tax expense was $300,000 for the December quarter.
For the full year, we currently expect our tax rate to approximate 3%.
However, our tax rate on a quarterly basis will fluctuate somewhat, given potential changes to our deferred tax assets.
Net income totaled $128 million or $0.57 per share.
Turning to the balance sheet, our cash and short-term investments at the end of the quarter totaled $830 million, an increase of $79 million from the September quarter.
Cash generated from operations during the quarter totaled $184 million.
Capital expenditures for the quarter were $110 million.
Non-cash charges for depreciation and amortization expense totaled $50 million.
Capital expenditures for fiscal 2007 are expected to approximate $400 million as we continue to invest in advanced [head] technologies, new product platforms, and capacity for our broadening and growing product portfolio.
Depreciation and amortization expense for fiscal 2007 is expected to approximate $200 million.
We did not repurchase any common stock during the December quarter.
Since May 2004, we have repurchased 10.2 million shares at a total cost of $115 million.
A total of $135 million remains under our existing stock repurchase authorization.
Our cash conversion cycle for the quarter was zero days, consisting of 43 days of receivables, 20 days of inventory or 18 turns, and 63 days of payables outstanding.
That was a look back at our second quarter.
Now I will move on to our expectations for the third quarter of 2007.
We expect demand for the March quarter to be down slightly from the seasonally stronger December quarter.
Strength in our newer markets should help to counteract some of this seasonal softness.
Accordingly, we estimate revenue for the March quarter to be between $1,325,000,000 and $1,375,000,000.
Gross margin percentage for the March quarter is anticipated to be roughly 17%, easing from the seasonally stronger December quarter, given typical seasonal factors in the desktop, consumer electronics, and branded products businesses coupled with continued competitiveness in the notebook space.
Operating expenses are projected to be approximately $126 million as the Company continues to invest in expanding its product and technology portfolio.
Interest income should exceed tax expense by about $3 million and our share count is expected to remain roughly flat.
Accordingly, we estimate earnings per share of between $0.44 and $0.48 for the March quarter.
I will now turn the call back over to John for questions.
John Coyne - President, CEO and COO
Thank you, Steve.
We will begin taking questions.
Operator
(OPERATOR INSTRUCTIONS).
David Bailey, Goldman Sachs.
David Bailey - Analyst
Could you comment on your internal inventory which was up on a day's basis sequentially when we would have expected it to be down in the December quarter?
As well as where you think the channel inventory is right now?
Steve Milligan - CFO, SVP
Regarding our internal inventory, a couple of things there.
First thing is, is that obviously our volume was up, so our inventory accordingly has increased from where it was at least last quarter.
The other thing from a turn's perspective, we try to manage our inventory between 18 to 20 days.
Right now, we're at 18 turns, so we're at the lower end of that but still within that range.
The other thing to keep in mind is that with our branded products business, the supply line is a little bit longer.
That requires us to carry a bit more finished goods than we otherwise would, so that's one thing that we are dealing with, with the increase relative to that business.
David Bailey - Analyst
And then just one other question.
On a dollar base, it looks like your OEM revenue was flat sequentially.
Is this a comment on your OEM customers or was this a strategic move?
What would you expect the mix to be in the March quarter?
Steve Milligan - CFO, SVP
Obviously, we saw some weakness related to some of our customers in the OEM space which I think has been, at least from a unit perspective, documented in terms of some analyst reports.
So that was really the main contributing factor to some of the change in our mix from a revenue perspective.
Just to add to that, one of the things that we have spent quite a bit of time focused on and we continue to be focused on is revenue diversification and customer diversification overall; so despite the fact that we did see some weaknesses with certain customers, we continue to do a pretty good job of spreading our risk and spreading our revenue base across different products and different customers.
Operator
Rich Kugele, Needham & Co.
Rich Kugele - Analyst
Just a couple quick questions.
First, Steve, the $13 million reserve, can you talk a little bit about what that might be related to?
Steve Milligan - CFO, SVP
Yes, I'm going to -- we don't really like to talk about specific customers and what that relates to, but it's one of our larger customers but unfortunately we've had difficulty getting paid and we felt that it was appropriate to provide for that from a financial perspective.
Rich Kugele - Analyst
And that represents though, the whole possible expense?
Or is there other reserves that may need to be taken over time?
Steve Milligan - CFO, SVP
That is our net exposure as we see it right now, yes.
Rich Kugele - Analyst
And then, secondly, can you just update us on your progress on the (indiscernible) 160 gig per platter?
John Coyne - President, CEO and COO
I think as I mentioned in my remarks, we continue to deploy both our new technologies, the 80 gig and the 160 gig per platter, 2.5 inch and 3.5 inch, steadily, in line with our business metric expectations.
We see that as one of Western Digital's strengths.
Our ability to optimize technology transitions and product transitions, so it is not our practice to give you more granularity than that because we consider it a significant competitive advantage.
Rich Kugele - Analyst
And then just lastly, I would assume that from a hedging standpoint in terms of currencies, because of your somewhat more diversified geographic presence, that's less of an issue, but any comments on the increasing Asian currency relative to the dollar?
Steve Milligan - CFO, SVP
Yes, we do have currency exposure primarily both in Malaysia and also in Thailand, given our manufacturing base there.
We do have, particularly in Thailand, hedging in Malaysia is a little bit more difficult given some liquidity issues with the currency, but we do have hedging strategies in place that help to mitigate that.
Also we work very actively with our vendor base to manage that currency risk down to an acceptable level.
So it does have an impact on us, but not anything that we feel compelled to comment on in terms of our financial results.
Operator
Rob Semple, Credit Suisse.
Rob Semple - Analyst
On the branded product, how does the gross margin on that compare to corporate?
Steve Milligan - CFO, SVP
That's generally a higher mix business as well, accordingly, a little richer margin profile business, which as I indicated in my remarks, was one of the main drivers for the margin expansion that we saw in our business as well as the ASP increase quarter-on-quarter.
Rob Semple - Analyst
I appreciate you can't really talk about this a lot, but in terms of the $13 million reserve, can you at least let us know if it was a distributor or an OEM?
Steve Milligan - CFO, SVP
I'd rather stay away from that.
Rob Semple - Analyst
And then just lastly, guys, with the cash balance where it is, I noticed you didn't repurchase any stock in the quarter.
Can you just kind of give us your thoughts on share repurchases and uses of cash going forward?
Steve Milligan - CFO, SVP
Yes, I wouldn't -- there's a couple of things on that.
Regarding our share repurchase, one of the things that at least for more or less the first half of the quarter, we were prohibited from being in the market, given our stock option investigation.
Subsequent to that point, obviously, the main use of our cash will be to continue to reinvest that back into the business.
One of the things that we have talked about and that we are continuing to work through in terms of the specific plans is increase -- the need to invest in our wafer fab from an expansion standpoint, whether that be a new wafer fab or something otherwise, and at least for the time being, we felt that it prudent to make sure that we had solidified our plans regarding that before doing anything extensive in terms of share repurchase.
But, that being said, I don't want the fact that we did not repurchase any shares to be an indication of our lack of commitment with regards to that program that we do have in place.
Operator
Steven Fox, Merrill Lynch.
Steven Fox - Analyst
I might have missed this, but in terms of just the PC business in itself, can you go back over what mix did during the quarter and your expectations for this quarter?
Steve Milligan - CFO, SVP
Mix relative -- can you clarify what you mean mix and what respect?
Steven Fox - Analyst
Relative mix of capacity of drives sold.
Steve Milligan - CFO, SVP
Overall, when you look at a calendar of Q4, mixup is usually fairly healthy given the stronger consumer bent to a calendar Q4, and mix overall from a product capacity perspective was within our expectations and within historical norms.
What we did see is obviously some additional strength in our branded products business that was a little bit different -- positively received and a little bit different than what we expected.
Steven Fox - Analyst
And the mix within PCs this quarter, where are you thinking?
Steve Milligan - CFO, SVP
Usually it's -- given you're coming off a consumer business, it's usually fairly modest mixup quarter-on-quarter.
Steven Fox - Analyst
And then lastly, just a bigger picture question.
I was just curious if you see a strategic need to invest in software and services companies going forward?
John Coyne - President, CEO and COO
I think our primary focus right now is on the core business, and the continued growth of those faster growth market offerings that we currently have; mobile being our primary focus, branded products, nearline storage, and CE.
In the branded products arena, certainly, the making that product line extremely easy to use and accessible from anywhere are significant benefits to the consumer in that space.
And so we will -- we are working on the right software support to ensure that the products we offer are compelling.
Operator
Mark Moskowitz, JPMorgan.
Mark Moskowitz - Analyst
A couple questions here.
Could you guys maybe characterize what you saw in the various regions as far as any incremental competitive or pricing pressures or maybe even a retraction in those type of pressures?
Steve Milligan - CFO, SVP
I think the only area that I would maybe call out is -- you see that our revenue as a percentage of the total in the Asian market was a bit down.
Now there's a few reasons for that.
One is we did see some softness on a relative basis from a [tam] perspective.
The other thing is, is that market was a little bit, at the margin a little bit more competitive from a price perspective than what we saw in other regions, and we sort of chose to back away from some of that competitiveness.
Otherwise, I don't know if I would say that there was anything distinguishing in terms of Americas or Europe from a regional perspective.
Mark Moskowitz - Analyst
Was there any participants that suddenly disappeared at any point in the quarter as far as being more or less competitive?
Steve Milligan - CFO, SVP
We try not to make it a habit to call out our competitors specifically.
And so, but we did -- I think that things were a little bit more rational than what we'd seen over the prior quarters.
Mark Moskowitz - Analyst
And then if we could shift gears to the margins.
I would have thought that your gross margin would have had a bigger uptake given your momentum you have in the branded piece and given the higher margin there.
Can you maybe just characterize the puts and takes in terms of what led to the incremental base point improvement in gross margin sequentially, but maybe characterize how much was branded versus maybe pricing pressures versus mix?
Steve Milligan - CFO, SVP
Yes, I think really what we saw in terms of quarter-on-quarter margin changes is most of it was due to mix of business from a business perspective, and the branded products was a large contributor there.
Relative to other businesses, margin was fairly flat and actually, if you take a look at some other information from our competitors, that's not dissimilar to what others have seen in terms of legacy margin performance.
And so, in that regard, in fact, our margin expansion on our fiscal Q2 was a little bit larger than what others saw in terms of legacy performance.
Mark Moskowitz - Analyst
And then just lastly, can you give us a sense of the central for the notebook margins to be at or above Company average going forward?
When should we think of that inflection point, given some of the investments you've made in providing for a wider product portfolio as well as a more cost-optimized type of manufacturing process?
Steve Milligan - CFO, SVP
In terms of -- I think that the -- it's difficult to say exactly when that crossover point might be.
We continue to do a pretty good job in terms of improving our costs and some of the newer products that we're coming out with we think will continue to move down that path.
The biggest question mark which, frankly, I'm not sure we have an answer on is how does the pricing environment evolve over time?
There are six participants, it's a very competitive market.
We expect that to continue certainly here in the near-term and I think that our position on it is that we've got a business model and a manufacturing and quality capabilities that will enable us to fight, if you want to call it the long battle in that business.
Hopefully over time, the competitive positioning will change a bit in terms of competitive posturing and that sort of thing.
John Coyne - President, CEO and COO
I think just to add a little more color on our perception of the mobile market, if you look at the last year, some over 80% of the growth in notebook PC shipments was generated by those notebook companies who do not have hard drive businesses.
Over 50% of the increase in hard drive shipments into the notebook space were garnered by ourselves and Seagate.
So I think when you look at that trajectory, it's clear that the winners in the notebook PC space are -- who are the people who asked us to be in that business in the first instance based on our track record in desktop of providing scale, quality, reliability, cost capability.
It's clear that the people who are winning in the marketplace are those who appreciate the attributes of our business, and so we expect to continue to grow in the mobile space, and as Steve mentioned, it's a long haul game, not a short haul game.
Mark Moskowitz - Analyst
With that said, John, and I appreciate the insights both of you provided there, could you maybe give us a sense of in terms of what you've seen in the battlefield the last few quarters as you suggest with Seagate and WD having great momentum, are any of the legacy players having any sort of tonal change where maybe they're not putting on as much armor as they had in the past in terms of preparing for this long fight.
Maybe they're starting to show signs of deemphasizing the business over time.
John Coyne - President, CEO and COO
I think each of the competitors have their various challenges to deal with, and the shape of their total business versus their participation in the 2.5 inch space is significantly different for each competitor.
This space is competitive and I anticipate it will remain competitive for the medium-term, but it's not clear to me yet that any one of the competitors has made a clear decision altering their posture.
Operator
Harry Blount, Lehman Brothers.
Harry Blount - Analyst
Question coming back to the retail side of the equation, was there a change in either the number of distribution points or levels of inventory at the existing distribution points that would explain the significant growth you had both sequentially and year-over-year?
John Coyne - President, CEO and COO
Well, yes, we have -- I think we can attribute our success in the branded product space to two primary elements.
One is the product.
We have some really superb products, both from a design perspective and an ease of use and understandability perspective.
So that's been very powerful.
The other element has been our approach to taking those products to market at our choice of partners and working with those partners to -- and we've addressed both the retail channels, the large stores, and the direct marketing channels.
So, the number of touch points with the end consumer have increased significantly year-over-year.
Steve Milligan - CFO, SVP
Just to cover-up one thing to make sure that there are no concerns with it -- relative to the distribution pipeline, there has been no change to that.
It's really a product and breadth of customer issue.
Harry Blount - Analyst
So, but is there anything you can give me to frame either the number of distribution points that you have seen increase year-over-year or sequentially?
And then when you talk about inventory in the channel, are you including retail inventory or is that even a separate discussion from what you've disclosed?
Steve Milligan - CFO, SVP
Typically, when we talk about channel inventory, we include both.
But one thing, just one thing that we're looking at is that as our -- typically the retail channel has a longer -- has had more inventory.
And so that one thing that as that business grows, we do need to consider whether or not it is appropriate to look at channel inventory in those regards separately, but that's not the way that typically we've done that in terms of disclosure to the investment community.
Harry Blount - Analyst
Any comment on the distribution points?
Steve Milligan - CFO, SVP
Frankly, I don't really have a data point on that to tell you the truth.
Harry Blount - Analyst
Because you can see where my concern is, obviously.
You're up almost $100 million sequentially in branded and I go back and look historically, that's up dramatically relative to historic sequential.
Steve Milligan - CFO, SVP
Yes, but I think that -- yes, I mean it's really -- John's point is really the point, is that our products are doing very well.
We're doing very well in the marketplace and hard drives are a much more attractive commodity in the retail space, and we just don't have a data point to throw at you in terms of a number of distribution points.
So I think that your concern, although understandable, is unfounded.
Harry Blount - Analyst
On the $13 million, I know you've avoided the question twice.
I'm going to try it a different way.
Is the nature of the fact that it's a bad receivable due to payment terms or is it a equality issue or what is the nature of the dispute?
Steve Milligan - CFO, SVP
Well, the nature of it is lack of payment.
Harry Blount - Analyst
Right, I understand that, but --
Steve Milligan - CFO, SVP
And financial concerns with regards to that partner.
Harry Blount - Analyst
But is this a quality issue or is this the way that this partner is --
Steve Milligan - CFO, SVP
It's purely a payment issue.
It is not a -- there's no dispute of that sort of thing.
It's purely a concerns with the regards to the collectibility of that receivable full stop from a financial standpoint.
Harry Blount - Analyst
Last question for me is the desktop business, you guys have obviously done a great job of diversifying into new product sets.
The flip side of the argument is the revenue from desktops is down 11.5% year-over-year, which would be worse than what we've seen broadly defined in the marketplace.
So could you maybe talk to that a little bit?
Steve Milligan - CFO, SVP
I'm trying to validate your numbers, I don't have those in front of me.
I don't -- the numbers that you're quoting in terms of down 11% do not jibe with the numbers that --
Harry Blount - Analyst
Basically I took 58% of 1.4 -- oh, I see, never mind.
I've got the issue here.
I did have the wrong number.
But if I do the recalc, I actually have it down more than that, I guess, maybe.
Steve Milligan - CFO, SVP
No, if you do the math, it's roughly flat, which basically if you look at it, first thing is, is that we're seeing unit growth, but obviously last -- a year ago this quarter we had -- we were, from a pricing standpoint, different sort of supply demand dynamics, and so obviously, the unit growth that we have seen has been offset by ASP declines, which, frankly, is not surprising on the desktop space.
Operator
Aaron Rakers, A.G. Edwards.
Aaron Rakers - Analyst
A couple of clarifications, actually.
First of all, I apologize if I missed this, but did you guys say how many weeks of channel inventory you have?
Steve Milligan - CFO, SVP
No, I actually forgot to answer that, that David Bailey answered that.
So, channel inventory continues to be within manageable ranges of -- we've talked about four to six weeks and it continues to be in decent shape from that perspective.
Aaron Rakers - Analyst
And then in regards to the notebook gross margin trend that I believe Mark was asking about, can you at least give us some color if we saw that gross margin increase in this last quarter and if that's a trend you believe will continue or I think you had mentioned that it was flat.
Just any comments in regards to how that looks.
Steve Milligan - CFO, SVP
I haven't actually commented on what it's done, but notebook margins continue to gradually increase quarter-on-quarter.
Aaron Rakers - Analyst
Final question on capital expenditures, just again, what was your guidance for this quarter?
Steve Milligan - CFO, SVP
$400 million.
And what we had talked about before -- oh, I'm sorry, for the quarter.
I did not give a number for the quarter.
Aaron Rakers - Analyst
And is there any changes within that in regards to spending on components versus capacity expansion?
Steve Milligan - CFO, SVP
No.
We continue to as a rule -- not as a rule, but about 50% of our capital spending is related to our components business or heads business.
The other 50% related to HDD assembly capital and other types of capital.
And that's been pretty consistent.
Operator
Christian Schwab, Craig-Hallum Capital Group.
Christian Schwab - Analyst
Fantastic quarter, guys.
Just to make sure I did the math right, we take the $13 million out of OpEx, you did $0.62?
Steve Milligan - CFO, SVP
I believe something like that, yes.
Christian Schwab - Analyst
We haven't seen that type of sequential decline in -- from December to March in earnings in like a really, really long time.
So, I know we had this -- why are we being so conservative in the face of gross margin?
Steve Milligan - CFO, SVP
I think really what it comes down, I'd have to go back and see specifically how that's compared on a EPS perspective, but I think that you've got to really break down the components of that.
We do usually see from a market perspective, some softening from a demand perspective, and although we are expecting price declines to be within seasonal norms, that market demand statement and then some price declines will put pressure on us from a revenue perspective and so therefore, we reflected that in terms of lower revenue guidance from compared to our fiscal Q2 and then, typically margins are down.
We could all argue as to how much they are normally down, but right now, we think that they're going to be down about 100 basis points.
And then you do that math and then factor in a bit more OpEx even when you back out the $13 million, and the math results in that EPS number.
Christian Schwab - Analyst
And so if we look at the 100 basis points dropping the gross margins that you are guiding the street to, that's just -- it has nothing to do with price if we look at price and mix and demand?
Steve Milligan - CFO, SVP
Well, it does have to do with price because as I indicated, we do see some price declines usually, and so it's really -- it's kind of all of the above.
But the net of that is that we think that right now sitting here, that we're going to see that sort of decline in our gross margins which is not at all outside of the norms of what we would see in a fiscal Q3.
Christian Schwab - Analyst
And then on the finished goods inventory, remind me why that was up?
You mentioned that.
Steve Milligan - CFO, SVP
We talked about that earlier, but really, a few things obviously, our volumes are up, therefore we've got a little bit higher inventory.
We have talked about inventory model of 18 to 20 turns, we're 18 turns, so at the lower end of that, but still within our norm.
And the other thing is our retail business from a standpoint of supply lines is a little bit longer and that requires us to carry a bit more finished goods than what we normally have done historically.
Christian Schwab - Analyst
Just to feed that channel on faster in other words?
Steve Milligan - CFO, SVP
Yes, we have to stage some product differently for that business.
Operator
Dan Renouard, Robert W. Baird.
Dan Renouard - Analyst
My question related to a couple of earlier questions on mobile.
I guess you guys have talked for quite a lot even before you entered the market, that you thought eventually the mobile margins would look very similar to desktop for the industry, and I think you were also speaking for yourself.
But I guess you're ramping so you've got your own dynamics as you ramp.
Do you have any perspective?
Pricing is obviously coming down a lot more quickly than it did before you and Seagate got into the market.
Do you have any perspective on what inning we are in towards that in-game you talked about or have we already passed it?
Where your sense is for the industry, desktop margins or where we are at and from here it could get worse?
Or do you sense that margins are still meaningfully above that for the industry?
Thanks.
John Coyne - President, CEO and COO
I think regarding margins, Steve mentioned that our margins in the mobile space continue to improve quarter-over-quarter.
We would expect that that will continue modestly to improve as we go forward, as we gain scale, experience, and continue to do what we do well, which is to drive cost out of the business.
I think the fundamental question is who has the track record, the understanding of what it takes to succeed here in the long haul, and that's companies with scale and companies who understand how to deliver high quality and high reliability at very low cost.
Steve Milligan - CFO, SVP
I think to guess where we're at from what inning we're in, it's hard to say and I said that as sometimes it's hard to tell -- well, it is hard for us to tell what some of our competitors are thinking, so I think that that may be a question better directed at others.
Operator
Mark Miller, Brean Murray, Carret & Co.
Mark Miller - Analyst
Congratulations, by the way, on a record quarter.
It's very impressive.
Just curious, we saw Seagate terminate its relationship with ESIS and we also saw -- the (indiscernible) Company seem to have stable if not -- I mean, your ASP's were up.
Component pricing was weak, which would seem to me that it benefited the (indiscernible) company.
Several people reported that.
I'm just wondering how much that helped you or did it help you at all during the quarter and do you expect to see that help you in the forthcoming quarters?
John Coyne - President, CEO and COO
I'm not sure that we saw that component pricing was weak.
But, the business, the hard drive business is about delivering value to customers.
We've driven an over $30 billion business over 400 million units by continuously quarter-over-quarter, year-over-year, driving down costs, gathering scale to address that, and delivering very high quality.
We have a very broad base of fully engaged suppliers with whom we have great relationships that are supporting that business model.
It's been very effective for us, very effective for the supply base, and I think it's going to continue in that mold.
Mark Miller - Analyst
Well, maybe it was mix, but both -- well, Seagate -- I'm sorry but [Comag], Hutchinson, I believe also [Hoya] all indicated their ASP sell recently.
Next question -- I hate to rain on the parade, but ASPs were up, mobile margins are improving, more branded sales, record number of ships.
I would almost expect that your margin should have been significantly higher, it should have grown more than 60 basis points.
Was there anything that was subtracting from margins?
Like did you purchase more heads from outside?
Just curious.
It just seems to me everything was moving in the right direction for margins and we only got a 60 basis point improvement.
Steve Milligan - CFO, SVP
Yes, I think one thing, and not meaning this in a defensive way but meaning it purely in a factual way, if you look at our margin quarter-on-quarter improvement, it was actually greater when compared to other's legacy margins on a quarter-on-quarter basis.
So I think that what you are seeing is really a reflection in my view of what is going on from an industry standpoint and in that regard, keep in mind that I think that one of the things that we all talked about earlier in the quarter is that going into the quarter, the OEM pricing in the desktop space was a bit more competitive than what maybe all of us had hoped.
So I think that that helped to create a little bit of a drag from a margin perspective.
And additionally, as you know, we've talked about a margin of 15% to the 20% range and so we're still well within that margin model and also continue to be more towards the higher end of that model.
Mark Miller - Analyst
So you didn't have to buy a greater percentage of heads from out of house?
Steve Milligan - CFO, SVP
No.
Operator
Ananda Baruah, Banc of America.
Ananda Baruah - Analyst
Just on OpEx and I guess R&D in particular, I understood that you guys are making some incremental investments.
Can you give us any sense for how we should expect the R&D investments to take place I guess linearly throughout the year?
Is it going to be more of a choppy nature to it, depending on which stage of the investments and the programs you're in?
Steve Milligan - CFO, SVP
There could be some of that, but I think that for the most part, our research and development spending should continue to gradually increase.
If there is any, if you want to call it choppiness to that, it can have something to do with at times what our incentive compensation payouts might happen to be.
We set those every six months and depending upon our financial performance, that can vary during those periods of time but that impacts our spending and our SG&A spending.
Ananda Baruah - Analyst
I guess by my (indiscernible), just based on sort of SG&A just maybe being flat (indiscernible), it looks like (indiscernible) R&D guidance would be maybe $5 million or $6 million sequential increase.
Is that the kind of order of magnitude we should expect going forward or would it be a little tamer than that?
Steve Milligan - CFO, SVP
It can be that quarter-on-quarter and some quarters could even be less, but that -- I think that's sort of a reasonable level.
Operator
Jesse Tortora, Prudential.
Jesse Tortora - Analyst
Can you give us any indication of which new market segment you might target first?
Whether it's 1.8, gaming or enterprise?
John Coyne - President, CEO and COO
Well, I think as you have seen, the current plan which we've been steadily executing over the last several years is bearing fruit now, and so our new market statement in the last call was an evolutionary statement.
We don't traditionally announce products until we are shipping them to customers.
So, the opportunity set certainly is as you have mentioned.
In the enterprise area, we are strong in nearline storage and with our well experienced in terms of a understanding of the space, and so there is an opportunity there to add the Tier 1 storage to that portfolio.
In the CE space, we are strong in DVR.
We do not currently participate in gaming, but we have done so in the past, and we do not currently participate in a large way in mobile devices.
So, as we look at each of those opportunities, we continue to assess the ability to deliver on the WD model, get good return on our investment, and do that rapidly and as we assess those opportunities, I guess we will announce product into those markets in due time.
Jesse Tortora - Analyst
So, you think you'll -- clearly, we have a number of players entering the 18 inch market, so could there be a scenario where you gear this product up and determine it's not attractive for you to enter in?
I guess determining, depending on the supply demand dynamics and pricing?
John Coyne - President, CEO and COO
Well, from a technology perspective, we have all of the building blocks to do a 1.8 inch product.
We have PMR.
We have the small [form] factor experience, both in one inch and 2.5, and so we really, we very well understand what it takes to productize that.
Today, the 1.8 inch looks narrow from a market opportunity perspective.
It's dominated by a single customer and a little crowded on the supply-side now, so in the immediate future, it doesn't look attractive to us, but we have all of the pieces to go there should that assessment of market opportunity change.
Jesse Tortora - Analyst
And just one more question.
How are you guys thinking about balancing share gains versus profitability over the next few quarters here?
John Coyne - President, CEO and COO
Well, I think as Steve indicated, we have a gross margin model that we operate in and we tend to -- as long as we stay within those boundaries, we seek to grow the business and grow the business both vertically and horizontally in terms of more in each product segment to generate return for the shareholders.
So, we tend to ensure first that we can turn -- maintain profitability and being able to do that, grow the business.
Operator
Sherri Scribner, Deutsche Bank.
Sherri Scribner - Analyst
I just have a question on the media side.
We've heard a lot from [Comag's call] and from Seagate about the potential for higher cost of precious metals impacting the cost of perpendicular media.
In terms of your perpendicular plans, have you factored that into your model in terms of having additional costs for the perpendicular drive?
Do you see that as something that will raise your costs and lower the margin?
John Coyne - President, CEO and COO
Yes, we have factored -- as you know, we deal with all the merchant media suppliers.
We have very good relationships with that broad-based supply situation.
We have discussed with them.
We are confident that there is availability to support our needs through the upcoming year.
I'm also very pleased with the proactive steps that those suppliers are taking to manage this, the precious metals specific element of cost as well as their total cost portfolio by proactive design activities to reduce the usage, process improvements to reduce usage, and, indeed, evaluation and qualification of alternative materials, so that I'm pleased with their ability to manage their overall costs in line with our expectations from a business model perspective and our outlook and guidance.
Sherri Scribner - Analyst
And then in terms of the CapEx, I think in the past you said that roughly half of that would be for heads.
It sounds like some of the additional investment this year is for wafer starts.
Is it fair to say that the CapEx is still going to be roughly half of the CapEx spent on heads?
Steve Milligan - CFO, SVP
Yes, that's correct, Sherri.
Sherri Scribner - Analyst
And then in terms of this quarter, it looks like for the first time in quite a while, your EPS growth was slower than your revenue growth and I'm just wondering is there something going on in the industry that makes it more difficult for you to reduce your costs quicker at the sort of faster pace that you used to be able to in order to offset some of the ASP decline?
Steve Milligan - CFO, SVP
Yes, Sherri, the biggest contributing factor to that is the fact that we had the $13 million reserve for the receivable, that if you back that out and then redo the math, I think you will see that our revenue and earnings grew at very similar rates.
Sherri Scribner - Analyst
So in the future you would expect that your EPS would continue to grow faster than the revenue?
Steve Milligan - CFO, SVP
Well, I think we'll have to see.
But that's a nice goal.
Operator
Matt Kather, W.R. Hambrecht.
Matt Kather - Analyst
A question for you guys, going to a new area on the PVR's, at CES and checking with some of the satellite providers, I've not been able to uncover any new meaningful programs, particularly in the HD side taking up average capacity in the boxes in 2007.
Are you guys able to identify any new programs in the PVR area without identifying specific customers that you expect to hit during this year?
John Coyne - President, CEO and COO
I think the DVR space is interesting in that I believe it has clearly been very high growth and as we forecasted out on the longer-term basis, we are looking at about a 20% consensus growth rate in that marketplace, which we, in direct dealings with our customers, can see support for that kind of trajectory.
It does, however, being driven primarily by the cable and DirecTV companies, it does on a quarter-to-quarter basis rely on launch of new programs and can be a little spotty to call from a quarter-to-quarter perspective.
But everything we see augers well for a continued fundamental growth pattern there.
Matt Kather - Analyst
I guess just to follow up on PMR, I don't know that you're willing to disclose this but I'll ask anyway, how many units of the 24.5 million that you shipped were CMR discs?
John Coyne - President, CEO and COO
We don't disclose that in that we believe that our optimization and management of transitions is one of our competitive advantages, so we try not to show other people how it's done.
What I would say about PMR as an industry observation as well as a Western Digital observation, is that I think this transition has been easier than anyone expected given the nature, the fundamental technology of the transition.
So I would say that the transition is going better from a industry perspective capability of suppliers and execution on the integration level than anyone expected.
Matt Kather - Analyst
The last thing on PMR without trying to ask something that you guys can't answer, on the component side, do you think that you are currently taking more media and more heads due to this LMR to PMR transition that typically happens when we have a technology transition.
Do you think that you're taking excess components as the yield obviously improve and you guys start to transition in that technology?
John Coyne - President, CEO and COO
No, I don't there's -- I believe that both ourselves and the industry are tracking in line with -- in line or slightly ahead of expectation relative to the transitions.
So I want to thank everyone for joining us today.
We're very excited about the growth opportunities in the data storage industry and about WD's ability to participate in this market as one of the leaders in the years ahead.
I look forward to updating you on our progress.
Thank you very much.
Operator
Thank you.
This does conclude the conference call.
You may disconnect at this time.