威騰電子 (WDC) 2009 Q3 法說會逐字稿

Good afternoon and thank you for standing by.

Welcome to Western Digital's third quarter financial results for fiscal year 2009.

Presently, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session.

(Operator Instructions).

As a reminder, this call is being recorded.

Now I'll turn the call over to Mr.

Bob Blair.

You may begin.

Thank you.

I want to mention that we'll be making forward-looking statements in our comments in response to your questions.

Concerning inventory levels in the June quarter, our ability to respond to future changes in demand, future investments in technology and acceleration of our solid state drive programs by the intellectual property and technical expertise added through our acquisition of SiliconSystems, the results of our restructuring activities and our expected costs and savings from these activities.

Our continued profitable growth, capital expenditures and depreciation and amortization for fiscal year 2009 and our financial results expectations for the June quarter including revenue, gross margin, expenses, restructuring costs, share count and earnings per share.

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 January 29, 2009, as well as the additional risk factors reported in the press release and 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.

In addition, references will be made during this call to non-GAAP financial measures.

Investors are encourage to review the reconciliation of the differences between these non-GAAP measures to the comparable GAAP financial measures in our press release included as exhibit 99.1 to the Form 8-K we furnished to the SEC today, a copy of which can be found under the SEC filings link in the investor relations section of our website at www.westerndigital.com.

I also want to note that copies of our remarks from today's call will be available on the investors section of Western Digital's website immediately following the conclusion of this call.

I would now like to turn the call over to John Coyne, President and CEO of Western Digital.

Thanks, Bob.

Good afternoon.

Thank you for joining us today.

We are pleased with our March quarter financial performance, a result of crisp execution by the WD team, maintaining a focus on profitability and cash generation.

We managed our market participation, product mix and costs to optimize our returns in a challenging environment.

We maintained our overall market presence while holding gross margins flat with last quarter.

Demand for ATA hard drives in the March quarter remain depressed from year ago levels, falling 12% year-over-year and 9% sequentially to 103 million drives due to the continuing effects of the worldwide economic downturn.

This demand was slightly better than a 13% quarterly decline we had expected.

WD took a disciplined approach to supply during the March quarter.

We reduced production to match drive shipments which were down by 8% year-over-year and 11% quarter-over-quarter to 31.6 million units.

Additionally, we reduced finished goods by 1 million drives.

We're encouraged by the supply demand dynamic in the industry.

In response to customers' significant inventory reductions as they aligned with reduced demand levels, hard drive production was rapidly scaled back during the quarter.

Manufacturers' inventories exiting the quarter for both 3.5 inch and 2.5 inch ATA drives were just over one week while component inventory and distribution was at the low end of the normal four to six week range.

As we anticipated, the pace and timing of demand reductions and inventory realignment have been different for the 3.5 inch and 2.5 inch markets.

The 3.5 inch market is approximately 50% distribution, and the majority of OEM supply chains are short, with drives air freighted to system assembly sites in the region of sale.

These supply chain characteristics lead to a very transparent and responsive market which adjusts rapidly to demand changes.

In November and December, we saw this market undergo a rapid demand decline, amplified by inventory adjustments in line with that demand change.

The December quarter demand dropped by 8 million units or 12% quarter-over-quarter to 60 million units.

We estimated that approximately half of this was inventory adjustment.

March quarter, 3.5 inch ATA sales were flat with the December quarter.

Distribution inventory was maintained flat as sell out equaled sell in, while manufacturers' inventory was reduced by about 1 million units to one and one-quarter weeks.

In contrast, the 2.5 inch market for hard drives is approximately 80% OEM.

With the majority using a China ODM assembly and ocean freight supply chain model, this, combined with the fact that this has historically been a high growth sector, meant that adjustments to the new market demand realities took somewhat longer to move through the chain.

Starting in January, we saw a massive inventory squeeze which took 10 million units out of the market demand in the first two months of the quarter.

This reduced demand from 53 million units in the December quarter to 43 million units in the March quarter, a 7% year-on-year and 18% quarter-on-quarter reduction.

Again, the industry was quick to react on the supply side.

Matching output closely to demand and additionally reducing manufacturers' inventory by over 3 million units to 1.1 weeks of supply.

The industry built 12 million less 2.5 inch ATA hard drives than in the prior quarter, a 20% quarter-on-quarter reduction in manufacturing activity.

The balanced supply demand dynamic created in the quarter and the low level of inventory in both distribution and OEM channels are positives as we look forward into the June quarter.

However, the most important determinant of our business performance in the quarter and into the second half of this year will be the true consumption trends.

Significant uncertainty still remains about the magnitude and direction of end user demand.

We will keep our operations highly flexible to respond to whatever direction demand will take while remaining highly focused on inventory, cash, cost and profitability.

The actions we have taken and are taking to resize and structure the business to remain profitable and cash flow positive at a $1.5 billion revenue level are well advanced and are already showing up in our cost of goods and operating expense lines.

While very focused on the control of operating expense, we continue to make substantial investments in future technologies and products.

Indeed, despite the constraints of the current economic cycle and our consequent restructuring actions, we increased our March quarter R&D spending, excluding variable compensation by 6% compared with the same period last year.

This investment was funded by reductions in base SG&A of some 10% year-on-year.

Complimenting our internal investments, we are continuing our strategy of utilizing externally developed technology by strengthening our relationships with industry leading suppliers.

In April, we concluded a new agreement with Showa Denko, extending our long time partnership with them as a strategic supplier of advanced media.

Our sustained investment in technology and product breath continues to bear fruit.

With our shipments of the industry's first two terabyte drive growing throughout the quarter, supporting multiple applications in our component and branded products business.

This week, we announced an additional version of this two terabyte drive for the high duty cycle business critical enterprise SATA market, again demonstrating WD's ability to rapidly mature industry leading technologies in mass production.

We also extended our technology and product breadth during the quarter with the acquisition of SiliconSystems which has become the WD solid state storage business unit.

With revenue in 2008 of $47 million and an established footprint in the industrial network communications, medical, aerospace and military markets, the business is modestly accretive to WD.

The addition of SiliconSystems' technical expertise will accelerate WD's solid state drive development programs as we assess opportunity in the netbook client and enterprise markets, providing greater choice for our customers to satisfy all of their future storage requirements.

Integration into WD is well underway and proceeding according to plan.

Our overall results continue to demonstrate the effectiveness of the WD business model in all environments.

Tim Leyden will now review these results for the March quarter in more detail and provide our outlook for the June quarter.

Tim?

Thank you, John.

During the March quarter, the WD team continued its disciplined approach to market participation.

Having sized capacity to match our expectation of demand, we paid close attention to the fundamentals of cash generation and profitability in a challenging macro-economic environment.

We did this by optimizing product mix, limiting our participation in certain markets and concentrating on cost reduction and factory utilization.

We are pleased with the results of our actions to size the business to reflect the demand realities that the industry faced, and we sacrificed some near term share growth in order to make progress towards industry supply/demand equilibrium.

We are monitoring the market size and the supply/demand balance, and we are poised and well positioned to leverage our asset velocity model, to take advantage of profitable growth opportunities as the industry continues to cope with unpredictable demand patterns.

Our revenue for the third fiscal quarter was $1.6 billion, down 21% from the prior year hard drive revenue of $2 billion and down 13% sequentially.

Shipments totaled 31.6 million units, down 8% from the prior year and 11% sequentially.

Average hard drive selling price was approximately $50, down $1 from the December quarter and $9 from the year-ago quarter.

Our Q3 ASP reflects a continued competitive pricing environment, particularly in the notebook market where supply exceeded demand in the early part of the quarter and in the branded products market, where price degradation continued throughout the quarter.

Demand for our desktop products in the March quarter was stronger than historical seasonal norms, resulting in increased volumes as compared to declines in all other markets.

The relative strength in desktop was somewhat favorably impacted by a replenishment of our customers' inventories as they had cut back their orders significantly towards the end of the December quarter.

This phenomenon was more pronounced and happened earlier in the desktop market than in other markets.

WD's flexible supply model allowed us to quickly respond to these changes in the overall demand profile.

Demand for other products was affected most significantly by further inventory reductions driven by the overall weak consumer and commercial spending environment.

Our unit shipments of 2.5 inch drives were $10.1 million in the March quarter as compared to $10.2 million in the year-ago quarter and $13.8 million in the December quarter.

In this market and particularly in the earlier part of the quarter, we were selective in the business that we chose to pursue.

We shipped 3.5 million 3.5 inch drives for use in digital video recorders in the March quarter as compared to 3.1 million in the year-ago quarter and 4.1 million in the December quarter.

Revenue from sales of branded products was $343 million as compared to $330 million in the year-ago quarter and $403 million in the December quarter.

Industry pricing was particularly competitive in this market.

We believe this was primarily driven by a large competitor liquidating excess inventory.

With the industry's leading cost structure and compelling product lineup, we continue to view this market as a key contributor to WD's long term profitable growth.

Hard drive channel revenue was 48% OEM, 30% distribution and 22% branded products in the March quarter compared with 50%, 34% and 16% in the year-ago quarter and 57%, 21% and 22% in the December quarter, respectively.

The Q3 geographic split of our hard drive revenue was 26% Americas, 28% Europe and 46% Asia as compared to 28%, 31% and 41% in the year-ago quarter and 23%, 29% and 48% in the December quarter.

Demand strength in Asia, while more muted than in recent quarters due to the inventory correction in the 2.5 inch market, continues to be driven by the concentration of global manufacturing in that region and more recently, by the effect of the Chinese government's stimulus policy.

Our gross margin for the quarter was 15.9%, down from the 22.6% we reported in the year-ago quarter and flat with the December quarter.

Total operating expenses of $192 million included a $14 million charge for in-process R&D related to the SiliconSystems acquisition and $4 million of costs associated with the restructuring plan announced in the December quarter.

Excluding these items, total R&D and SG&A was $174 million for the March quarter, $13 million higher than the total R&D and SG&A reported in the December quarter.

December OpEx benefited from a $16 million reversal of a prior quarter bonus accrual and a zero bonus for the period, whereas the March quarter included a $14 million bonus accrual.

Adjusting for these changes, the R&D and SG&A for the March quarter was down $17 million from December.

Restructuring charges related to the resizing plan we announced in December of 2008 have totaled $117 million to date, $4 million of which was incurred in the March quarter.

We now expect the total cost of our restructuring to be about $122 million.

This is lower than the $140 million forecasted on our January call.

We have temporarily extended the operation of our Sarawak substrate facility through June while we continue to explore the option of disposal versus closure.

We continue to expect the annual savings from the restructuring to be $150 million, once all actions are completed.

Including the $14 million in-process R&D charge and $4 million restructuring charge, operating income was $61 million, or 3.8% of revenue.

Excluding these charges, operating income on a non-GAAP basis was $79 million or 5% of revenue.

Interest and other non-operating expenses were approximately $3 million.

This includes about $1 million of unrealized losses in our previously disclosed investments in auction rate securities.

These investments totaled $18 million at the end of the quarter.

Tax expense for the March quarter was $8 million.

For fiscal 2009, we expect our book effective tax rate to range between 8% and 10% as we take into account our expected continuing profitability and the global mix of income by region.

Our cash tax rate is expected to be between 2% and 3% for the fiscal year.

Including the $14 million in-process R&D charge and the $4 million restructuring charge, net income totaled $50 million or $0.22 per share.

Excluding these charges, net income on a non-GAAP basis was $68 million or $0.30 per share.

Turning to the balance sheet for the March quarter, our conversion cycle was five days which consisted of 47 days of receivables outstanding, 26 days of inventory or 14 turns and 68 days of payables.

We generated $355 million in cash flow from operations.

We paid out a net of $44 million related to the SiliconSystems acquisition.

Capital expenditures were $106 million and depreciation and amortization totaled $119 million.

Cash and cash equivalents increased by $203 million, ending at $1.6 billion.

In the June quarter, we will be paying out an additional $19 million related to the SiliconSystems acquisition, bringing the total net cash paid to $63 million.

We'll also be making our first quarterly debt repayment installment of $19 million.

A summary of our debt repayment schedule was included in our most recent 10-Q filing.

Capital expenditures for fiscal 2009 are expected to be about $500 million.

This is consistent with the reduced forecast we provided on our January call.

Depreciation and amortization for fiscal 2009 is expected to be about $480 million.

We will be providing a fiscal 2010 capital forecast during our July earnings call.

We did not repurchase any shares of stock during the March quarter.

We continue to carry a healthy cash balance as we navigate the current economic downturn.

We'll continue to manage our cash conservatively until demand visibility becomes clearer and the economic uncertainty abates.

Now I will discuss our expectations for the fourth quarter of our fiscal year 2009.

You will recall that we indicated on several occasions that this quarter will be a 14 week quarter with our fiscal year ending on July 3, 2009.

First let me outline the market situation as we see it.

Historically, the June quarter sequential unit volume has been flat to slightly down.

Global macroeconomic conditions remain challenging, and while we have seen much progress towards inventory rationalization in the industry, we expect demand patterns to be less predictable than would be the case if normal seasonal conditions were present.

Taking into account the inventory situation, our 14 week quarter and other known variables, we are modeling market volumes that will be essentially flat with the March quarter.

We believe in a commodity market such as ours that balancing of supply and demand continues to be critical and we remain focused on maintaining that equilibrium.

Our sequential ASP declines have been about 5%, and we anticipate that pricing will continue to be competitive.

The production realignment undertaken by the 3.5 inch industry participants has led to a better balance between supply/demand and inventory holding patterns, and we are now seeing that dynamic extend to the 2.5 inch marketplace.

Taking these factors into account, we expect current quarter revenue for WD to be in a range of $1.45 billion to $1.6 billion.

We are modeling gross margin of 15.5%.

R&D and SG&A are expected to total approximately $175 million.

This includes the combined incremental impact of OpEx spending related to our recent acquisition as well as the 14th week in our current quarter.

Restructuring costs are expected to be $5 million.

Our net interest expense is projected to be about $4 million, assuming no further losses in our investments in auction rate securities.

We anticipate tax expense of about $10 million.

We anticipate our share count to be approximately 227 million.

As a result, we expect GAAP earnings per share to be between $0.14 and $0.24.

Excluding the $5 million of restructuring charges I outlined earlier, we estimate non-GAAP EPS of between $0.16 and $0.26.

This guidance excludes any impact from the possible disposal of our Sarawak facility.

Operator, we're now ready to open the call for questions.

Ladies and gentlemen, we will now begin the question-and-answer portion of today's call.

(Operator Instructions).

One moment, please, for the first question.

Our first question comes from the Sherri Scribner with Deutsche Bank.

Your line is open.

Hi, thank you.

I had two questions.

One, clearly this quarter you guys lost a little bit of share in 3.5 inch and in 2.5 inch.

What would be your plans going forward for share gains?

In the past, you've talked about -- you've been generally pretty optimistic about your share gain.

Do you sort of see a new pattern emerging where you want to be more cautious about share gains and you are focused on profitability, or do you still plan on additional share gains as we move through the year?

Hi, Sherri, this is John.

Our objective remains sustained profitable growth.

Over the past five years or so, we've been putting together a broad product portfolio addressing multiple segments of the market.

We have been successful in growing our position in each of those segments to a substantial level.

Having achieved that balanced business portfolio and good presence in each segment, that affords us the ability tactically in any given quarter to be able to address market conditions by segment and manage the portfolio to achieve solid overall results, just as we did last quarter.

Where on an overall drive industry basis, we maintained share, we gained a little bit in the desktop, we lost a bit in the 2.5 inch space.

When I say we lost it, we know exactly where it is.

We haven't actually misplaced it.

And as we look forward into the market, we continue with our profitable, sustainable growth path.

We will continue to pursue growth in our existing market segments as that offers us appropriate rewards, and we will continue to grow through the addition of participation in new segments as we've indicated an intention to enter the enterprise, mission critical space and with the recent acquisition of the solid state business unit, future -- existing participation in solid state solutions, but an opportunity to broaden that participation over time.

So you can expect that WD will continue to pursue sustained profitable growth.

Okay, thank you.

That's helpful.

The color on that is helpful.

And then in terms of the gross margin, I guess I'm a little surprised that the gross margin guidance is down a bit.

Is there anything particular we should think about there in terms of -- I would have thought that your cost cutting would have helped you in the June quarter a little bit more.

Is that related to the 14 week quarter, and do you see that as sort of a bottom for the gross margin?

Yes.

When we look at the fourth quarter, generally, it's our most challenging quarter from a historical and seasonal viewpoint.

And in this quarter, we will incur 14 weeks of utilization and we won't necessarily be able to have the sort of proportionate increase due to the 14th week that we would normally anticipate.

Okay, great.

Thank you.

Thank you.

The next question comes from David Bailey with Goldman Sachs.

Your line is open.

Great.

Thank you very much.

I was wondering if you could talk a little bit about your participation in the netbooks segment.

I know last quarter you'd said that you're shying away from that, and are you developing a cost optimized product for that segment?

I don't recall indicating that we were shying away from netbooks.

In fact, we see the netbooks segment, which is one of the few areas in the computing and internet connected space and entertainment space that is actually growing.

We see it as a significant opportunity.

We think last quarter there was about, somewhere between five million and six million netbooks shipped, and our participation in that market was similar to our participation in our traditional notebook environment.

And are your margins similar to the notebook margins as well?

Our margins are at the low end of our margin hierarchy.

But I mean with our low cost model, we are very well positioned in order to be able to participate in that, and we're satisfied with the margins that we're getting in that segment.

Okay.

Thank you.

Rich Kugele with Needham & Company, your line is open.

Thank you.

Good afternoon.

Just a couple of questions.

First, can you give us a little color on the dynamic for gross margin improvement sequentially?

Is it the effect of the restructuring, or do you have your own aerial density changes going on that is benefiting the cogs line?

John indicated how we participated in the market by being tactically opportunistic.

So from a mix viewpoint, we benefited from that.

And then we did benefit from the improvement in utilization as we had resized our business, and of course we worked on costs like we always do.

And then I'm sorry, more for the June quarter?

Oh, for the June quarter, we anticipate -- I mean it will be the same thing.

As I indicated to Sherri, we won't be able to get the same proportionality increase on 14 weeks from a revenue viewpoint, so consequently production, we're going to have to match the production and cover the absorption for the disproportionate overhead that is going to go into the manufacturing overheads.

Okay.

And then, I guess just secondly here, significant capacity has been taken out of the drive industry, whether really at the drive level or even in the component supply chain.

Is there anything that gives you pause, John, that has perhaps been impaired, perhaps even permanently, due to the downturn, or are you comfortable that the industry is on a solid enough footing that if demand does return later this year, that it can be responding positively to it, or do you think there's going to be shortages, for example?

I think the fundamental structure in the supply base is sound.

We've certainly sized our business to the opportunities we currently see.

Historically, if those -- if emerging opportunities showed up, we have a track record of being pretty good about addressing them.

The -- we do expect to see some spot shortages that, for instance, a number of wafer fabs in Asia today are running flat out, and last quarter, they were completely empty or significantly reduced in throughput, shall we say.

So there will be a little bit of jerkiness in the supply chain I expect over the next couple of quarters as people try to understand the macroenvironment, read the tea leaves properly and respond appropriately.

But structurally and on a medium term basis, I don't see any fundamental issues.

Okay.

Then just the last question is obviously inventories on your own balance sheet, others' balance sheets and in the channel have improved significantly.

Usually there is a bit of a lag effect before that starts to impact the OEM pricing negotiations.

Have you started to see any rationality appear there at the OEM level?

Are they starting to recognize that they aren't going to get the types of ASP declines that they've gotten in recent quarters?

Well I think the OEM's behavior is always rational.

When the industry is foolish enough to produce significantly above demand, then pricing power absolutely moves to the large customers and they behave very rationally in that kind of environment.

Job one for every procurement officer in every major company is availability.

And so in times when supply is short to demand, that becomes the major concern of the procurement department, followed by good value for money.

Okay.

Thank you very much.

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

Hi, guys.

Two questions.

First, Tim for you, on the cost saves that you've identified, the $150 million, could you give us an update on timing?

I think the past comments have been -- will be captured by the conclusion of the June quarter, and I just wanted to get an update there.

And then I had one followup, please.

Yes.

We're on track for the conclusion during the June quarter.

And Tim, the distribution between cogs and OpEx in terms of that $150 million?

It's about 60% OpEx and 40% cogs.

Fair enough.

And just to follow-up, you mentioned that one of your competitors has been more competitive in the retail space or branded space.

Has that impacted the margins of that particular business, which has been very profitable for you in particular, and how do you see that unfolding going forward?

Thanks.

Yes, I didn't indicate that one competitor was more competitive.

I indicated that one competitor we thought was clearing out inventory.

Okay.

So consequently, that, I think, hurt wealth creation for many of us in the industry.

But from a viewpoint of branded products and margins, we're now from a hierarchy viewpoint, if we look at it with -- just in order to give some insight, but not to give too much away competitively --

Yes.

We are classified the margin hierarchy into three different stratifications.

First stratification is the heavily engineered type products, which is the enterprise SATA and the SSD type products, and then the second stratification comes into the consumer type products in order to cover for inventory carrying and other administrative overhead type of costs.

So we have the second highest margin there.

And the third one comes in the commercial type products, which is desktop and laptop and of course, in netbook.

So that's the -- and that currently is the hierarchy.

So consequently, it's in the middle of the group.

It doesn't sound like it's (inaudible)

Brand of products.

Okay.

Thanks very much, guys.

Christian Schwab with Craig-Hallum Capital, your line is open.

Great, thank you.

Could you just remind me, Tim, what our gross margin target is?

The gross margin model, the long term gross margin model is 18% to 23%.

18% to 23%, great.

And then, can you elaborate on what is going on the leadership position in the 2.5 inch, on the 250 per platter?

Do you guys think you're there first?

Do you think a few others will be there around the same time?

I'm just wondering if you can give us an update on next generation?

This is John.

Well clearly, we led at the 250 gig per platter as we had done on the two previous generations, and the next industry technology deployment will be 320 gig per platter in the 2.5 inch space, and we fully expect to continue to be a leader in that space.

And we will, on a broader context, one of Western Digital's long time strengths has been our ability to manage the full portfolio of technologies within products and throughout our entire production chain, whether it's our extended chain of merchant suppliers and our internal component factories as well as our drive factories to manage our mix there, to optimize our return on investment and maximize our margins, and we intend to continue to do that.

Great.

And then on the head strategy there, is that similar to previous strategies, internal plus external?

Absolutely.

We have, for a long time had an approach to those technologies which we had internalized the head and media of having a significant minority of that business on the outside in the merchant market.

We worked very closely with those suppliers, TDK, SAE on the head side and the primary partner on the media side is Showa, and we work very diligently with them to assure our access to and utilization of technologies that they can bring to our ability to integrate those technologies and take them rapidly to market.

And by doing so, manage risk in new product introduction as well as manage total capital investments and total technology investments in our own business, while getting the majority of our components from our internal structure, which addresses cost and the total package, we believe has been very successful and we believe it will continue to be successful for us.

Great.

And then on the merger of a couple of your competitors who together now will end up with meaningful 2.5 inch drive markets here, do you think that leads to opportunities for you in the near term?

No deal is done until it's done, but for trying to predict the future, one tends to look at the past.

And certainly, the last three mergers in the industry that included two parties with overlapping product lines resulted in an opportunity for the non-merging companies in the industry.

Right, right.

Our tech suggested that market share shift has already begun.

Would you agree with that?

I would agree with that, yes.

Great.

And then as we look to another competitor, not one of those two, but another one that produces on that part of the world, there were --- our checks suggested they had limited exposure in a lot of desktops, particularly North America a little bit and Europe, but only were sitting around in Asia.

Do you think anybody is changing their commitment to the industry which could be a positive long term fundamental?

It's very hard to tell.

I mean we're certainly -- the model that we have developed allows us to operate very profitably and very well in the overall market environment as it exists today.

So we do not rely on changes in the structure of the industry to -- for our survival and/or our overall future.

But -- so the industry doesn't have to change to make us successful, but certainly changes in the overall structure could potentially be of benefit not only to us, but to the entire industry.

Great.

Fabulous quarter.

Thanks.

Thank you.

Aaron Rakers with Stifel Nicolaus, your line is open.

Yes, thanks for taking the question and also, congratulations on a good quarter.

I guess I want to understand the gross margin a little bit more.

Yes, I think last quarter in reference to a question that was asked on the call, I think the comment was made that as the industry realigns itself, and it looks like that definitely has taken shape, that you guys would be able to get back into your targeted gross margin level of 18% to 23% in pretty short order.

So if you strip out the 14 week quarter, I guess I'm trying to understand why we wouldn't be getting close to that 18% to 23% level again?

Well we sized the business to be profitable and cash flow positive at $1.5 billion.

And obviously, with the industry conditions being the way they were, that was -- that profitability, and we indicated it as well with our earnings expectation, was that it was going to be right around break even.

And so as we go forward into the future, it will be very dependent on what conditions stay present in the industry.

Obviously, we'll have to grow a little bit from where we are at the $1.5 billion.

We'll probably have to grow somewhere to about halfway to what our previous revenue run rate was.

And then I think at that stage, and with supply demand dynamics being somewhat in balance and our segment mix spin somewhat similar, then I think we could get to the low end of that 18% to 23% range under those conditions.

So you're saying relative to the 1.5, take a half way point to the 2.2 that you've kind of done in recent history in terms of quarterly revenue?

Yes.

Is that fair?

Okay.

And how much of an impact is the extra week in terms of the operating expense structure in this quarter?

And I'm trying to think about that given the full extent of the cost saving as we roll into September and there forward?

Yes, I think it doesn't compute to 14, 13s, if you will.

It probably computes more to like 13.75 in terms of what the OpEx run rate would be.

Okay, fair enough.

And then final two questions for me.

I want to make sure I have this clear.

You're saying that your tax expense will be $10 million, is that right?

Yes.

Okay.

And then I guess I'm trying to understand on the SSD, the SiliconSystems acquisition, understanding where they're currently positioned, but you can speak to what addressable markets you really see in front of you for the SSD opportunity?

Sure.

I mean, the SSD market as we understand it in 2008 was about a $1.1 billion market.

That, in context, the hard drive business in 2008 was a $35 billion market.

The projections that we're synthesizing from all of the forecasters and from discussions, internal and external show about a $5 billion opportunity for SSD, three to four years out and a $40 billion opportunity for HDD three to four years out.

But you can see -- I'm sorry.

Within that, the $1.1 billion last year, about $400 million to $450 million of that was embedded systems which was the -- in the markets that SiliconSystems addresses with current product line, we believe the balance was a split between enterprise tier zero type applications and notebook and netbook applications.

Thank you very much.

That's -- and we think most of the growth is in the forecasted growth, most of that is in the enterprise and client computing and netbook spaces.

Thank you.

Mark Moskowitz with JPMorgan, your line is open.

Thank you.

A few questions if I could.

You mentioned, John, that you suspended your relationship with Showa Denko.

Does that mean you guys maybe overpaid for Komag, in terms that you maybe bought a little more than your really needed with Komag, or do you see the potential still for Komag to help you with your potential mission critical enterprise entry in terms of aluminum disk?

No, I certainly don't think we overpaid for Komag.

I think our results over the time period since we bought Komag more than demonstrate the value of that acquisition to our business.

The Showa Denko relationship, and in fact, we also have relationships with other merchant market media suppliers as well as substrate suppliers, are part of our long term strategy of how we do internal, external blending to get the best technology, cost, quality and risk profile for the business.

And we've been consistent with that.

We intend to continue to be consist with that in mixing the majority -- producing the majority of our internal heads in media, but buying a significant minority on a consistent basis over the long haul in the merchant marketplace.

And then as far as the earlier question regarding the proposed Fujitsu Toshiba merger.

Given Fujitsu's, shall we say inconsistent execution within the mission critical enterprise, do you see this as really a prime opportunity for you to maybe accelerate your entry into mission critical, or do you see mission critical maybe still not being a top priority for WD in terms of growth?

Is that more on the SAS side, SATA or even USSD?

Well our approach to the enterprise business, as we assessed the opportunity in that space for many years that that assessment did not look positive in that there were multiple form factors, multiple interfaces, very low volumes of all of them, and relatively stable volumes of all of them, and multi competitors.

And that was not a good opportunity set from our perspective.

Because to address that, the engineering effort relative to the potential sales just didn't map out.

As the industry began to approach a series of transactions, 3.5 inch form factor to 2.5, SCSI and fiber channel to SAS, then things began to look much different from our perspective with a segment of that mission critical market now standardizing on a 2.5 inch form factor with a SAS interface offering, if you looked at that segment, which most forecasts indicate will be by far the dominant sector over the next three years, that looks more attractive.

And so we began investing in enterprise engineering some years ago, and we are preparing to address the needs in that market.

Now an interesting opportunity emerges as the tiering in that marketplace for high ups high transaction systems begins to see the advantage of solid state solutions against the multi drive destroked 15 K fiber channel solution to that problem.

We see the opportunity to provide value to customers in the high end of the enterprise tier to complement a mid range SAS based product and thereby be able to satisfy the total range of solutions on a forward-looking basis over the next several years.

Thank you.

Scott Craig with Bank of America, Merrill Lynch, your line is open.

Yes, hi.

Can you guys just comment on the impact that the bonus accruals will have in the coming quarter on the operating expense line?

And then secondly, how much capacity do you actually think has been taken out of the industry either in units or percentage when you think about both the 3.5 inch and the 2.5 inch based on your conversations with the industry pundits?

Thanks.

Well on the bonus question, the accrual that we made this quarter is pretty typical.

Somewhere between that $14 million to $20 million, to -- actually, somewhere between $10 million and $20 million, depending on how well the company is doing in absolute terms and relative to peers.

The second piece of the question, oh, capacity in the industry.

I think what is much more important than capacity in the industry is utilization of that capacity and how people are running production relative to overall demand, and I think there is some very positive signs there.

I think the industry was tremendously responsive and fast in the last quarter and very disciplined in managing supply relative to demand.

I think the fact that over the last two quarters the industry's taken -- our customers have taken about 10 million units out of inventory, is another very positive sign.

Because when we're trying to understand the macroeconomic impacts and trying to understand the real demand -- end user demand activity in the market, eliminating that 10 million of disconnect between what is happening on the customer -- the end customer side and what is happening on the supply side is very important to getting a good match between supply and demand.

So I'm very encouraged by all of the behaviors I see and the fact that the inventory is not clouding the issue any more.

So now it becomes a -- the uncertainty is now around the true end demand and what the impacts of the macroeconomic environment are going to be on consumers and commercial demand.

Okay.

Thank you.

Next question comes from Katie Huberty with Morgan Stanley.

Your line is open.

Thanks, good afternoon.

What was the headcount growth year-on-year if you net out acquisitions, and then how do you expect headcount to trend over the next couple of quarters?

I don't have the netting out the acquisitions necessarily closely to hand, but I certainly -- on a full year-over-year basis, we've grown about 2,000 people.

On a sequential basis, we've come down 7,000 people from the December quarter.

And are there -- is there more work you can do on that front, the next couple of quarters?

We do not have any substantial plans in that area.

We're pretty much done.

With the exception of our Sarawak facility where Tim mentioned, we continue to operate that facility as we continue to explore closure or disposal.

In either event, our headcount will come down by about 500 to 600 people at that point.

And then as a quick follow-up, as it relates to the SiliconSystems acquisition, do you plan to add or integrate any of your own technology to their current solution, or do you view that as largely a stand-alone business, as you purchased it?

I think there are multiple facets to it.

It is a revenue generator, a profitable business that we'll continue to pursue, and we would like to grow our presence in those markets, which we don't currently.

We didn't previously address as WD.

But there is also significant value from an engineering expertise and experience perspective that we expect will have a positive effect when combined with our existing internal resources.

Okay, thanks.

I should just clarify on the -- we have grown by about 2,000 people on a year-over-year basis.

But that does include the conversion of about 4,000 contract employees into full time employees.

So we're on a real apples-for-apples basis, we're down about 2,000 on a year-over-year basis.

Okay, thanks for the clarification.

Doug Reid with Thomas Weisel Partners, your line is open.

Thanks.

Could you comment on which segments WD chose to step away from in order to maintain supply/demand balance, and what is driving those decisions?

Well I think the areas that we stepped away from a little bit, in 2.5 inch we stepped back somewhat.

We didn't like the reward ratio in that business at the beginning of last quarter, so we stepped a little away from that.

We stepped into the 3.5 inch space, which was offering better reward for our energy at that time, and we also created some space in the branded products arena to allow what we saw as a required blowout of excess inventory.

Okay.

And then you can comment on the opportunity to gain market share at the next technology node at 2.5 and 320 gigabyte per platter?

That's the next technology and we'll announce products when we're shipping them.

Okay.

Thank you.

Okay.

I think we're done with questions.

So in closing, I want to thank the entire WD team.

The strong results in such a challenging market condition are a testament to their adaptability, their perseverance, their capability and focus and motivation.

And despite the current state of the economy, we remain very encouraged by our long term market opportunities.

The applications driving digital content continue to multiply, drive storage, delivering appropriately tiered, cost effective, high capacity storage and high performance, low capacity transaction oriented solutions will continue to provide great customer value in these markets.

And we remain committed to provide the best customer value proposition in the industry, to deliver financial results which allow us to continue making the substantial investments required to lead the industry and to generate superior returns for our supply partners, our employees, the communities in which we operate and our shareholders.

Thank you again for joining us today, and I look forward to keeping you informed of our progress.

This does conclude today's conference call.

You may disconnect at this time.

Have a great day.