威騰電子 (WDC) 2008 Q3 法說會逐字稿

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  • Operator

  • Good afternoon and thank you for standing by.

  • Welcome to Western Digital's third-quarter financial results for fiscal year 2008.

  • (OPERATOR INSTRUCTIONS).

  • As a reminder, this call is being recorded.

  • Now, I will turn the call over to Mr.

  • Bob Blair.

  • You may begin.

  • Bob Blair - VP, IR

  • As we begin, I would like to point out that we will be making forward-looking statements in our comments and in response to your questions concerning our opportunities and demand in the hard drive industry, customer preference for the WD brand, our capital expenditures, repurchases of our stock, our short-term investments, our cash conversion cycle, seasonality of the June quarter and our current financial outlook for the June quarter.

  • These forward-looking statements are based on management's current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including those listed in our 10-Q filed with the SEC on February 5, 2008, 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.

  • 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 John Coyne, President and Chief Executive Officer of Western Digital.

  • John Coyne - President, CEO

  • Good afternoon everyone and thank you for joining us.

  • With me today is CFO, Tim Leyden.

  • The market for hard drives continue to demonstrate strong year-on-year unit growth of 16.2% in the March quarter, while exhibiting an 8.6% seasonal decline from the exceptionally strong December quarter, as we had anticipated in our original guidance for the third quarter issued on January 23rd.

  • We are extremely pleased with the March quarter results we released earlier today.

  • The WD team again delivered excellent performance, continuing our strong track record of profitable growth.

  • Our Q3 revenue performance reflects customer preference for the WD value proposition of quality and reliability, a compelling product portfolio, and responsive and timely availability supported by a demonstrated willingness and capability to invest in the future.

  • Our earnings performance is the result of healthy market demand, a competitive cost structure, disciplined financial management, and a committed team with a passion to succeed.

  • Let me share some highlights of our March quarter performance compared with the same quarter last year.

  • Hard drive revenues rose by 43% to $2,022,000,000.

  • Hard drive unit shipments grew by 41% to $34.5 million.

  • Earnings per share expanded by 132% to $1.23.

  • The gross margins increased 680 basis points to 22.6%.

  • We continued to demonstrate financial and operational discipline, generating substantial cash from operations and maintaining our industry-leading asset velocity.

  • From the beginning of the quarter, we focused closely on sales linearity and achieved a significant improvement in performance year on year.

  • Our sales in the final week of the quarter were 9.8% of our total quarter volume compared with 13% in the same week a year ago.

  • As we watched demand and supply patterns emerge throughout the quarter, we made the decision to shut down our component and drive factories for substantially all of the last week of the quarter.

  • We did so in order to balance our supply with demand and ensure that we created no overhang of inventory to pressure the seasonally weak June quarter.

  • Consequently, our total inventory remained flat quarter on quarter at an industry-leading 25 days which included finished goods up modestly by less than one day of supply.

  • This supply demand alignment action reduced gross margins in the quarter by some 60 basis points.

  • Reflecting our confidence in the future of the hard drive industry and WD's strategy and business model, we announced a new share buyback authorization of $500 million over five years.

  • We continue to grow faster than the industry in practically all market segments we serve -- desktop, enterprise, branded, and mobile.

  • The one exception to the WD growth story in the March quarter was our DVR business, where consistent with our January commentary, we chose to reduce our volumes in order to improve profitability in that business.

  • A key driver of our success is our focus on product quality and reliability.

  • During the quarter, Warranty Week published an analysis of five-year warranty claim trends for U.S.

  • tech companies.

  • This data highlights significant and consistent improvement by WD over the last five years.

  • We have lowered the cost of warranty claims from an industry competitive 1.9% of revenues in 2003 to a clear industry leadership position of 0.9% in calendar year 2007.

  • At the same time, we have extended our average warranty period by some 50%.

  • While these improvements fall straight to the WD bottom line, more important is the fact that our customers also benefit substantially from the lower cost of ownership of WD drives and enhanced customer perception of systems which incorporate WD drives.

  • Earlier this week, we announced availability of the WD VelociRaptor, 2.5 inch, 300 GB, 10,000 RPM hard drive, the next-generation product in our popular WD Raptor enterprise SATA family.

  • This is the fastest SATA drive available in the industry today, delivering a 35% performance improvement over the WD Raptor drive.

  • At 300 GB, it delivers the industry's highest capacity in a 2.5 inch, 10,000 RPM drive, double that currently available from competition.

  • It incorporates the highest aerial density shipping in the industry at 290 gigabits per square inch.

  • Our IcePack adapter allows the drive to be mounted in a 3.5 inch drive bay while reducing operating temperatures some seven degrees, further improving long-term reliability.

  • WD VelociRaptor continues our industry-leading GreenPower initiative launched last July by delivering all of these attributes while consuming 35% less power than the previous Raptor family.

  • This product demonstrates the continued momentum in WD's development and deployment of leading technologies and further enhances our broad product portfolio.

  • In summary, we are pleased with our sustained progress against our profitable growth objective year-to-date.

  • We continue to feel good about the robust demand forecasted in our industry over the next several years and about WD's opportunity to continue to prosper by providing compelling solutions to customers.

  • Tim will now provide a Q3 financial report and our outlook for Q4.

  • Tim?

  • Tim Leyden - CFO

  • Our March results reflect strong execution by the WD team.

  • Throughout the quarter, we leveraged our operational flexibility and financial management discipline to carefully match supply with demand.

  • This resulted in outstanding revenue growth and operational results that delivered 680 basis points in gross margin improvement over the same quarter last year and revenue and earnings that exceeded our updated guidance.

  • A strong January and February coupled with the measured approach to March's more competitive environment led to better revenue linearity for WD year-on-year, enabling us to generate $431 million in operating cash flow, pay down $260 million in debt, while also repurchasing $44 million of common stock.

  • Revenue for our third fiscal quarter was $2.1 billion.

  • This includes $89 million from external sales of media and substrates.

  • Hard drive revenue of $2.022 billion was up 43% from the prior year.

  • And hard drive shipments totaled 34.5 million units, up 41% from the prior year period.

  • Average hard drive selling price was approximately $59 per unit, down $2 from the December quarter, and up $1 from the year ago quarter.

  • Product and channel mix changes as well as expected seasonal pricing factors contributed to the quarterly ASP decline.

  • The percentage of our hard drive revenue generated by non-desktop PC applications was 54% in the March quarter, consistent with the December quarter, and it was 47% for the year ago quarter.

  • We shipped 10.2 million 2.5 inch mobile drives in the March quarter as compared to 8.7 million in the December quarter and 3.7 million in the year ago quarter.

  • These increases were driven by continued strength in overall mobile storage demands coupled with increased customer preference for WD product offerings.

  • Sales in our stock, enterprise and branded products businesses were in line with our expectations.

  • In consumer electronics, we shipped 3.1 million 3.5 inch drives for use in digital video recorders in the March quarter, versus 4.1 million in the December quarter and 2.6 million in the year ago quarter.

  • Our moderation of unit shipments in this market generated the desired outcome of improved margins.

  • We continue to believe that this market offers us long-term profitable growth opportunities.

  • Hard drive channel revenue was 50% OEM, 34% distribution, and 16% branded products versus 48% OEM, 34% distribution, and 18% branded in the December quarter.

  • And it was 47% OEM, 34% distribution, and 19% branded in the year ago quarter.

  • These percentages exclude external sales of media and substrates, which totaled $89 million in the March quarter of 4% of revenue and $120 million in the December quarter or 5% of revenue.

  • As a reminder, there were no media and substrate sales in the year ago quarter as we had not yet made the media acquisition.

  • There was no single customer that comprised more than 10% of total revenue, reflecting a healthy diversity of customers in multiple markets.

  • The Q3 geographic split of our hard drive revenue was 28% Americas, 31% Europe, and 41% Asia as compared to 32% Americas, 32% Europe, and 36% Asia in the December quarter, and it was 36% Americas, 29% Europe, and 35% Asia in the year ago quarter.

  • These percentages also exclude external sales of media and substrates.

  • Our gross margin percentage for the quarter was 22.6% versus 23.3% in the December quarter and 15.8% in the year ago quarter.

  • The decrease in gross margin versus Q2 came from more competitive pricing, a higher OEM mix, and the negative impact of our one-week factory shutdown offset by increased volumes and improved costs.

  • Operating expenses totaled $179,000,000 or 8.5% of revenue.

  • Total operating expense was slightly down from the December quarter.

  • As compared to the prior year, operating expenses are up as a result of adding media operations, higher incentive compensation associated with stronger financial performance, and increased investments in new programs to support technological advancements and our broadening product portfolio.

  • Operating income was $298 million or 14% of revenue.

  • Interest and other non-operating expenses were approximately $8 million.

  • This includes about $3 million of unrealized losses on our previously disclosed investments in option rate securities.

  • These investments totaled $30 million at the end of the quarter.

  • Our $10 million tax provisions for the March quarter is approximately 3.5% of quarterly income before taxes, and the year-to-date rate is approximately 4% excluding Q1 nonrecurring items.

  • We expect our rates for the full year will continue to be at the low end of our previously-stated 4% to 6% range.

  • Our net income totaled $280 million or $1.23 per share.

  • In March, we announced a realignment of our media operations related to the planned completion of the majority of our external media and substrate supply obligations.

  • The total estimated cost of this realignment is about $16 million.

  • This is recorded as an adjustment to the goodwill balance as of the end of the quarter and did not impact March's operating results.

  • We continue to make excellent progress on our media integration and are on track to meet our previously-stated plans of full integration by the December quarter.

  • Turning to the balance sheet, our cash, cash equivalent, and short-term investments at the end of the quarter totaled $949 million as compared to $967 million at the end of December.

  • Cash generated from operations during the quarter totaled $431 million.

  • Capital expenditures for the quarter of $137 million were lower than our original expectation.

  • Our non-cash charges for depreciation and amortization expense totaled $111 million.

  • For the first nine months of 2008, our capital expenditures totaled $469 million.

  • We now expect capital expenditures to be about $625 million for fiscal 2008, about $75 million lower than our most recent guidance as we align expenditures with anticipated demand and realize efficiency gains.

  • Fiscal 2008 depreciation and amortization is expected to be about $410 million.

  • We reduced debt by a total of $260 million during the March quarter.

  • We repaid the $760 million bridge loan and replaced it with a five-year credit facility that consists of a $500 million term loan, which is currently outstanding and a currently unutilized $250 million revolving line of credit.

  • We also repurchased approximately 1.5 million shares of common stock for $44 million.

  • Since May 2004, we have repurchased 16.6 million shares at a total cost of $248 million for an average price of about $15 per share.

  • Earlier this month, we announced an increase to our stock repurchase plan of $500 million.

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

  • As of the end of March, we had cash and cash equivalents of $917 million and short-term investments of $32 million, which included $13 million of option rate securities.

  • These option rate securities are currently accounted for as current assets and are held as available for sale securities.

  • However, if the liquidity of these securities continues to become strained by the market, we may have to reclassify them as long-term investments.

  • As of the end of March, we had 44 days of receivables outstanding, 25 days of inventory or 14 turns and 64 days of payables.

  • This resulted in a cash conversion cycle of five days, which is within our stated model range of four to eight days.

  • Going forward, we expect to trend towards the high end of that range as we weigh working capital investments against opportunities for growth in new markets and opportunities to reduce shipping costs.

  • I will now discuss our expectations for the fourth quarter of our fiscal year 2008.

  • Revenue for the March quarter included $89 million from the sales of media and substrates to external customers.

  • As we indicated previously, we will not in future be breaking out the amount of revenue generated from these external sales due to the planned reduction in these activities and the expected insignificant impact on our total revenue.

  • Historically, drive demand goes down sequentially from the March to June quarter by approximately 2% to 3%.

  • We would normally expect natural demand reductions in this range.

  • However, late March competitive market dynamics now lead us to forecast a reduction of 4% to 6% and competitive pricing at the high end of historical norms in the June quarter.

  • Consequently, we're forecasting total revenues to be in the range of $1.825 billion to $1.9 billion.

  • This represents an increase of between 34% and 39% over the prior year period.

  • We are modeling gross margin of approximately 20%.

  • While this is down from the March quarter, it represents a 500 basis point increase over the 15 percentage point gross margin we reported for the June quarter of 2007.

  • Operating expenses are projected to be approximately $180 million as we continue to invest in expanding our product and technology portfolio.

  • Our net interest expense is projected to be about $5 million, assuming no further investment losses.

  • We anticipate our tax rate to be at the lower end of our previously stated range of 4% to 6% of pre-tax income, and our share count to be approximately flat with the March quarter.

  • Accordingly, we estimate earnings per share of between $0.77 and $0.83 for the June quarter.

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

  • Operator

  • (OPERATOR INSTRUCTIONS).

  • Steven Fox.

  • Steven Fox - Analyst

  • Merrill Lynch.

  • I was wondering if you can go back over a couple of things.

  • You mentioned how you made a decision to close production in the last week of the quarter.

  • Could you give us some more insight to how that decision was made, on what timing?

  • And is it possible that you would consider to do the same thing and for a longer period in the June quarter given the demand pressures or the economic concerns that are out there?

  • Then, I had a follow-up.

  • John Coyne - President, CEO

  • As I mentioned, we tracked the progress of the market and our progress in the market on a weekly basis, and we make decisions on what we're seeing in those market dynamics relative to matching our supply with the demand that we anticipate updated by those weekly pulsing of the market.

  • And we did that through last quarter, and we made appropriate decision to reduce production in order to ensure that our ending inventories were appropriate to the forward-looking demand and didn't overhang the market.

  • We will watch progress as we go through this quarter and we will align our production to the demand.

  • Steven Fox - Analyst

  • Could you also talk about the decision on the capital spending plans?

  • What does that -- how much of that is efficiency related versus more conservative expect demand outlook for say the next 12 months?

  • John Coyne - President, CEO

  • I think the demand outlook and we believe that the fundamental dynamics, the demand for storage growing at about 60% on an annual year-over-year basis in terms of terabytes of storage, serviced by a 40% to 45% aerial density growth and a 15-plus% unit growth, we believe those forecasts of demand remain intact.

  • That's the kind of demand profile I expect as we look forward.

  • We believe that the seasonality of the business is fundamentally tracking to historical norms.

  • As you look at that long-term outlook, the primary influence on our deferral of capital investment was realized efficiency gains of our existing installed capacity base.

  • Operator

  • Sherri Scribner.

  • Sherri Scribner - Analyst

  • Deutsche Bank.

  • We've heard a lot of comments from Seagate and others about aggressive pricing in the March quarter.

  • Can you maybe give us a little more detail in terms of where you saw aggressive pricing?

  • I think Seagate commented that they saw it on high cap and desktop.

  • There were some comments that there was aggressive pricing in notebook OEMs.

  • Can you maybe give us some more detail there?

  • John Coyne - President, CEO

  • The drive business continues to be a competitive business.

  • We did see some greater than anticipated pricing action in late March particularly.

  • As I noted, we had put a lot of emphasis with our sales force and our business teams to improve the linearity of our sales efforts through the March quarter, and we achieved that to a very large degree, shipping under 10% of our total units in the final week of the quarter.

  • Our data from the industry would suggest that the rest of the industry shipped about 16.5% of their total units in the final week of the quarter.

  • And we believe that puts significant pressure on pricing as the quarter closed, leading to a start point for the current quarter that is lower than we would have liked to see.

  • However, if you -- the guidance that Tim gave a moment ago indicates that we expect to see that end of March exit influence pricing this quarter, having a trend towards the higher end of seasonal normal pricing.

  • And we saw a little bit of a slow start influenced by the inventory overhangs that were present starting the quarter.

  • The underlying trends quarter to date meets our expectations.

  • Sherri Scribner - Analyst

  • I guess I wonder, is the pricing worse than what you saw last year when we had aggressive pricing in notebook or would you say it's relatively similar?

  • You said it was a little bit worse than you would have expected.

  • John Coyne - President, CEO

  • I think the profile is pretty much towards the high end of the pricing activity that we see.

  • But you have to bear in mind that the entire industry -- well certainly WD is running 500 basis points higher on the gross margin level this year than last in terms of our guidance for the quarter.

  • So I think the industry is in much better shape, but the overall seasonality overlays an industry that's in fundamentally better shape.

  • Sherri Scribner - Analyst

  • Then maybe if I could squeak in a question about your gross margin.

  • How much did the Komag acquisition help your gross margins this quarter, and how much more do you expect to get out of the Komag acquisition as we move through the calendar year?

  • Tim Leyden - CFO

  • You recall we indicated that we had gotten 80 basis points in the December quarter.

  • We added another 40 basis points approximately in this quarter and that leaves us to pick up -- over the next three quarters, we have to pick up the remaining 180 basis points of the 300 basis point cost improvement that we indicated we were going to get by the end of December.

  • Operator

  • Mark Moskowitz.

  • Mark Moskowitz - Analyst

  • JPMorgan.

  • A few questions if I could, John and Tim.

  • When you talk about the guidance as far as the ranges you gave for the industry growth and then your revenue growth, how should we think about the puts and takes in terms of your unit expectations relative to that 4% to 6% decline as well as your ASPs?

  • Are you going to grow at or below market?

  • Tim Leyden - CFO

  • Actually from an ASP viewpoint because we don't go into units, but from an ASP viewpoint, from Q3 to Q4, we see historically price declines being at the upper end of the spectrum due to seasonally lower demand and lower mix [operates] due to a higher percentage of our business going into the OEM channel, which means because it's a weaker channel -- it's a weaker quarter for both retail and the distribution spot market.

  • So consequently, we would expect the ASPs to be down similar to what they have been historically.

  • Mark Moskowitz - Analyst

  • And then how should we think about the retail performance in the quarter?

  • You've enjoyed great momentum there over the past couple of years because of sound execution and a very good product reception.

  • But I was kind of perplexed by the slowdown there sequentially.

  • John Coyne - President, CEO

  • Well I think the -- we're very happy with our continued position in the branded products area and the retail area.

  • There is one WD-specific issue in that we were transitioning from our older Passport industrial design to our new offering, so we're moving from the any color you want as long as it's black to our new palette of 15 different colors and finishes as well as segmented market functionality products targeted at individual markets.

  • So we constrained [sell-in] in order to flush the existing inventories out of the retail channel.

  • Our sellout was robust.

  • However, we constrained sell-in in order to clear the existing inventories before restocking with the new product line.

  • Mark Moskowitz - Analyst

  • So that was deliberate then.

  • There was no sort of issue in terms of disruption as you try to move to that more broad-based industrial design?

  • John Coyne - President, CEO

  • No surprises.

  • Mark Moskowitz - Analyst

  • And then, how should we think about that snapback then relative to your broader industry comments?

  • Could you maybe have some wiggle room there where retail maybe bounces back a little better in June?

  • Tim Leyden - CFO

  • I think that seasonally, retail in the June quarter tends to be the weakest quarter of the year for retail.

  • So I would anticipate something similar in the June quarter.

  • Mark Moskowitz - Analyst

  • And then just lastly, can you maybe just talk about what you are seeing in Europe?

  • Typically, your Europe business I think has been really strong on the retail side and with a lot of comments from some of your peers and some of the disties out there are suggesting that Europe is starting to really exhibit signs of some deterioration now that we saw a start in the U.S.

  • about six months ago.

  • John Coyne - President, CEO

  • I think if we look at the quarter to date pattern, Europe is a little slow out of the traps from a distribution perspective.

  • Overall, the business is tracking exactly as -- on a worldwide basis, industry is tracking as we expect, a little stronger in OEM and a little weaker in European disty.

  • Operator

  • Richard Kugele.

  • Rich Kugele - Analyst

  • Needham & Company.

  • Two quick questions.

  • First, on your notebook share, obviously you've gained a fair amount in recent quarters.

  • Have you sensed any indication from the OEMs that they are uncomfortable with that level of share, that Seagate sometimes hears their enterprise business?

  • Or do you think that any share improvements that happen at Seagate as they get more on par on aerial density can come out of other people that that doesn't necessarily have to come out of you?

  • John Coyne - President, CEO

  • Our current position in notebook is driven by our product portfolio, our execution relative to timely availability and our quality and reliability demonstration allied to our forward-looking roadmap for products in that space.

  • So we're certainly not seeing any signs of customer resistance to that compelling value offering.

  • Rich Kugele - Analyst

  • And then just lastly to follow up on your prepared comments there on the VelociRaptor, effectively, unlike the previous Raptor which has been somewhat more of a -- and this product accepted by kind of the high performance community, this one really is an enterprise 2.5 inch in a 3.5 inch clothing.

  • But can you just talk about how much of a leap it is to take this product and actually make it a 2.5 inch enterprise class SAS for example or -- did the next leap in technology to get it to be a pure play enterprise?

  • John Coyne - President, CEO

  • I think, as I mentioned, the product is a very significant demonstration of our continued momentum in technology deployment offering as it does, a leading aerial density in the industry today.

  • It is -- you are correct.

  • We're selling it in the 3.5 inch clothing targeted specifically at the high performance workstation and the high-energy gaming environment where the Raptor has established a very powerful brand addition for us.

  • However, as a 2.5 inch drive, it is also targeted at the blade server market in that SATA drives plug into SAS back plate.

  • So we expect to see some significant opportunity there.

  • As to the rest of your question, you know we never announce product until shipping [in volume].

  • Operator

  • [Robert Marson].

  • Robert Marson - Analyst

  • Congratulations on an excellent quarter and stellar execution.

  • The recent reports have now sort of tallied up last year's unit growth at over 500 million units and about 18% or 19% in the hard disk drive space.

  • That's a material acceleration from the prior three or four -- two or three years anyway.

  • Do you see unit growth maintaining a mid-teen level for your fiscal 2009?

  • And do you think that you guys can continue to grow market share in -- or maintain share in the external drive business as well as the 2.5 inch business?

  • And the reason I ask that is obviously your run rate execution -- exiting last quarter was significantly higher than it was 12 months ago.

  • And I am just wondering if you would have any opinion as to where it might be 12 months from now.

  • John Coyne - President, CEO

  • Sure.

  • Let me take -- separate the two parts of that question, the [middle] question.

  • Relative to the overall market, we think what we're seeing is the impact of the non-PC content driven demand for storage, that is last year, as you said, over 500 million drives shipped again say roughly 300 million PC systems in the year, so a significant greater than one-to-one attach rate drives versus PCs.

  • We believe a lot of that is being driven by rich content through the Internet, through Flash-enabled small mobile devices like cameras and audio players creating significant incremental types of demand that may be hooked to a PC or may be delivered through a completely separate device such as a DVR.

  • So we're very positive about those additions to the traditional underlining demand drivers, and so we do believe that the 12% to 15% kind of forecast of around -- are more driven by historical trend analysis than they are by that opportunity analysis of content generation.

  • So I believe the opportunity is in the 15-plus% unit growth opportunity over the next few years.

  • To your question about WD, our focus is to continue to provide the WD value proposition of high quality, high reliability, high availability and responsiveness, a very competitive offering, supported by the industry's lowest cost business model, and using our investments in technology to maintain compelling product portfolios.

  • I think if we can keep doing that, the customers are voting that they like it.

  • Robert Marson - Analyst

  • And one final point or question, how do you sort of feel about the entire industry's profit margin structure and the sustainability thereof?

  • I know that in the last four quarters, Western Digital and Seagate have made money.

  • Hitachi for the full trailing 12 months has struggled, and the other Asian companies have either broken even or lost money.

  • When I look at -- when I'm trying to roll off the business as best I can, I come to a high single, mid to high single digit operating margin for the business.

  • Do you feel there has been enough consolidation in addition to organic unit growth opportunities for the whole industry so that existing pricing structures and profit margin structures can continue within the business with Hitachi trying to become more profitable?

  • John Coyne - President, CEO

  • I think there's a -- when we look at consolidation, I don't think there's any compelling trigger to drive further consolidation in the industry.

  • The way we look at the industry today, you've got Seagate, a very large, very capable, very profitable company generating significant cash.

  • You've got Western Digital, a not so big, well-managed, low-cost, high profit, high cash generation business.

  • You've got Hitachi who seem to be finally focusing on the fundamentals of cost structure appropriate to the market opportunities available to them and driving towards a positive outcome.

  • And then, the three -- Toshiba, Fujitsu and Samsung -- essentially all dependent on the single merchant head supplier, TDK, for their products.

  • And if you look at the financials of TDK, I think that's where you see where the value is being captured.

  • However, Fujitsu, Toshiba and Samsung as well as Hitachi being divisions of large Asian corporate owners, it appears to me that as long as they produce marginally positive results on an ongoing basis, they will potentially keep being funded.

  • However, we have seen evidence over the last year and a half to two years that where they deliver negative results, the parents do not have the patience to allow that to continue for extended periods.

  • Robert Marson - Analyst

  • You have made your intentions known to enter the enterprise businesses.

  • Is there any -- and your chief competitor, Seagate, has sort of done its fair share in the consolidation movement.

  • Is there any chance you would try to purchase an enterprise drive business where it's become available?

  • John Coyne - President, CEO

  • We are looking at all business segments in which we currently don't participate and assessing the business cases for all of those opportunities.

  • Our experience tells us that organic growth has been the thing that has generated the best results for us as we have watched the outcomes of other people's horizontal acquisitions at the drive level, why we have focused on vertical acquisitions at the component level.

  • And so we don't currently have any designs on anything other than growing into segments in which we don't participate where we can close a business case to generate profitable growth from that activity.

  • Robert Marson - Analyst

  • Thank you very much and congratulations on an excellent quarter.

  • You don't have a lot of sponsorship on the Street, so you won't get a lot of congratulations on the call.

  • So I guess I need to two or three of them.

  • Again, congratulations.

  • Operator

  • Mark Miller.

  • Mark Miller - Analyst

  • Bream Murray.

  • I would certainly like to add my sentiments to the last gentleman and also agree with his ponderance of why you're not getting more support on the Street after exceptional quarters.

  • I just had a couple of questions.

  • One is the mobile; you've grown very strongly in the mobile units.

  • How are the margins doing there?

  • Are you getting better margins with this growth?

  • Are you maintaining margins?

  • Tim Leyden - CFO

  • We have a very cost competitive profile in our mobile product lineup.

  • And once again, I can reaffirm that our margin hierarchy is still intact, which is enterprise-branded products, mobile, desktops and DVR/CEs.

  • Mark Miller - Analyst

  • A second question is are you able to translate your technology leadership in the 3.5 space into share gain at the high end?

  • Are you seeing any share gains at the higher end -- the higher capacity points?

  • John Coyne - President, CEO

  • In 3.5?

  • Mark Miller - Analyst

  • In 3.5.

  • John Coyne - President, CEO

  • We've chosen to deploy our technology first at the volume end of the 3.5 inch market.

  • So we deploy first on our single platter products and we are moving that technology across the broad range of our overall product line.

  • That's the strategy that appeared to us to generate the optimal impact on our bottom line, and that deployment across full product range is going very well.

  • Operator

  • David Bailey.

  • David Bailey - Analyst

  • Goldman Sachs.

  • I was wondering if you can give us a little bit more detail on where you are seeing the most pricing either by segment or product area.

  • John Coyne - President, CEO

  • I think we've seen -- most of the pricing movement has been in the high cap desktop arena.

  • We've seen also some pricing activity as more folks have come into the current technology deployment in the 2.5 inch space.

  • So us people have shown up with more cost effective 160s and with 250s and now beginning to see some 320 volumes coming into the market.

  • That's having an impact on the high-end pricing of the 2.5 inch space as well.

  • David Bailey - Analyst

  • Then just, could you tell us where you think channel inventory is at this point?

  • Tim Leyden - CFO

  • Yes, channel inventory is in the normal four to six week range.

  • Although as Seagate indicated, it's at the higher end of that metric.

  • David Bailey - Analyst

  • And where are you do you think?

  • Tim Leyden - CFO

  • We're within our normal four to six week range.

  • Operator

  • Aaron Rakers.

  • Aaron Rakers - Analyst

  • Wachovia.

  • I guess I want to dig a little bit more into the gross margin line.

  • If we think about your positioning over the last few quarters in the high capacity notebook market and we think about the competitive landscape going forward, how much has that been a contributor to the gross margins trend?

  • And how should we think about that going forward as you just mentioned that pricing is starting to look a little bit more aggressive there?

  • Tim Leyden - CFO

  • In the notebook specifically, we've got -- as I indicated to a prior questioner, we've got a very cost effective platform, and we have benefited from a higher mix as you indicate.

  • And we have seen more competition in the March quarter at the 250 GB capacity point and at the higher end.

  • So we do anticipate that there will be a more balanced competitive environment in that going forward.

  • But again, our most sustainable advantage is our cost competitiveness, and we feel pretty comfortable that we will be able to deal with the competitive situation as it arises.

  • Aaron Rakers - Analyst

  • When I look at your geographical mix in this last quarter, it looks like North America was down quite a bit on a sequential basis as well as Europe.

  • Can you give us an idea of what you're seeing in terms of just demand from a geographical perspective?

  • Tim Leyden - CFO

  • From a geographical point of view, the primary factor in the ship from North America to Japan is primarily on the entrance in our -- to Asia is the increase in our notebook shipments because most of the ODMs and delivery points are in Asia for notebook.

  • And we are seeing North America with normal -- what we will consider normal demand, albeit a little bit softer in North America versus Latin America.

  • Aaron Rakers - Analyst

  • And then final question from me is, when we -- again, a look at the retail business, I can understand kind of the transition from a product line perspective, but are you starting to see competition become more effective in that market, i.e., through competitive solutions or just through the breadth of their own channels?

  • John Coyne - President, CEO

  • No.

  • Operator

  • Jeff Brickman.

  • Jeff Brickman - Analyst

  • UBS.

  • Just a couple of quick questions.

  • Just on the R&D side of things, you guys have been absolutely pretty incredible at staying at kind of leading edge technologically, and yet you have less than half the R&D spend of some of your competition.

  • Just wanting to kind of understand longer-term do you think that you can continue to do that or maybe should we expect you to kind of go back to maybe the model that you had more a couple of quarters ago and historically where you look to spend a little bit less and then go after markets as they are mature?

  • John Coyne - President, CEO

  • I think we've guided that the long-term expectation is that we will be in the 9% to 10% range on OpEx, of which R&D is a large component.

  • But we will continually strive to be highly efficient in the leverage we get out of that dollar spending.

  • Jeff Brickman - Analyst

  • Just on -- just kind of one other question just on notebook, and I know it's been kind of asked a couple of different ways, but as you look at the market now, you clearly have a bit of a technological advantage.

  • It sounds like a lot of customers, particularly OEMs, are looking to really get your product when and where they can.

  • How do you kind of weigh your relative position versus the potential for price aggression?

  • Do you think you can kind of combat some of it by just obviously having a bit of an advantage there or is this going to be a scenario kind of like we saw in high cap last year where there's basically no parity, or at the very least, people can kind of stack stuff together to be kind of aggressive?

  • John Coyne - President, CEO

  • As Tim said, our focus is -- on the cost side, we were very high focused on designing for costs and then executing for low costs.

  • And I think that's a differentiator in that when we addressed the 2.5 inch market five years ago and put our plans together and began to design product, we fast forwarded to the present day where we are rapidly approaching the point where the volumes of 2.5 are going to crossover the volumes of 3.5.

  • And so it's a -- when we sat down to go look at that business, we said it was going to be a high-volume business, a similar scale to desktop.

  • And therefore that the cost profiles would be similar.

  • And we set out to design a solution to that and we have achieved that.

  • I think some of the incumbents, some of the more traditional suppliers of 2.5 inch drives are lumbered by a fundamental design approach that does not acknowledge those kinds of market requirements.

  • And consequently, they have a fundamental cost penalty in attempting to address that market.

  • And I think our customers clearly recognize the quality and reliability have not been compromised by our approach.

  • We are delivering the technology.

  • We're delivering the product capacities and performance levels they want, and we are doing that with a very solid, credible forward roadmap and manufacturing and supply chain structure that they have confidence will deliver the values that they need over time.

  • Operator

  • Jung Pak.

  • Jung Pak - Analyst

  • BMO Capital Markets.

  • I want to ask about your share repurchase program.

  • Over the last few years, you guys have purchased about 50 million worth of shares and with your new share authorization, I was wondering if you are going to ramp that up to about $100 million given the duration of the program or how aggressively you guys be?

  • Tim Leyden - CFO

  • As I indicated in my remarks earlier, we will weigh the repurchase opportunities against investment opportunities in other areas.

  • And we will look at the repayment of outstanding debt.

  • We haven't placed any constraints on our potential behavior there.

  • So we are taking an opportunistic approach and where we see that the stock is undervalued and that it's a very good investment, we will take advantage of that as we see the opportunities arise.

  • Jung Pak - Analyst

  • One other question, on your Cape, the $75 million cut, can you talk about where -- what parts of your business are you guys cutting in terms of capital investments?

  • Tim Leyden - CFO

  • As John indicated, it's basically better equipment utilization in drives and components right across the business.

  • And that's effectively what's driving that and just managing it as we always do on a just in time basis, adding capacity just in time as we need it.

  • Jung Pak - Analyst

  • Are you guys investing less in media heads or drive assembly equipment testing?

  • Tim Leyden - CFO

  • Again, it is right across the entire business.

  • Operator

  • Christian Schwab.

  • Christian Schwab - Analyst

  • Craig-Hallum Capital Group.

  • My quick question was regarding finished goods inventory.

  • It kind of appears that the industry is in a similar situation we were in 2004.

  • Thankfully, we only have one guy with a very bloated inventory.

  • We don't have Mac Store with it as well.

  • But it appears if one wanted to be an optimist, that both you and Seagate's management may realize that given the significant decline in earnings on a sequential basis, you are predicting Seagate down 40% and your sales down 35%.

  • Do you believe that that ultimately you hope is a conservative rock bottom number or are you fearful that the environment is a lot worse than that if you can recall that a few years ago?

  • Tim Leyden - CFO

  • Rock bottom number, I don't know how to answer that one because I really can't predict.

  • But from an inventory viewpoint, manufacturers' inventory, we were at seven days at the end of Q2.

  • We are at eight days at the end of Q3.

  • And the rest of the industry was at 10 days at the end of Q2 and is at 15 days at the end of Q3.

  • Addressing your 40% down quarter on quarter, I think that that's a bit -- it doesn't take into account the actual increase that we've seen versus this quarter last year, which is 500 basis points.

  • And as well as that, the seasonality which is generally from Q3 to Q4 has been down.

  • And last year, our EPS was $0.38.

  • So we're forecasting between $0.77 and $0.83.

  • If you don't think that's a good increase, I don't know how I can help you.

  • Christian Schwab - Analyst

  • Do you guys still calculate distribution inventory on a 13 week rolling average versus Seagate at a four week rolling average?

  • Tim Leyden - CFO

  • We never did it on a 13 week rolling average.

  • Seagate has done it at the 13 week rolling average previously.

  • But this quarter, I think that they actually changed that metric.

  • Operator

  • Scott Craig.

  • Scott Craig - Analyst

  • Banc of America.

  • Just two quick questions here.

  • First on the DVR side, is there more opportunity to improve the profitability there?

  • And is it necessary to walk away from business and maybe grow slower than the market in order to achieve that or are there other ways you can achieve it?

  • Then secondly, another question on inventory, from an inventory perspective, I guess the one thing that some people are concerned about is everyone in the industry is pointing to sort of normal channel inventory levels and normal levels in general.

  • Yet, we saw a pretty sharp drop-off in demand in the last part of March, so how do you guys triangulate being "normal" inventory levels when demand seems to be falling off of it here?

  • One would think that the whole industry should take actions like you guys did and close shop for a week or two and really bring inventory levels down.

  • But it doesn't seem to be occurring widespread, so I'm just curious on your thoughts there.

  • John Coyne - President, CEO

  • Let me address the DVR market.

  • I think we made some pretty good progress in the actions that we took last quarter to manage that market and that opportunity and those -- that's managing product mix, customer mix, and cost.

  • And we're working all of those things.

  • As Tim said in his remarks, we think this is a very good opportunity area for us to generate profitable growth on a go-forward basis.

  • Inventory, Tim, do you want to address that or--?

  • Tim Leyden - CFO

  • Inventory yes, I do think that the inventory should be managed according to the demand.

  • We do have the tools available with the weekly reporting which happens.

  • So we would be happy if others deployed the same sort of discipline in that particular [capacity] also.

  • John Coyne - President, CEO

  • But I think to put things in perspective, you referenced the 2004 situation where the level of inventory build was two ex the current build in terms of percentage of inventory relative to industry sales.

  • So I think we have a little overhang.

  • I think it has reflected itself in a little slower distribution start this quarter.

  • We don't actually from the data see that there was any significant reduction in demand in the back half of March.

  • The data indicates the demand was steady.

  • I think the fact that Western Digital's linearity sales was very good left some of our competitors with a bit of a [hill] decline in the back half of March.

  • Bob Blair - VP, IR

  • Is there one more question?

  • Operator

  • Robert Marson.

  • Robert Marson - Analyst

  • Do you guys know where your products are ending up on a geographical basis?

  • The reason I ask that is because there's this global infrastructure boom going on in BRIC and other parts of the world -- Brazil, Russia, India, China area and Middle East and Latin America.

  • Is there any way to gauge the final consumption of your product and how that's going to shift with the increased global growth at the expense of U.S.

  • growth in PC consumption?

  • John Coyne - President, CEO

  • We get some visibility to that the distribution channel and retail through our point of sales data.

  • It's not so clear necessarily in our OEM business where those products finally end up.

  • But what we are seeing in our direct business is a lot of strength in Latin America, in China, in the Eastern European countries, in India, so all of the BRIC economies we are seeing significant strength there.

  • And we believe from talking with customers that the OEMs that we sell to are looking at a similar profile in their businesses.

  • Operator

  • I would now like to turn the call over to Mr.

  • John Coyne.

  • John Coyne - President, CEO

  • So I would just like to recap the highlights of the call.

  • We are very pleased with our sustained progress against our profitable growth objective year-to-date.

  • We continue to feel good about robust demand forecasted for the industry over the next several years, and we feel good about WD's opportunity to continue to prosper by providing compelling solutions to our customers.

  • With that, I would like to thank you all for joining us today and I look forward to updating you on our progress in the future.

  • Thank you.

  • Operator

  • Thank you.

  • This does conclude today's conference call.

  • You may disconnect at this time.