威騰電子 (WDC) 2010 Q4 法說會逐字稿

Good afternoon and thank you for standing by.

Welcome to Western Digital's fourth 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 response to your questions concerning industry inventory, pricing and demand, our position in the industry, our growth and profitability, the impact of our entry into and our position in the traditional enterprise market, the impact of our acquisition of Hoya's magnetic media operations, the sufficiency of our cash to meet operating needs.

Our investments in technology and capacity, our expected capital expenditures, depreciation and amortization, and tax rate for fiscal 2011, our share repurchase plans, our long-term business model and our financial results expectations for the September 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 the SEC on April 30, 2010.

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 today's remarks from today's call will be available on the investor section of Western Digital's website immediately following the conclusion of this call.

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

Thank you, Bob.

Good afternoon.

And thank you for joining us today.

Fiscal 2010 was another highly profitable growth year for WD.

Ever increasing demand for cost effective, high capacity storage continues to provide opportunity for substantial growth and consistent value creation over an extended term, when addressed with an effective business model.

With a relentless focus on customer needs, quality, low cost and high asset efficiency, WD has become solidly and increasingly profitable throughout the last decade.

Over the last five years, WD has profitably grown revenue at a compound annual rate of 22%.

In this same period, we have grown operating income at a compound rate of 50% per annum.

For fiscal year 2010, we grew revenue 32% to $9.8 billion.

We increased operating income by 194% year-on-year.

The hard drive demand growth story continues to be driven by the proliferation of multiple devices and applications that are resulting in the generation, utilization, and storage, either locally or in the cloud, of massive amounts of digital content on low cost, high capacity hard drives.

We believe that the industry's growth trajectory will continue over the foreseeable future, creating significant additional opportunity for WD with its well honed business model and expanding product set, to continue to generate growth on a sustained and profitable basis.

This growth opportunity has been created in large part by our ability to continually drive down average cost per gigabyte, leading to attractive price points that have driven mass market adoption of devices incorporating hard drives.

At the same time, we have gradually expanded gross margins while growing revenues by continuously increasing efficiencies and reducing costs.

Our assessment in late April of a June quarter TAM in the range of 157 million to 162 million units proved overly optimistic.

Actual demand for hard drives in the quarter was about 156 million units, down 4% sequentially, but up 16% from the year ago period.

The major factors leading to the lower TAM were weakness in Europe, destocking by OEM customers, and a shift in OEM ordering patterns to take advantage of lower cost sea versus air freight.

In hindsight, this expanded the March quarter at the expense of the June quarter.

Given the change in the demand during the June quarter, WD and others in the industry responded quickly to adjust build plans, resulting in quarter ending inventory modestly increased, but at manageable levels.

Chip inventory increased from seven to 10 days, while component distribution inventories increased slightly, but remained at the mid-point of the normal four to six-week range including in transit.

Taking these market dynamics into account, we were pleased to deliver one of the strongest fiscal fourth quarter performances in Company history.

While market dynamics in the June quarter will temper short-term growth rates, and affect price levels in the September quarter, we believe that the second half of the calendar year, and calendar year 2011, will continue to present substantial growth opportunities and rewards for hard drive industry participants with effective business models and compelling product offerings.

WD continues to generate substantial free cash flow, while continuing to reinvest significantly in our business, both in expanding and enhancing our product offerings, and in improving our operations.

Over the course of fiscal 2010, we continued to lead the industry's fastest growing segment, 2.5 inch drives, deploying industry leading aerial density products at the 640 gigabyte, 750 gigabyte, and 1 terabyte capacity points.

We made our entry into the traditional enterprise market with the introduction of our first 2.5 inch SAS hard drives for server applications, part of our multi-year commitment to serve this important and heretofore unserved market for WD.

We brought to market our first client oriented solid state drive to complement our existing portfolio of high reliability embedded SSDs, and we are in development of our first solid state drive for high-end enterprise applications.

In our branded products business, we broadened our portfolio of WD storage devices with the introduction of MyBook Studio LX, hard drives for Apple users, and the MyBook AV DVR expander hard drives, which allow users to keep more of their favorite movies and TV shows.

We extended our family of WD media players with the WD TV live plus, featuring added services such as Netflix, You Tube, Flicker, Pandora, Live 365, as well as Media Fly, that enable consumers to stream their favorite shows and personal content directly to their TVs.

It is also the first network media player compatible with Windows 7.0.

On the manufacturing side, we improved the security of supply of glass substrates, and enhanced our long-term cost structure with the acquisition of Hoya's media operations.

Before I pass the call to Tim Leyden, I want to acknowledge our loyal customers who are the primary reason for WD's continued significant growth as a leading supplier of storage devices.

We will continue to work passionately and diligently to earn their ongoing business.

I also want to thank the WD team and our supply partners for their exceptional contribution to WD's revenue, profitability, and cash generation in the fiscal year just ended.

Tim?

Thank you, John.

In the June quarter, demand was weaker and more back end loaded than we had anticipated.

We believe that the weaker and less linear demand resulted from a number of things.

OEM restocking during Q3 reduced market size in Q4.

The European credit crisis led to some purchasing pause by retailers for a number of weeks, due to the euro exchange fluctuation.

And there was relative weakness in the consumer space.

The combination of these factors, and the pressure exerted by some competitors increasing their production in a smaller market, contributed to more downward pressure on selling prices than we had expected.

Given these conditions, we acted to optimize our financial results, while at the same time defending our market position.

We are pleased that despite these challenging fiscal Q4 conditions, we achieved gross margins of 22.5% for the quarter, a 15-year high for WD in a fiscal Q4, and at the high-end of our long-term gross margin model range.

For our full fiscal year 2010, total revenue was $9.8 billion, hard drive shipments were 194 million units, and ASP was $50.

Revenue from non-hard drive sales totaled approximately $154 million.

The corresponding numbers for fiscal 2009 were total revenue of $7.5 billion, shipments of 146 million units, and ASP was $51.

Revenue from non-hard drive sales totaled approximately $62 million.

Compared with 2009, gross margin in fiscal 2010 was 24.4% versus 17.9%.

Operating income was $1.525 billion versus $519 million, net income was $1.382 billion versus $470 million, and earnings per share was $5.93 versus $2.08.

Net income in fiscal 2010 included $27 million of expense related to litigation settlements.

Net income in fiscal 2009 included a $14 million in process R&D charge related to the acquisition of Silicon Systems, $112 million of restructuring charges offset by related tax benefits of $4 million, and an $18 million gain on the sale of the Company's substrate manufacturing facility in Sarawak, Malaysia.

Turning to the 2010 fourth quarter results, total revenue was $2.4 billion, up 24% from the prior year, but down 10% sequentially.

Hard drive shipments totaled 49.7 million units, up 24% from the prior year period, but down 3% sequentially.

Revenue from sales of WD TV media players and solid state drives totaled approximately $27 million, up 20% from the prior year and down 41% versus the March quarter.

Average hard drive selling price was approximately $47 per unit, down $1 from the year ago quarter, and down $4 from the March quarter.

We shipped 19.9 million mobile drives in the June quarter, compared to 16.9 million in the year ago quarter and 19.8 million in the March quarter, reflecting new consumer demand in the US and EMEA, offset by commercial and emerging market growth.

During the June quarter, we shipped 5.3 million drives into the DVR market, compared to 3.7 million in the year ago quarter and 4.6 million in the March quarter.

The strength in this market in the June quarter was in line with historical seasonal patterns.

Revenue from sales of our branded products, including WD TV, was $400 million, up 26% from $318 million in the year ago quarter and down 14% sequentially from $467 million in the March quarter, reflecting the typical seasonality of the retail market.

In addition to normal seasonality, the decline in the value of the euro impacted selling in Europe for a number of weeks.

Enterprise SATA demand continued to grow in fiscal Q4, particularly at the high capacity points.

Our product lineup has us well positioned in this segment.

Our SAS products are making progress towards our multi-year plan to gain a representative share of the traditional enterprise market.

Moving onto our sales channel and geographic results, revenue by channel was 54% OEM, 29% distribution, and 17% branded products in the June quarter, mirroring the same percentage splits as in the year ago quarter, and 49%, 33% and 18% in the March quarter.

No single customer comprised more than 10% of total revenue.

Relative to the geographic split of our revenue, the Asian market continued to be strong at 54% of revenue in the June quarter, as compared to 54% in the year ago quarter and 52% in the March quarter.

The Americas and European regions contributed 25% and 21% respectively, in the June quarter, compared to 24% and 22% in the year ago quarter, and 24% and 24% in the March quarter.

Our gross margin for the quarter was 22.5%, up from 19.2% in the year ago quarter and down from 25.2% in the March quarter.

Gross margin was impacted on a sequential basis by pricing, channel mix, segment mix, and volume reductions.

Total R&D and SG&A spending was $242 million or 10.2% of revenue.

This includes the $27 million of litigation settlements, and compares with $184 million or 9.5% of revenue in the year ago quarter, and $224 million or 8.5% of revenue in the March quarter.

Operating income was $293 million or 12.3% of revenue.

This compares with $209 million or 10.8% of revenue in the year ago quarter, and $441 million or 16.7% of revenue in the March quarter.

Net interest and other non-operating expenses were approximately $1 million.

Tax expense for the June quarter was $27 million or 9.2% of pretax income.

Our net income totaled $265 million or $1.13 per share.

This compares with $196 million or $0.86 per share, and $400 million or $1.71 per share in the year ago and March quarters, respectively.

Turning to the balance sheet, we generated $1.9 billion in cash flow from operations during fiscal 2010, including $363 million during our fourth quarter.

Our cash conversion cycle for the fourth quarter was a positive two days.

This consisted of 48 days of receivables outstanding, 28 days of inventory of 13 turns, and 74 days of payables.

Our inventory turns were reduced by approximately one turn as a result of including the Hoya inventory that we acquired on June 30.

Excluding acquisitions, capital expenditures for the June quarter were $185 million.

Our non-cash charges for depreciation and amortization expense totaled $134 million.

Capital additions for fiscal 2010 totaled $737 million, lower than our April projection of $750 million, as we scaled back in line with lower demand.

Depreciation and amortization expense for fiscal 2010 totaled $510 million.

During the fourth quarter, we acquired the magnetic media sputtering operations of Hoya Corporation for $233 million in cash.

We expect that the Hoya facility will be mildly accretive to WD's long-term gross margin model by the end of the calendar year, but prior to that it will have about a 50 basis point negative impact on the gross margin as we get it tuned to WD's production standards.

We made $82 million of debt repayment installments during fiscal 2010, including $25 million during our fourth quarter.

We reduced our debt balance to $400 million at the end of fiscal 2010.

We exited fiscal Q4 with cash and cash equivalents of $2.7 billion, a decrease of $92 million from the March quarter.

We continue to hold a cash balance in excess of our anticipated operating needs, with a strategy to maintain operational flexibility, increase our investments in advanced technology, expand our product breadth through the pursuit of internal and external opportunities, and to protect against macroeconomic weakness.

The balance remaining in our stock repurchase authorization is $466 million.

Now I will discuss our expectations for capital, depreciation, and tax for fiscal 2011.

We expect our capital expenditures for fiscal 2011 to be between 7% and 8% of revenue, with an additional $200 million related to our six inch to eight inch wafer conversion, and some expenditures to optimize the output from our recently acquired Hoya production facility.

We expect total CapEx in Q1 to come in around $275 million.

We expect depreciation and amortization to be about $650 million for the fiscal year.

We expect our book effective tax rate to range between 6% and 9%, and our cash tax rate to be between 1% and 2%.

Now I will move on to our long-term business model.

We believe that annual growth from unit shipments for the hard drive market will continue in the 10% to 15% range into the foreseeable future.

We should generate industry revenue growth of between 5% and 7.5%.

Given this industry growth rate, we expect to operate within our long-term gross margin model range of 18% to 23%, with some longer term upward momentum from increasing our percentage of internal media, as well as advancing our presence in the traditional enterprise market.

Our OpEx model is targeted to continue in the 9% to 10% range, and our resulting operating income will range from 8% to 14%.

Tax expense is estimated to be in the range of 6% to 9% of income before taxes.

These parameters would yield net income in the 7% to 12.5% range.

Now turning to our guidance for fiscal Q1.

Historically, September quarter demand has been up by 10% to 13% when compared to June volumes.

However, a number of factors are leading us to forecast lower growth this quarter.

We believe that some of July's natural OEM demand was fulfilled at the end of June, and that OEMs are less concerned about shortages than they were a few months ago.

US retail sales statistics also suggest that there has been some emerging consumer demand weakness.

Additionally, we believe that OEMs have planned for regular back-to-school season, and that components to satisfy those demand expectations are either in their manufacturing pipelines or in transit at this point in time.

As we enter the quarter, demand has started out slowly as some customers deplete on hand component inventory, and await confirmation of the extent of back-to-school demand.

These factors will dampen the typical seasonal uplift to an expected range of between 2% and 6%, which translates into a TAM range of between 160 million to 165 million units.

Taking these factors into account, we anticipate that pricing will be competitive and further dependent on emerging demand level dynamics as back-to-school season gets underway.

Should demand turn out to be stronger than we anticipate, we expect to be able to respond to the upside.

Accordingly, we expect current quarter revenue for WD to be in a range from $2.350 billion to $2.450 billion.

R&D and SG&A are expected to total approximately $235 million.

Our net interest expense is projected to be about $1 million.

We expect our tax rate to be about 7.5%.

We anticipate our share count to be approximately 236 million.

We estimate earnings per share of between $0.80 and $0.90 for the September quarter.

Bob?

We're ready for questions, operator.

(Operator Instructions).

Our first question comes from Rich Kugele with Needham.

Your line is open.

Thank you.

Good afternoon.

A couple questions.

First, just to follow up on your comments on pricing, were they centered primarily around the consumer retail side of your business, which if you look at it, at least 20% or is it an OEM comment as well so was that pricing that was set at the end of June heading into this quarter and there really is little that can change it?

Pricing, we saw pricing that was worse than what we would have expected in pretty much all of the segments of our business during the course of the quarter.

And of course, it was heavily in the areas where consumers -- in the segments where consumers are strongest which is retail and the channel.

And then as a result of that, it takes a little while longer, but OEMs do reset their prices as a result of prices they're seeing coming out of those channels.

We're expecting that for Q1 -- that in what would normally have been expectation of either flat to up is that pricing will be -- the price declines will be worse than historical.

Even though there will be a little bit of mix up because of the consumer demand -- weighting of consumer demand as we get headed to back-to-school season, we don't think that that will be sufficient to offset the pricing decline.

And then in terms of your CapEx commentary, even for this coming quarter, have you throttled that back as well or is there already stuff that's in process and you can't stop it?

Can you just talk about what you -- at least directionally, you expect your capacity utilization to be in light of that CapEx?

What we have CapEx on our other and in the pipeline that is with these market and size numbers that is in excess of what we would wish, so consequently we're going to have to work on it in order to push it out.

Okay.

Then just lastly, despite even this type of guidance, you should be generating a significant amount of cash flow, yet to stock and the group as a whole trades at probably record trough levels.

What is the Board's view and management's view of exercising the rest of that buyback or even potentially going private?

I have to ask the Board about going private.

We are obviously evaluating what's the best way to use our cash at all times.

We believe that we have an inclination towards utilizing cash operationally and strategically because we believe that that's the option that offers the best return to the shareholders in the long-term.

Okay.

Thank you very much.

Ananda Baruah with Brean Murray, your line is open.

Thank you, guys, for taking the question.

Just going back to pricing, as you guys envision September quarter demand, hopefully playing out and then if we can get some semblance of typical seasonality as well from your perspective into December, how do you -- what does it take to get pricing declines back to where you think they should be so normalized pricing declines and not necessarily stability, but where you think it should be as we move through the fall?

I think the requirements for stabilizing pricing and continuing to work on efficiency and cost and thereby, expanding margin, that typically is a cyclical process.

Once demand exceeds the baseline build plans of the drive industry, we'll begin to see that dynamic kick in.

What we -- it is quite possible that as we see the actual back-to-school sell through happening, that we will see the normal seasonal uptick in the late August, early September timeframe.

And I believe if we see a strong sell through in back-to-school that will inject confidence into the planning and demand profiles of our customers as we head into the holiday season demand period.

It is quite possible that we'll see that in the very late of Q1 and through F Q2.

Thank you.

That's helpful.

And just as we think about gross margin dynamics for the September quarter, you mentioned I think there was four things, price and channel mix, segment mix and then number four was volume as impacting the June quarter, gross margins.

Is that the same order that we should think about them?

Order of magnitude, what should we think about what's going to impact gross margin in the September quarter?

Sorry, the December quarter?

I think it is pretty much in the same order I would imagine because the segment mix will be a bit better because of the consumer, and retail and channel as back-to-school comes and the season comes -- and so pricing channel segment.

I don't think volume because we are in an up market and we're going to defend our market share.

Okay.

Great.

One last one related for me if I could.

Is there anything on the cost side, in terms of component cost takeouts as we move through the September quarter that you guys can do -- to catch up to some of the price declines that have taken place that could serve as a bit of a support to the gross margins?

I think very consistently, part of our business model is to consistently and continuously reduce costs through efficiency improvements and by design, and that process is alive and well and we're focused on continuing to accomplish that as we move forward.

I think if you look at the long-term cadence of the industry, we have consistently expanded margins as we have moved through the last decade.

We have done that -- half of that has been driven by growth of our business, and the other half has been driven by our vertical integration of our business and our efficiency and cost efforts.

We started out at the beginning of the decade 2001, 2002, average 12% gross margin, 2003 2004 was 16%, 2005, 2006 was 18%, 2007, 2008 was 19% and 2009, 2010 was 21%.

We have seen a continuous expansion in margins at the same time that we have seen north of 20% compound annual revenue growth throughout that period.

We would expect to continue to exercise the same model on the same underlying market demand set as we move forward.

Thank you very much.

Scott Craig with Merrill Lynch, your line is open.

Hi.

Thanks.

Good afternoon.

Can you maybe talk a little bit around the long-term gross margin target and how Hoya is going to impact that?

Then my second question would be from the European retailer's perspective, you mentioned that they took a pause there so to speak.

Did that come back towards the end of the quarter and then into the September quarter so far?

Thanks.

The European situation, the pause that they took for a number of weeks was when the currency was fluctuating mostly in a downward direction as far as they were concerned.

Consequently, they were unsure about what to do as they grappled with having to buy goods or denominated in dollars, and had to offer it on the market to the end-user at a fixed price point.

They were concerned and had uncertainty so they hesitated to refill their pipeline.

When the currency fluctuation settled down a bit, they did come back into the market and started refilling their pipeline, but at a muted level versus what would have been normal otherwise.

The second question is the Hoya gross margin.

As we indicated, it will be mildly accretive is the terms we used, and that is based upon the fact that we fallen a little behind our model of internal versus external.

And in getting back to our model which the Hoya acquisition will help us to do, it will add something in the re region of about a half a percentage point or so to gross margins in the longer term.

Okay.

Thank you.

Aaron Rakers with Stifel Nicolaus, your line is open.

The first question would be on the OpEx.

I just want to be clear.

$235 million, how much of that is reflective of the Hoya acquisition in the quarter when you benchmark that against -- looks like the $215 million adjusted for that litigation expense last quarter?

There isn't really anything to speak of Hoya expenditures in the OpEx.

Okay.

I ask the question of why $235 million?

Last quarter, you guided $220 million, and you came in at $215 million adjusted, so what's the sequential increase driven by?

Variable compensation accrued.

Consequently, as you can imagine with the expectations that we had for the first half of the year, we didn't reach those expectations and there was an amount that went back in there and also to bring the number down to $215 million.

At the level of expectations that we're now setting, we have put in that estimate for OpEx in order to cover that and also we continue to invest in R&D.

Okay.

Looking at the other pieces of the P&L just to get to the number, it looks like you're guiding somewhere around 19% gross margin inclusive of a 50 basis point head wind from Hoya.

Is that correct?

Yes.

Final question would be from me, is when you look at the TAM assumptions you guys are making, I think there is a lot of I think questions out there about the back-to-school build dynamic as it relates to more products shipping ocean versus air.

How much of your TAM assumptions have you adjusted for that dynamic and is it -- do you guys have good visibility into that trend?

I think the build has largely taken place already and is -- or is in the very final stages of build with the majority already in transit.

The real thing that we are watching is the actual sell through during back-to-school season.

I think the general input from our OEM base is pretty cautious right now, and they, too, are waiting to see what the consumer demand profile is going to look like through late July and August.

We're looking for that to tell us whether the rest of the quarter will be one of muted expectations for the future, leading to consumption of on hand component stock or whether the view of the future by our customers will be more positive which would lead them to immediately begin to replenish stocks of components.

And your visibility to that won't really happen until, what, late August?

Mid-to-late August.

Fair enough.

Thanks, guys.

Kevin Hunt with Hapoalim Securities, your line is open.

Thanks.

I had a couple of questions.

Just to follow up on the Hoya question, when did you say that that would turn from a drag to a benefit?

Beginning in the next calendar year, and so it will be a drag until the end of this calendar year.

That would gradually build towards, you said about a half a point advantage?

Yes.

All right.

And my second question is really just digging in more to this demand outlook, your outlook was lower than Seagate's which was much lower than Intel's and Dell and other people that have given an outlook recently.

I am trying to tie out -- you're implying somewhere about a 15% annual year-over-year unit increase versus those other larger guys saying 20%.

And they're all talking about better corporate builds offsetting this weaker back-to-school.

Why are these things different to you than the rest of Wall Street is the question, number one?

I think when you peel apart Intel's numbers and guidance, you will see that the majority of their growth was in their server business, in terms of the growth rate as they gave the detail on the segments.

Their growth for the PC-related market was 2%, and we believe the bulk of that was ASP growth rather than unit growth.

We think part of their forward positive guidance relates to the fact that as they did a product transition to Calpella, there was no build up of inventory at the component level in the OEM customers.

In fact, there was a brief shortage as they transitioned from old to new.

I think there is a different stocking dynamic in Intel versus the drive industry.

There is, however, and we are seeing it, an uplift in commercial, but the combination of the macroeconomic conditions in Europe allied to the strong proportion of our business in distribution and retail and in OEM consumer is -- the commercial boost is not making up completely in terms of overall growth rate for the softness we currently see in consumer and the -- what we saw through last quarter was some flushing of inventory by the OEMs.

We are building into our forward look for this quarter, an expectation that they will release another little bit of on hand component inventory.

However, all of that being said, so we're planning on a conservative basis from a capacity utilization perspective and a CapEx perspective.

However, as our history indicates, we're ever mindful of close attention to the actual numbers and the ability to sprint up to address opportunities as they present themselves.

The other part of the same question, you alluded to about drives being on both and so forth, and that being a new dynamic.

Is that going to then change going forward, the seasonality that you see and if so, wouldn't that also change the holiday build and pull that forward earlier into say the third quarter?

It's not so much drives on both as systems on boats.

I think there is a little bit of a stand off going on there, but the OEMs are waiting to see the back-to-school before they decide fully what to do for the holiday, and that may force some of the holiday to be air freighted.

And that seems to be a preference for them to look at a more assured build plan for the holiday, based on knowledge of the back-to-school sell through than shaving the little bit of incremental margin and pre-committing themselves by building that product early and putting it on boats.

Okay.

Thank you.

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

Thanks very much.

I had two questions as well.

What do you think the industry capacity is for both the September and the December quarters as you look at the TAM, particularly that you just mentioned 160 to 165?

How do you think that matches up against the capacity that will be in place during the course of this quarter and next?

I think the capacity is a little ahead of that number.

The real issue is what each company decides to do relative to utilization of capacity.

Okay.

With one player in particular, I guess.

The second question then is I just wanted to see if I could get your take on the status of the collective and broader inventory.

You talked about some of the different piece parts, but if you tried to characterize, not only what's in the channel but also, what will end up on the balance sheet of the vendors and even guesses on OEMs, just trying to understand what the balance is of inventory today.

Seagate referred to a specific number where they talked about 5 million incremental drives, but want to get your take on the balance of inventory.

Yes.

We think there is about 2.5 weeks of total inventory between drives that belong to the drive makers, that's the OEM [JIT] and the finished goods inventory that's in the drive makers, and -- plus the inventory that's in the distribution and retail channels, the drive level.

When you add all of that together, about 2.5 weeks, which is an increase of about 10% over the position ending last quarter, ending the March quarter.

John, sorry, what do you think the inventory is at DISDE?

DISDE is about five weeks for us and for the industry.

When you include both the inventory on hand at the distributors -- component inventory on hand at the distributors and in transit that they already own.

Right.

Okay.

Thanks very much.

You're welcome.

Sherri Scribner with Deutsche Bank, your line is open.

Thank you.

You made a comment that you thought that the OEMs did some restocking in the March quarter and I was curious how much restocking do you think we saw in the March quarter if you had an estimate?

The best point we have is the mismatch that was there between the movement in market size from December to March where drives were up at 2%, but PC's were down 7%.

In terms of the litigation settlement, can you provide us a little more detail on what that litigation settlement was about?

And I am making the assumption that that settlement was in the SG&A line and is that correct?

That's correct.

Substantially, all of the expense for litigation related to the [Maxell] lawsuit which is described in our previous SEC filings, we do not or did not admit any liability in that.

However, we settled in order to avoid the expense and distraction and uncertainty of ongoing litigation.

Great.

Thank you.

You're welcome.

Steve Fox with CLSA, your line is open.

Good afternoon.

First of all, just another question on Hoya.

When you look at the net benefit once you have improved efficiencies, can you talk about the accretion a little bit more, at least maybe provide a guide post on internal costing versus external purchases of those platters?

That's about as much -- the half a percentage point is about as much as we're going to say.

It has an important benefit to us in that it secures supply for us and of course gets us back to our model on internal versus external.

Those are two critical things for us.

Just from a competitive behavior standpoint, if the unit demand plays out like you just discussed, why is it that we should have some confidence that one of the large players won't continue to be aggressive on prices?

Is there any signs that would be positive that they have started to be more responsible with pricing?

You have to put yourself in position of the players in the market.

This is not an old boys club.

It is a competitive commodity marketplace.

We didn't grow revenue by 22% annually for the last five years, and by 20% annually over the last ten years by sitting back and relaxing.

We did it by providing exceptional value to our customers in quality, reliability, desirable products, availability of product, and price.

On the other side of that, we expanded our gross margins throughout that process where we went from 10% market share to over 30% market share at the same time that we expanded our margins from 12% to 21%.

I think what we're seeing is that the third large player who has significantly improved internal execution and capability over the course of the last few years, and is now in a position to seek to grow just as we have been and are, and so the real issue is, have you got the right products.

Are you able to make them at the right costs to profitably grow your business on an ongoing basis in a market that offers a 15% annualized growth in demand.

If you can answer yes to all of those boxes, you got a great business which grows consistently on revenue and profit, and returns great value to the shareholders of those businesses.

Fair enough.

Thanks for the perspective.

Mark Moskowitz with JPMorgan, your line is open.

Thank you.

Maybe I could follow on that last topic.

Trying to get a sense in terms of the third major participant that is executing better.

Do you think there is any misread on their part where maybe they don't have all the reporting mechanisms in place as Seagate and WD have, in terms of trying to really assess the very fluid ebb and flow of both the channel as well as the OEM markets?

Or is it more of just these guys made a concerted -- almost what I would call, second quarter in a row now where their quarterly growth is outsized relative to you and Seagate?

We'll have to wait and see until they report as to exactly what they have done from a unit, revenue, profitability perspective.

There is of course -- you have to recognize the models.

Whenever quarter-over-quarter demand is lower, that always favors the smaller player in that environment, in terms of their growth.

Because if you have -- let's say, pick a number.

If you have 10% share at a major OEM and your two major competitors have 45% each and the market goes down, as the small player you can afford to bid aggressively to get an increase in share and either keep your volume constant or grow it and get the benefit of that growth on your bottom line.

For the very large participant at any given customer to lean into that wind and price to grow volume, it is usually too costly to do that so there is a natural tendency for the smaller players to grow when the market goes down.

And then the ability of the large players to scale up rapidly causes them to typically grow when the market demand moves up.

John, maybe as a follow-up to that discussion point, can you give us any more color?

I know Rich tried to ask earlier, but we're all trying to understand if the third participant is being used as a lever by the OEMs to really extract from pricing discounts?

Are you seeing them start to have a lot more bull in the glass china ware section here where the HPs and the Dells and the others now have recognized the third participant as maybe a legitimate source for both desktop and notebook more so than historically?

We do a lot of procurement.

We prefer a multi-source model.

This could be a situation and that could be more chronic rather than acute.

But throw your mind back.

It has been this way for the last ten years.

The OEMs have sought multiple suppliers and those people who had a good business model -- just look at WD's performance in an environment that was much more competitive than it is today.

There were a lot more players and a lot more choices for the customers.

Over the years, we have not only survived, but thrived in that environment.

I see every reason to expect to continue to do the same as we go forward.

Okay.

Just last question if I could, as far as the debate over ocean versus air freight, it seems based on my analysis that over the last eighteen months, we have seen a pretty big shift already to ocean versus air across the PCs.

I am just trying to get a sense, is this a customer acknowledgement that maybe the Company down in Round Rock has been really accelerating their ocean freight over the last call it quarter or two to catch up with their peers?

Is this causing some of the disturbance in your model?

It has been a rolling phenomenon across the major PC companies that as more and more competition has emerged from Asia and where the business models tend to require a smaller net margin, that it has certainly caused all of the traditional players to dig deeper, looking for a lower cost.

And see, freight is one element of that lower cost.

But it does create a little bit less visibility into real demand because it extends the time between the decision to build and the actual sale.

Thank you.

Katie Huberty with Morgan Stanley, your line is open.

Thanks.

Good afternoon.

John, it sounds like a big swing factor in the second half will be the demand during back-to-school and therefore, the behavior around holiday builds.

What are the other one or two big swing factors you see that could impact results, either positively or negatively?

The biggest one that we're looking at is macroeconomics, and whether the European recipe for recovery works and whether the US stays on track.

That's the biggest dark cloud that we're continually looking at and then the sunshine that's lurking behind that is the commercial refresh and the rate at which that progresses.

There is a moon there as well which is the strength in Asia, which is significant.

Yes.

And on the commercial point, are you seeing any air freighting for commercial demand, where you could potentially see those builds get pulled forward into September?

Or is the -- sorry, the ocean freighting, just consumer or is it also commercial?

There is some commercial on boats, too.

But commercial has a large component of desktop in it, and typically they're regionally assembled and the drives are air freighted into those locations.

Okay.

And then lastly, do you share Seagate's view that you won't be able to reset ASPs as an industry until the next big product cycle that comes in twelve months?

No.

What would be --

Our model is not solely driven by product refresh.

Our model is driven by continuous provision of the demand capacity points at the best mix of technologies that support continuous and ongoing cost reduction.

We're going to have to wrap it up now.

I want to thank everyone for joining us today, and we look forward to speaking with you and meeting with you and in the months ahead.

Thank you.

Thank you.

This does conclude today's conference call.

You may disconnect at this time.