威騰電子 (WDC) 2010 Q2 法說會逐字稿

Good afternoon, and thank you for holding.

Welcome to Western Digital's second quarter financial results for fiscal year 2010.

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 will turn the call over to Mr.

Bob Blair, you may begin.

Thank you.

I want to mention as we begin that we will be making forward-looking statements in our comments and in our response to your questions concerning industry pricing and demand, the impact of our entry into the traditional enterprise market, our immediate and long-term growth opportunities, our response to customer needs in existing and new markets, our expected capital expenditures, depreciation and amortization, and tax rate all for fiscal 2010, our investments in product line expansion, our share repurchase plans, and our financial results expectations for the March quarter including revenue, gross margin, expenses tax rate, 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 SEC on October 29, 2009.

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 also want to note that copies of remarks from today's call will be available on the investor section of Western Digital's Web site immediately following the conclusion of this call.

I would like to now turn the call over to President and Chief Executive Officer, John Coyne.

Thanks, Bob.

Good afternoon, and thank you for joining us.

For the third consecutive quarter, demand for hard drives was at the high end of expectations as the positive industry conditions that first materialized in the June quarter continued throughout the second half of the calendar year.

The demand strength continues to be primarily consumer driven.

But we are now also seeing some signs of recovery in the commercial sector.

We believe that overall hard drive shipments in the December quarter totaled 160 million units, up 29% on the year ago quarter, and 5% sequentially.

Industry inventory, OEM and distribution combined, remains extremely lean at approximately two weeks of sales reflecting the strong demand the the quarter, constraints in the industry supply chain, particularly in media and substrate, and continued industry discipline in managing the supply/demand dynamic in those segments where supply constraints are not dominant.

We are very pleased with WD's continued progress in pursuit of our primary objective of sustained profitable growth as we continued to respond to strength in customer demand.

For the third consecutive quarter, we significantly increased output in a supply-constrained environment providing strong support of our customers growth opportunities.

Strength in overall market demand, continued customer preference for WD products, our timely investments in capital, the support of our supply partners, and strong execution by the WD team generated record revenue and profits on record unit shipments.

A moderate pricing environment, combined with our passionate focus on cost and efficiency enabled gross margins well above the high end of out model range.

We contained operating expenses under the low end of our model yet we continued to grow our R&D investments by 8% sequentially.

Asset management remained crisp, resulting in record cash generation.

I'm particularly pleased that our management through the difficulties of the recession, and our subsequent response to improving market conditions since April, have increased our calendar year 2009 revenues and net income by 4% and 34%, respectively, compared with calendar year 2008.

Our compound annual growth rate over the last three calendar years, which includes the dampening effect of the recession, was 19% for revenue, 25% for units, and 29% for net income.

We continue to realize tangible benefit from the substantial investments we've made in technology, products, processes and capacity over the last few years with several notable product achievements in the last quarter.

Most significant, as part of our sustained portfolio diversification and expansion strategy is our entry into the traditional enterprise market with the shipment of our 2.5-inch 10K SAS product line beginning in early November.

This new product family complements the range of enterprise SATA drives which we have been shipping for some years now and will allow us to both expand our business with many existing customers and add new customers in the enterprise storage arena.

In the December quarter, driven by strong customer adoption of our newest products, we led the industry in volume shipments of the market's largest capacity points in the industry's fastest growing segments, 1 terabyte, 750 gigabyte and 640 gigabyte 2.5-inch drives in the branded products and notebook markets and 2 TB 3.5-inch drives in the branded and enterprise SATA sectors.

In the branded products area we continue to innovate.

Our new WD SmartWare, which is now available across our refreshed My Passport and My Book external storage product lines, has received very positive reviews for its highly intuitive easy-to-use visual representation of the backup and synchronization process providing a highly differentiated and superior user experience.

Further developing the theme of convenience and ease of use, we also introduced e-label display features on our premium external storage product lines.

In media players, we expanded our popular WD TV range with the successful launch of our WD TV Live product which adds network connectivity enabling home content aggregation as well as direct access to stream external content.

Additionally this month, we launched the industry's first certified USB 3.0 external drive with the My Book 3.0, an industry leading high performance solution for power users.

Entering calendar 2010, we are very excited about the immediate and the long-term growth opportunities for WD in both the consumer and commercial storage segments.

Over the last nine months, despite the backdrop of a worldwide recession, we seen increasing levels of demand for high capacity cost effective storage.

We believe this demand is driven by the ubiquitous role of digital content in everyday life and spurred in the consumer segment by increasingly versatile and powerful devices and PCs with new attractive price points.

In support of this thesis, yesterday's New York Times cited a recent study from the Kaiser Family Foundation that determined the average young American now spends practically ever waking minute, except for time at school, using a smart phone, computer, television, or other electronic device amounting to more than 7.5 hours a day.

This compares with less than 6.5 hours five years ago.

This does not count the hour and a half that youths spend texting or the half hour they talk on their phones.

And because so many of them are multi-tasking they pack an average of nearly 11 hours of media content into that 7.5 hours.

Meanwhile, in the commercial sector, the prospects for a recovery in corporate IT spending, the demand for green IT infrastructure solutions, and a PC refresh cycle provide more optimistic indicators than a year ago at this time.

We are addressing what we believe is a secular shift to increased usage of mass volume storage in all walks of life.

To do so we are focusing on enhancing the advantaged business model we have developed over the last several years.

In responding to our customers needs, and earning their business in the fastest growing markets, we provide a critical combination of quality and reliability, portfolio breadth, technology and product availability underpinned by our low cost model, our vertical integration, the industry's fastest asset turns and strongest balance sheet.

We believe this WD focus represents a sustainable advantage as we continue to respond to customer needs in our existing markets and as we move in to new markets for WD such as the traditional enterprise.

However, our enthusiasm is tempered by current macroeconomic uncertainties and we continually monitor the actual demand data and remain on guard against excessive optimism about the 2010 outlook.

We are maintaining our flexibility and agility and are willing to apply the brake if conditions warrant.

Before I pass the call to Tim Leyden, I want to thank the WD team and our supply partners for outstanding execution in seizing the opportunities that emerged throughout the quarter, and our customers for providing those opportunities.

Once again, we have further strengthened WD and our long-term mission of generating sustained profitable growth.

Tim?

Thank you, John.

Revenue for our second fiscal quarter was $2.6 billion, up 44% from the prior year and 19% sequentially.

Power drive shipments totaled 49.5 million units, up 39% from the prior year period, and 12% sequentially.

Non hard drive revenue, including sales of WD TV, HD media players and solid state drives, totaled approximately $47 million compared to $12 million in the prior year and $36 million in the September quarter.

Average hard drive selling price was approximately $52 per unit, up $1 from the year ago quarter and up $3 from the September quarter.

Industry demand was strong, coming in at the high end of our anticipated range of 152 million to 160 million units.

Within that environment, demand for WD's products was stronger than expected.

We satisfied a disproportionate share of the overall market growth, which is a validation of the benefits of having a large scale vertically integrated and agile business model.

Our low cost focus combined with a favorable product and segment mix, moderate price declines enabled us to service that demand at margins that exceeded our business model parameters.

Desktop demand was stronger than expected due in part to the reemerging commercial market and growth in China.

The market size was constrained by supply and pricing remains stable.

We see unfulfilled demand rolling over into the third quarter.

We shipped 21.2 million mobile drives in the December quarter compared to 13.8 million in the year ago quarter and 19.2 million in the September quarter.

This above market growth was driven primarily by our ability to meet customer appetite for high capacity drives at 640 GB and above.

During the December quarter, we shipped 4.1 million drives into the DDR market, flat with a year ago quarter and up from 3.1 million if the September quarter.

This improvement in sequential quarterly volume was driven by improved market demand and adoption of WD GreenPower drive platforms.

Revenue from sales of our branded products, including WD TV, was $569 million, up 41% from $403 million in the year ago quarter and 49% sequentially from $382 million in the September quarter.

The increase in branded revenue is partly due to increasing demand for external storage, the refresh of our branded products line, and continuous consumer preference for WD products in this space.

On the enterprise front, demand for nearline storage once again exceeded expectations and our SATA product portfolio was well positioned to avail this market expansion and mix up, particularly at the high capacity point.

The traditional enterprise market continues to recover.

In this space, we are pleased with the acceptance of our new [fast] products.

Moving on to our sales channel and geographic results.

Revenue by channel was 48% OEM, 30% distribution, and 22% branded products in the December quarter compared with 57%, 21% and 22% in the year ago quarter and 52%, 31%, and 17% in the September quarter, respectively.

The geographic split of our revenue was 25% Americas, 25% Europe, and 50% Asia as compared to 23%, 29%, and 48% in the year ago quarter, and 22%, 22%, and 56% in the September quarter.

The increases in the percentages for Americas and Europe from the September quarter reflect strength in branded products and component distribution.

There was one customer, HP, that comprised more than 10% of our total revenue.

Our gross margin percentage for the quarter was 26.2%, up from 15.9% in the year ago quarter and 23.3% in the September quarter.

As mentioned earlier, our low cost focus, a favorable product and segment mix, and moderate price declines contributed to gross margin favorability.

Total R&D and SG&A spending was $214 million or 8.2% of revenue.

This compares with $161 million, or 8.8% of revenue in the year ago quarter and $195 million, or 8.8% of revenue in the September quarter.

Our spending reflects our confidence in the strong future opportunities for storage in the environment of expanding digital content.

Operating income was $473 million, or 18.1% of revenue.

This compares with $16 million or 1% of revenue in the year ago quarter and $319 million, or 14.4% of revenue in the September quarter.

Interest and other non-operating expenses were approximately $2 million.

Tax expense for the December quarter was $42 million or 8.9% of pre-tax income.

That's within our model range of 7% to 10%.

Our cash tax rate is expected to be between 1% and 2% for the fiscal year.

Our net income totaled $429 million, or $1.85 per share.

This compares with $14 million, or $0.06 per share and $288 million, or $1.25 per share in the year ago and September quarters, respectively.

Turning to the balance sheet.

For the December quarter, our cash conversion cycle was a negative three days.

This consisted of 47 days of receivables outstanding, 21 days of inventory, or 17 turns, and 71 days of payables.

We generated $557 million in cash fill from operations.

Capital expenditures were $199 million, and depreciation and amortization totaled $126 million.

We also made our third quarter quarterly debt repayment installment of $19 million, thus reducing our debt balance to $444 million.

Cash and cash equivalents increased by $379 million, ending at $2.435 billion.

The 49.5 million hard drives we shipped in the December quarter represent a new output record for the Company.

We believe that 2010 will be a strong year for the proliferation of digital storage and continued customer preference for WD product.

Consequently, we are increasing our capital expenditure forecasts for fiscal 2010 to between $650 million and $750 million compared with our previous projection of $650 million.

Depreciation and amortization for fiscal 2010 is now expected to be about $550 million as compared to our previous estimate of $540 million.

We are ever mindful of the potential for a dip in demand that may be caused by economic circumstances beyond our control and we remain focused on supply/demand equilibrium and poised to use our flexible and agile business model to respond quickly to demand changes.

Over the medium term, we continue to have strong growth potential in the existing markets we serve, and in currently unaddressed markets given our market position, broad portfolio, willingness to invest in R&D and production assets and our strong balance sheet.

Nevertheless, we are actively seeking to augment this strength by selective investments in product line inspection both internally and externally.

We have $466 million remaining in our stock repurchase authorization as we evaluate the merits of further repurchases against internal and external investment alternatives.

Now I will discuss our expectations for the third quarter of our fiscal year 2010.

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

We believe that continued demand for storage of digital content will drive positive growth for the storage industry as a whole despite global macroeconomic conditions continuing to be challenging.

In this robust storage demand environment, we believe that WD is well positioned within the industry to benefit from this growing market because of our agility, flexibility, product lineup, technology and financial resources.

Historically, March quarter demand has been down sequentially in a range from 5% to 7%.

However, we believe that true demand in the December quarter was not entirely satisfied.

And this coupled with an expectation of continuing strong demand for digital storage leads us to model the market size of between 152 million to 158 million units, a sequential decline of 1% to 5%.

We anticipate that pricing will be flat to down but will be rational based on supply/demand balance in all markets.

Consequently, we expect current quarter revenue for WD to be in a range from $2.45 billion to $2.6 billion.

R&D and SG&A are expected to total approximately $220 million.

Our net interest expense is projected to be about $2 million.

We expect our tax rate to be about 9%.

We anticipate our share count to be approximately 235 million.

Accordingly, we estimate earnings per share of between $1.45 and $1.55 for the March quarter.

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

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

(Operator Instructions).

One moment, please, for the first question.

And our first question comes from Arun Sharma with UBS.

Your line is open.

Hi, thank you.

I was wondering if you could talk about degree of corporate PC refresh and the level of Windows 7 benefits you're (inaudible) to your outlook, and has there been any change to your views on these two areas over the past few months?

And I just have a quick follow-up after that.

Thanks.

Yes, I think we've seen a modest awakening in the commercial sector.

We continue to map that to be relatively modest in the current quarter.

Probably through mid-year with a continuing uptick as we head into the back half of the year.

Okay, great.

And then given your outperformance on the margin side the last two quarters, how are you -- are you guys reevaluating, how are you looking at your 18% to 23% target going forward?

I mean are you still comfortable with that range or should we see it as fairly conservative over the next year or so?

What are the puts and takes in terms of margin expansion going forward?

Thank you.

It's our 18% to 23% margin model range is our long-term range.

And it is, we are comfortable with it, with the current product and segment mix.

We have indicated that as we gain more traction in the traditional enterprise market that we would get to a 10-percentage-point market share, it would add about 0.75% or so to the margin model.

Since it's our long-term margin model, we are comfortable with it at the moment.

But there is opportunity for us to be able to expand that and we are forecasting for our Q3 that we will be above the top end of the margin model range.

It is possible given behavior of competitors, the supply/demand balance, the industry conditions and the segment mix to actually go above the upper end of that model range.

Great.

Thank you very much.

Richard Kugele with Needham your line is open.

Thank you.

Good afternoon, well done.

Just two questions, first, on the head procurement, the obviously the external supply chain for heads has dwindled.

You do a fair amount internally, but of all the components, that one seems to be the one where the vendor seems most unwilling to expand capacity.

Are you comfortable with the external supply of heads in particular and as you, or have you compensated for that in this new CapEx number so you can do more yourself?

Rich, this is John.

Consistently since we acquired the internal head capability, we have maintained a consistent model of roughly 80 internal, 20 external.

And that continues to be our model.

We are working closely with our external partner to share our views not only of overall market opportunity but specifically Western Digital opportunity within the market.

And I believe we are very well aligned together in pursuing the model that we've consistently pursued over the last number of years since we acquired head capability and we see that continuing into the future with very solid support from our external partner.

Okay.

Then, secondly, in terms of the unmet demand in the December quarter is there a way of at least ballparking just how much demand may have been left on the table?

And then, in that vein, the inventory lump numbers you talked about are extremely lean and I can't recall actually seeing that type of a number before.

Do you foresee an ability to go and get to even contractual levels for JIT hubs and such, or are the OEMs okay as long as you continue to replenish as quickly as they need it?

Well, I think that you're correct that inventory levels have been extremely lean since April, since the recovery in demand surprised all of us and has continued to move along at a good clip.

So if you look at our estimates for demand, the 152 million units to 158 million number that Tim just gave, that is reflecting some spill over of unfulfilled demand from the December quarter.

If you look at total industry demonstrated capability last quarter and I certainly don't think anybody was holding back product, then potentially we could rebuild a couple of million units into inventory through the quarter running full out, which wouldn't move the needle very much off of a very lean inventory environment.

So I expect if there is any real inventory replenishment to get things into a more traditional, sustainable model, that will occur in the June quarter.

That will be required to occur in the June quarter in order to support what we expect to be a very robust back half of the year.

Again, I believe industry supply chain investments are lagging opportunity and will constrain total availability through the entire calendar year.

That's great, thank you very much.

Thank you.

Next question comes from Steven Fox with CLSA.

Your line is open.

Thanks, good afternoon.

Two questions.

First of all on pricing, can you just be a little bit more specific, you said pricing flat to down.

Were talking about like-to-like or mix adjusted and is there any differences by product segments we could be aware of?

And then, secondly, when you look at the retail market, the rebound in external drives, how much of that would you tie into, say, bundling of externals with PCs and how much of that was just sales of externals on their own?

Thanks.

Okay, Steve, I will take the pricing one and John will respond to the branded.

On the flat to down pricing, it's the average pricing I'm referring to.

We don't give out like-for-like pricing.

And the reason that we are modeling that is because the demand is down, I mean we are anticipating that demand will be down from 160 to158, or at least that's the high end of the range that we are modeling.

There is also, we have strength, we have the strongest competitive position in 2.5 inch.

As you know in the September and December quarter some of our competitors turned their attention towards small form factor and gaming, and in the March quarter they come back into the market and address the more mainstream product.

So consequently with that as a backdrop, that's why we are modeling it to be down.

Okay.

And relative to strength in the external storage market, the branded products market, the vast majority of that is for independently purchased external attach as distinct from bundling with initial sales of PCs.

Is there any other color around what drove the acceleration besides obviously better economic trends?

Anything else that you would add, whether it's retail promotion?

I don't know what else --

Well, I think the underlying theme there, I believe, is the increasing proliferation of devices which only have capacity for transient storage.

And so those devices are interacting with tons of storage, of content that people want to capture and store for extended periods.

They are generating content -- if you look at the number of devices today that have high resolution cameras and high resolution video capability.

So the amount of content being generated by the small devices with small capacity solid state storage onboard is generating huge demand for transfer to mass storage capability, the best of which is the externally attached hard drive.

We think that's the fundamental underlying driver.

Relative to WD's success in this area, I think we've talked before and we're continuing to focus on the ease of use, the style, the convenience of product and delivering leading capacity points to the market.

I think all of these things combined with our consistent interaction with our channel partners and consistent positioning of our product line makes that a very attractive line for our partners and results in a very high level of access to consumers for the WD brand.

Great.

Thank you, that's very helpful.

Thank you.

Rob Cihra with Caris & Company.

Your line is open.

Hi.

Thank you very much.

I wanted to ask a couple sort of product questions.

First, within notebook you made mention of the 320 GB per platter (inaudible).

Was that my phone?

I think so.

Hello?

Hello.

Yes, okay.

You guys make phones?

On a 320 GB per platter, just wondering where you are in terms of that ramp?

I mean are qualifications done?

Are you shipping in volume, with the type thing where it was actually meaningful as a percentage of units relative to the 250?

And then, similarly, I'm wondering if you are willing to give us any view on the SAS product, what kind of units, I mean are there meaningful units yet, how is that going, what kind of acceptance, that sort of thing?

Thanks.

Certainly our shipments of 640 GB capacity point into both the notebook marketplace and through our branded products channel were significant and meaningful and we're by far the largest shipper of that technology and capacity point into the market.

In relation to our SAS entry, it was planned to be modest.

It is modestly ahead, both in volume and mix of what we expected and has been well received.

But we are not breaking out units at this time.

And when do you think you would break out units?

I mean is there --

When it becomes meaningful to the overall business.

Great, all right, thank you very much.

Sherri Scribner with Deutsche Bank your line is open.

Hi, thank you.

I wanted to get a sense of your view of the first quarter, your guidance for the industry is a little bit more conservative than Seagate's guidance that they gave last night.

I think they said units would be about flat to down about 3% in the quarter.

I wanted to get a sense of why you are a bit more conservative than Seagate?

And then as a follow-up to that question, in terms of the capital expansion that you are planning for this year, what kind of assumptions have you made about unit growth for 2010 and would you be comfortable with the numbers that Seagate gave last night of units growing about 17% to 20% in 2010?

Thank you.

Okay.

Conservatism, I'm not sure, we are really looking at what we see in interpreting the market.

I can't speak for Seagate.

We did our own analysis and came up with those numbers.

Those are the numbers we are comfortable with.

In terms of the total growth for the market for calendar 2010, we don't have any significant difference between ourselves and Seagate for those totals.

Okay.

Thank you.

Our different view of the current quarter is within 1.5%.

Sure, sure.

No, it is.

Just wanted to get a sense, thank you.

Mark Moskowitz with JP&C, your line is open.

Yes, thank you.

Good afternoon.

Two quick questions if I could, it's kind of a loaded question, the first one, so I do apologize, but I assume you are pretty darn close to 100% capacity utilization right now.

And I know sometimes when you go above 95% and you're running full tilt there can be some inefficiencies.

I just want to get a sense, if we don't see really any pull back in this gradual recovery that appears to be in earnest here right now, as you bring on the extra capacity could you actually optimize your utilization and your yield to even drive greater margins above what you are seeing right now, maybe bring down capacity utilization back closer to 95% or so?

Do you get some optimization benefits there?

Then I have a follow-up.

Two pieces to my response to that.

The first relating to utilization, once again last quarter the opportunity provided by our customers exceeded our expectation and consequently our desire to get utilizations down into the mid-90s, we didn't achieve that.

We ran at higher than 95% utilization all through the quarter.

The second part of the question, you're correct, when you are running at close to 100% utilization, we lose some of the key value that we like to bring to customers which is the flexibility and availability equation to satisfy their needs for change.

That's number one.

Number two, when you are running very full there do tend to be some inefficiencies related to meeting the customer needs while running very full and so there are some optimized situations.

(no audio) (technical difficulties)

Please continue to hold.

One moment, please continue to hold.

You may resume.

Mark, where did we leave off with you?

Hello?

We'll go ahead and go onto Ben Reitzes with Barclay Capital.

Your line is open.

Okay.

Glad I stayed on.

The question is about the longer term.

As you know, when you have gross margins like this and then you still keep your long range where it is you run into the problem that you have down earnings potentially next year depending on how quickly you want to get back down to the target range.

So I guess my question is how are you guys thinking about the longer term given the conditions in the short term with that predicament?

Are you guys targeting -- maybe you don't want to go into FY 2011, but knowing that we have that difficulty do you think that the industry and what you're hearing into the next fiscal year supports earnings growth given what we have to model with gross margins?

Thanks.

Well, let me try and tackle that.

And I apologize for the dropped line.

I'm not sure what happened.

How we're looking at the industry, as I mentioned, we're looking at a fundamental, we think a fundamental change in the demand for storage and an increase in that demand.

And to some extent a delinking of that demand from the underlying GDP growth rates, or at least a multiplication of demand relative to GDP growth rates.

So that's a very, very positive thing.

We believe that our drive technology is going to offer the most compelling solution to those increasing storage demands going forward for the foreseeable future.

We believe you've seen in our performance and Seagate's performance in the past quarter, I think you're beginning to see the power of the large scale, vertically integrated companies when executing effectively and consequent ability to continue to invest substantially in the technology to drive future solutions to that storage demand.

So I think all of those things point towards a very positive environment.

We are not yet at the point where we are altering our model.

But I believe the vectors for storage needs, the consolidation in the industry, the consolidation in the supply chain, I think are all pointing towards an ability to up that model in the future.

Okay, great.

Then just with regard to the enterprise, in terms of, you mentioned it's not big enough to break out yet your SAS product, and you were happy with it.

What do you see as your pace of new product introductions, what should we expect?

And what should we also expect on the SSD side in that vein?

Okay.

Clearly a single product is not going to support the needs of our customers in the traditional enterprise space.

We have a developed road map which we have discussed with customers and which we believe addresses a significant amount of their needs.

I think on the previous call I indicated our expectation that within three years the enterprise, traditional enterprise space would be serviced over 90% by 2.5-inch 10K SAS, and that our solution for higher performance than that would be addressed with solid state.

And I've also indicated we expect to have an enterprise-ready solid state product line offering in 2011.

And so we will continue to expand the current drive based 2.5-inch 10K SAS, continue expand that product line over the course of this year and follow up with an extension to the product line with higher performance products in 2011.

Thanks so much.

Mark Moskowitz with JP&C, your line is open.

Thank you for the follow-up there.

Hey, John, I was wondering, first, if you could maybe help us in terms of understanding the second part of the answer you're providing to my question earlier in terms of when can you restore that flexibility to maybe address your customer needs and then maybe reallocate to optimize the business proposition?

And then the follow-up I wanted to ask earlier was just if you could talk a little more about the structural change we could be seeing in terms of desktop resurgence in the emerging markets.

Do you see more of the tower computers coming back and is that something that could stick around for more than just a few quarters?

Sure.

I'm not sure exactly where we dropped you, Mark, and I apologize for that.

That's fine.

What our objective is, is to get back to the low to mid-90s in terms of utilization, so that we have ongoing day-to-day flexibility to move with the market.

I don't see us accomplishing that in the current quarter.

I'm hoping we will able to be able to achieve that in the June quarter.

So that's about the timing and that's driven by, just by our ability to bring in and commission and install and qualify the capital to accomplish that from an overall capacity perspective.

In relation to desktop, I think that the primary driver there -- there is a healthy resurgence in desktop, commercial desktop demand.

That's a -- continues to be a price sensitive business and the difference between desktop, replacing a desktop system which potentially can reuse a lot of accessories and so on versus going to mobile, combine that with CIO concerns about security and mobility of data and so on.

I think there is good life ahead of us in the desktop PC arena.

On the consumer side of the desktop, it's really the high end machines there that offer the geeks and freaks ability to configure systems out as they desire with very high performance and high capacity solutions.

And then, of course, the 3.5-inch drives going into external solutions, where increasingly we are seeing adoption of home network systems -- things like the WD World Edition and WD Share Space which provide whole home solutions for multiple network computers that are very simple to operate.

These also have a healthy appetite for very high capacity 3.5-inch drives.

So I think they are the fundamental drivers of demand there.

Thank you.

Thank you.

Kevin Hunt with Hapoalim Securities your line is open.

Thank you.

I just had a question on the R&D.

It's been ramping up over the last quarter or two and based on that, the guidance you gave, it looks like it will continue.

And so I wanted to kind of understand is that something you expect will continue to ramp up going forward and then maybe you could help us understand what sort of, where that sort of is targeted at?

I think the R&D spending will ramp, the percentage as a percent of revenue will be relatively static, you can see our total OpEx actually is down, our range is 9% to 10%.

We are down at 8.2%.

If we continue, which I certainly hope we can, to grow revenue at a similar pace on a long-term basis, that we've achieved over the past number of years, then you can anticipate that our dollar spending in R&D will continue to increase.

And back to my earlier comment about the ability of the large scale, fully integrated companies to invest in the future of this technology, those investments are not trivial.

There are, over the next three to five years, some very significant technical hurdles to be overcome, new technologies to be introduced and we are currently spending heavily in those areas to ensure that our current ability to deliver industry leading capacities and ramp them into stable, high reliability production that that ability to lead the industry is maintained as we move through these significant technology changes in the future.

Thank you.

David Bailey with Goldman Sachs your line is open.

Great.

Thank you very much.

Since the December quarter you've seen a steady shift in your business towards distributors and away from the OEMs.

Can you talk about the strategy behind this and the impact that it's had on ASPs?

Well, I would have to recharacterize that a little.

There has been no shift away from OEMs, in fact, we've increased our OEM business.

And we continue to provide very strong support of our OEM opportunities for growth.

We are also mindful of the opportunities in distribution and in branded and we're continuing to apply resource and product allocation to those areas also.

So I mean we are growing all across the board.

If you look at the numbers for last quarter the market grew by 8 million units, we grew by 5.4 million units.

And a piece of those 5.4 million units went to each of the markets that we serve.

Okay.

And then on the head count, your head count has come up a decent amount since June, I think it's around 9,000.

How should we expect this to trend going forward, and where have you been allocating the resources?

Head count, primarily the head count increases are related to production personnel in our Asia facilities, heads, media and drives.

If you run the numbers back over the last couple of years you will see that productivity continues to improve as we ramp, but we will, as we ramp substantial volumes we will also ramp substantial people.

We have increased our technical head count also and our professional head count and in those areas we are now back at levels that are higher than pre-recession levels.

The good news about that process where we reduced some head count across the board last December through March has allowed us to rebuild with more current and future oriented skill sets.

And we have a significantly stronger professional and technical employee base today than we had a year ago.

Okay, thank you.

Kaushik Roy with Wedbush your line is open.

Thank you.

Congratulations.

So 2010 seems like it's going to be a good year, what could go wrong?

Let's say when all the capacity comes on line the next two to three quarters what's your sense for the second half of calendar 2010?

We believe that the underlying digital content creation, the underlying lifestyle changes and dependencies on the Internet and the delivering and consumption of content, now we believe these are very strong secular moves that are offering a growth path that is layered on top of the modest recovery that we are seeing in worldwide economic activity today.

Frankly, we think the worldwide economic recovery is a lot more fragile than the growth in demand for digital content distribution and storage of all kinds.

So what could go wrong would be, I think the primary concern would be a macroeconomic event, a macroeconomic deterioration, we are watching actual demand very closely and events in the world around us to track that.

And what we can do in that environment if it were to occur will be similar to what we did when it occurred last year.

On the other front, I think concerns that seem to swirl around about capacity investments being made in the industry are way overblown if you look at our capital investment behavior over the past several years, and recognize that the activities in which we are investing have significantly changed.

You go back to 2003, we were a pure play drive assembly Company with very low CapEx requirements.

We added heads which engendered a significant increase in CapEx requirements.

We then added media in 2007 which adds a further level of CapEx requirement.

But in all cases, we have been very close coupled in terms of our investment decisions relative to -- are all made on a back off the day we think they are needed by the lead time of the equipment.

We work very hard with our capital equipment supply base to limit those lead times and to continually shorten those lead times.

So we are very focused on just-in-time investment, the support, what we believe is real demand.

We've also shown in the last year a willingness and ability to tune our utilization of the assets we have invested in to the actual market requirements.

We've demonstrated that doing that, that behavior generates far more reward for us than any other behavior.

And I think most of our colleagues in the industry have demonstrated similar learning and similar behavior.

So I'm very positive about the industry's ability to see what is going on in terms of real demand and take appropriate actions to match supply to that demand.

The biggest concern I have right now is that the level of investment being put into capital by the extended supply chain is inadequate to support the opportunities that we believe are there through the end of the calendar year and beyond.

Going to the gross margin question, do you think December was the peak gross margin or you could possibly see better margins sometime during this calendar year?

We always seek to improve.

Okay, thank you.

Aaron Rakers with Stifel Nicolaus your line is open.

Yes.

Thanks, guys.

Real quickly, I guess the question for me would be looking at the gross margin for this current quarter, taking the midpoint of your guidance it appears that it looks like it's assuming somewhere around a 25% or so gross margin.

Is that the way to think about it?

Are you guys conservatively guiding for that or why would we see some type of contraction, if so?

I think it's closer to 24% in the on the midpoint.

We are guiding to that because we believe that, as I've indicated previously, we talked about the market size, we've indicated that we think it will be in the 152 million to 158 million unit range.

We also have got strength in 2.5 inch, we've got the strongest market position there, and that's got the most competition.

And as well as that is the people servicing gaming and small form factor turn their attention to servicing that market in the March timeframe after they have dealt with the Christmas rush.

So consequently that's, those are the reasons why we are looking at the decline in margin.

And it's pretty similar to the decline that we heard yesterday from Seagate.

With that said, I mean relative to that, it sounds like the potential upside would be more or less just driven by volume or it seems like everything else is remaining fairly stable through the quarter.

So is that a fair assumption?

Yes.

We seek to optimize everywhere we can improving costs, improving mix, taking advantage of market demand and assuming inventory stays in balance and the rest of the folks in the industry are rational.

And then final question for me, and I know it's a small revenue contribution but it is growing here over the last couple of quarters, your non-hard drive business, and I would assume that's a lot of the industrial, military SSD stuff, how should we think about that from a model perspective here as we move forward because if we take what we've seen it starts to become somewhat meaningful here as we move out over the next 12 to 18 months?

Yes, I expect it will.

You've observed from the numbers that the combination of the media players and the solid state drives taken together are the fastest growing component of our business.

And they are both growing.

And we anticipate they will both continue to grow.

So, again, I think we will break them out somewhat more as they become individually larger and significant for the overall business results.

I'm not quite sure of when that will be, the sooner the better as far as I'm concerned.

Is it fair to assume that that carries a much better gross margin structure relative to the high end of your 18% to 23%?

What we've given before from a stratification viewpoint on gross margin applies there.

We've got the engineering product which is enterprise and SSD had the highest tier of margin.

The next tier of margin consists of the consumer type products which is DDR branded and WD TV.

And the lower tier is the OEM heavy products which is desktop and notebook.

Perfect, thanks, guys.

Katy Huberty with Morgan Stanley your line is open.

Thanks, good afternoon.

Earlier this week, EMC refreshed its mid-range SWORD systems with SATA-only drives, is that indicative of end user demand for cheaper and lower power consumption storage this year?

Yes, we believe it is.

Some two years ago now, we introduced the WD GreenPower drive technology to the market and we are seeing increasing adoption of that technology both in the -- well, in external storage and DVRs and notebooks, netbooks -- sorry, in desktops, and in the enterprise SATA environment.

We think that technology provides a significant value where we are seeing customers acknowledge that and certainly the -- there is a lot of work going on in the enterprise environment that is developing the management tools to come up with more effective tiered storage solutions that are using, I think, the system that EMC announced last week, if I'm not mistaken, had an SSD layer and then high capacity ATA for the bulk storage providing a complete high performance, high capacity storage system.

We believe that's a significant trend as we look out into future.

We are aiming to have products to support that trend.

Thanks for that.

Just a quick follow-up on inventory, you've talked about bringing channel inventory up a little bit between now and June, but what would you expect to do with your own inventory levels between now and June as you prepare to serve the seasonal demand in the back half of the year?

Assuming seasonality in the June quarter, likely we would seek to level load our capital investment by increasing inventory exiting the June quarter to support what is typically a significant ramp requirement in the September quarter.

Okay.

Thanks.

Jayson Noland with Robert Baird your line is open.

Yes.

Thank you, a couple of questions.

Tim, the trajectory of CapEx is declining a bit into the second half of the fiscal year, maybe some thoughts there.

And is it in part a function of just external suppliers not keeping pace?

Not so sure if it's declining it's only minor.

I mean we've spent, what, 176 and 200, so that's 376.

So it's effectively exactly 50% of the upper part of our range.

Of our $650 million to $700 million range.

Is there a reason why there wouldn't be upward pressure to it in the second half?

Well.

I mean when we started off originally with our CapEx forecast at the beginning of the year we had it at $600 million.

At that stage, we were actually front end loading that $600 million in order to deal with the strong demand that we foresaw in the September and December quarters.

As we have seen the unexpectedly strong demand from then on, we have been planning to add capacity on a just-in-time basis and that's really what we are aiming to do.

So we would like, if we really had our choice, we would really like to put capacity in the weaker quarters, in order to be ready for the stronger quarters, but we try to do things on a just-in-time basis because we are trying to respond to customer need.

So I think our capital position is adequate to address what we see as the strong demand and if it comes out stronger we will make decisions to increase it if necessary.

Okay.

Then maybe if you can just talk to use of cash in general as it builds up here on your balance sheet.

Yes, our -- we beefed up our cash during the downturn primarily because at the time, I mean it's lots of people seem to have forgotten now, but at that time we were wondering whether we had enough cash.

And with the macroeconomic situation being the way it was.

We still remain cautious but we are biased towards using it for operational and strategic purposes as opposed to using it for capital restructuring or whatever.

Our bias is to find and expand product lines and to spend the money operationally because we believe that in the long-term that that provides the best value and the best return for our shareholders.

Thanks, Tim.

Next question comes from Doug Reid with Thomas Weisel Partners.

Your line is open.

Thanks.

Just wondering if you could help break out CapEx into a maintenance level for given output and incremental just looking over your, say, the past year or sufficiently long range to be able to see that difference in what is maintenance level versus growth?

Yes.

From a CapEx viewpoint our model is to stay within 7% to 8% of revenue.

And we've, in the past when we were not vertically integrated we had a lesser percentage, then as we added heads and more lately, media, it went from about 6.5% prior to media, out to I'd say 7% to 8% that we have right now.

When we look at capital, you have to look at it over a long-term basis.

If you look at it in shorter terms, it can appear lumpy, but over the longer term we pretty much spend almost three-way between heads, media and assembly and test, it's pretty much split evenly.

We don't have a number to tell you about what's replenishment number.

Okay.

Thank you.

Thank you.

Ananda Baruah with Brean Murray your line is open.

Ananda, your line is open, please check your mute button.

Thanks, guys.

Sorry about that.

Thanks for taking the question.

Just quick, I guess, philosophical question.

Is there anything about, I guess, taking the capacity down to kind of low to mid-90s, granted that's still a pretty healthy level, but if you take capacity utilization down there, is there anything, I guess, on the pricing side that says pricing as a rule would begin to decline at more typical levels again?

And then I guess with the question is, the follow on would be if that's the case, could there also be an argument to say maybe it's in a weird way healthier to keep it at mid-90s to high 90s if we can keep pricing more stable?

Actually it's to the contrary.

By operating at 93% to 95%, load level on a planned basis against our anticipation of overall demand volume, it allows us the flexibility to respond to opportunity to go after mix opportunities that are outside the scope of our preplanned production.

And traditionally WD has done very well in building customer satisfaction on the one hand, which tends to be sticky.

And on the other hand, building profitability by jumping into opportunities presented by missteps by competition or by changed market conditions that get recognized late and where customers are seeking to respond quickly to that.

So having that flexibility to respond in short order to upside opportunities or to mix changes is actually a benefit when it comes to overall financial performance.

Awesome, thanks, that's helpful.

Just a follow-up if I could.

I apologize if this has been asked or stated already.

But is there any way to at least, maybe order of magnitude, separate out how much of the gross margin upside to the sort of normalized model range is due to the high capacity utilization levels versus kind of mix versus what has been stable pricing on like-for-like?

On the gross margin, I mean we know those numbers.

We actually have, if we look at it for last quarter from a ranking viewpoint, cost improvement was number one.

Mix was number two.

Utilization was number three.

And then we had benign pricing percentage.

Got it.

That's quite helpful.

Okay, guys, thanks a lot, great.

Thank you.

Robert Walker with FTN Equity Capital your line is open.

Hi, this is Robert Walker on for Bill Fearnley.

Hey, guys, you mentioned the industry supply chain investments, you've seen those lagging, the opportunity you see which is going to constrain demand for the whole year.

Do you think OEMs might order in calendar 2Q in anticipation of a third quarter, fourth quarter demand?

That's a possibility there will be some modest activity of that kind.

Certainly our discussions with our large OEM customers are much more focused on availability and our commitment to support their plans through the back half of the year.

So that potential would be part of those discussions.

Okay, and then just quick follow-up.

Last night Seagate mentioned kind of a 170 to 180 range for a quarter would be difficult for the industry to hit.

Do you see that as well?

And, I guess, when do you see capacity finally kind of catching up with demand, is that not until early 2011?

Thanks.

Yes, I think yes to both.

That's my concern about industry and supply chain investments, that the timeline relative to those investments, even if made today, it's going to be a push to get significant output from those investments in the back half of 2010.

So I believe we are going to run constrained all the way through the back half of the year and into 2011.

Great.

Thank you.

Thank you all for the joining us today.

I apologize about the brief interruption in service during the call.

We look forward to keeping you informed of progress in the quarters ahead.

Thank you.

Thank you.

This does conclude the conference call.

You may disconnect at this time.