威騰電子 (WDC) 2011 Q1 法說會逐字稿

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  • Operator

  • Good afternoon and thank you for standing by.

  • Welcome to Western Digital's first quarter financial results for fiscal year 2011.

  • 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 been recorded.

  • Now I will turn the call over to Mr.

  • Bob Blair.

  • You may begin.

  • Bob Blair - VP of IR

  • Thank you.

  • I want to mention as we begin we will be making forward-looking statements in our comments and our response to your questions concerning the role in growth of digital content, growth opportunities for storage companies, and our responses thereto, industry inventory pricing and demand, our business model, our position in the industry, total available market for hard drives in the December quarter, our expected capital expenditures, depreciation and amortization, and tax breaks for fiscal 2011, our share repurchase plans, and our financial results expectations for the December quarter including revenue, 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-K filed with the SEC on August 13, 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 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 would now like to turn the call over to President and Chief Executive Officer of Western Digital, John Coyne.

  • John Coyne - President & CEO

  • Thank you, Bob.

  • Good afternoon, and thank you for joining us today.

  • With me are Tim Leyden, recently named Chief Operating Officer; and Wolfgang Nickl, our newly appointed Chief Financial Officer.

  • Although my titles of President and CEO are unchanged, my emphasis has shifted to how we can best leverage our resources to accelerate our growth in the years ahead.

  • As the new leader of all WD operations and keeper of our low cost model, Tim will discuss current industry dynamics and the Company's performance in the September quarter, while Wolfgang will report on our financial results and provide our outlook for the December quarter.

  • With the advantage of a deeply experienced, dedicated, and passionate team we are excited as we lead WD into its fifth decade.

  • As we look out over the next ten years, the role of digital content in our daily lives -- at home and in the workplace -- will become increasingly ubiquitous with the explosion of data and video rich applications creating huge amounts of digital content that need to be stored and managed.

  • This will be driven by both the traditional computing markets and by new, or evolutionary platforms, such as handheld devices, television and other home entertainment devices, where the analog to digital conversion is in its infancy.

  • In addition to the continuing growth of traditional PC platforms, the growth of cloud computing, tablet computing, and the proliferation of Smartphones creates myriad opportunities for storage companies in traditional hard drive and emerging solid-state drive markets.

  • We will shape the future at WD by sorting through all of these opportunities and acting decisively in our core business and in our business development efforts to continue delivering value to customers and shareholders.

  • You have seen some early indications of one new strategic direction for WD -- into the movement of data and content around the home.

  • With our WD TV live media players, our WD MyBook live network storage solution, and most recently our WD LiveWire powerline network offering.

  • Going forward, we are looking for ways in which to pursue strategic growth initiatives such as this both organically and through acquisition.

  • Turning to the current hard drive industry environment, we are again reminded that this is a competitive industry of seasons and cycles.

  • The management of supply and demand remains an imperfect science.

  • The moderation and industry demand growth in the last two quarters came on the heels of an unprecedented four quarters of strong sequential growth coming out of the Great Recession.

  • As an industry we clearly overshot the recent market demand and we have spent the last six months correcting for that.

  • We believe this will prove to be an interlude, the resumption of the industry's traditional cadence of growth over the last ten years.

  • Having said this, it's important to note that growth has not disappeared in the hard drive industry, post-recession.

  • Expected year-on-year volume growth in calendar year 2010 of 15% brings the five-year industry compound growth rate which, includes the recession of late 2008, to about 11%, while the average growth rate over the last ten years has been 12.5%.

  • In the last two quarters some competitors have made aggressive bids to recover market share.

  • This is a scenario we have seen play out from time to time over the years in the drive industry.

  • Our observation is that these are temporary skirmishes which do not derail our fundamental, long-term, profitable growth story as we address these challenges with a tested business model we have developed and honed over time.

  • For the last ten years, WD has been navigating these industry swings and consistently winning share with our focus on customer value by having the lowest cost model in the industry.

  • We have grown revenues by 18% annually over the last ten years and by 22% annually for the past five years, by providing exceptional value to our customers through the high quality, reliability and desirability of our products along with predictable availability and competitive prices.

  • At the same time we have expanded our full year gross margins from 11% in 2001 to 24% in 2010.

  • This is accomplished primarily through successful vertical integration, expanding our product breadth, delighting our customers, and execution of our low cost model.

  • We that we will continue to -- with this approach as we go forward.

  • Tim Leyden will now comment on how the September quarter played out for WD and the industry.

  • Tim Leyden - COO

  • Thank you.

  • As John indicated, we have navigated through multiple market driven supply/demand imbalances in the hard drive industry and WD remains prepared to address them with what we believe is the industry's lowest cost model.

  • Continuing our unwavering focus on low-cost leadership is my top priority in my new position.

  • This couples with a focus on staying on the industry area density curve, a continued depreciation of customer needs, and a broad and diverse set of competitive product offerings in all segments will keep us in an advantage positioned.

  • This proven approach to the hard drive business has served us, our customers, and our shareholders well over the last ten years.

  • As John mentioned earlier, we saw an unprecedented four consecutive quarters of increasing hard drive shipments from April 2009 to March 2010, and it is now apparent that we have been experiencing a correction of PC makers inventories beginning in the June quarter of this year.

  • Despite weak demand for the first two months of the September quarter, and a quieter than normal back-to-school season, industry shipments nevertheless climbed towards the high-end of our $165 million unit forecast for the September quarter.

  • But, to accomplish this, shipment volumes in week 13 were over twice the average of the previous 12 weeks.

  • In light of the sluggish demand in July and August, we reduced our build plans for September, delayed our capital spending, and selectively stepped back from participating in some very aggressive pricing at the end of the quarter.

  • The lower than expected demand early in the quarter led to a buildup of manufactures inventory during the first eight weeks of the quarter, and contrary to prior fiscal first-quarter historical trends, it contributed to aggressive pricing during the remainder of the quarter.

  • We maintain shares in the 3.5-inch market and yielded 1.5 points of share in 2.5-inch as a result of our temporary pull-back.

  • We exited the quarter with well controlled inventories in each of our segments.

  • We expect that the incremental part of the week 13 shipments will be consumed during the current quarter because customers will not wish to carry this inventory into a seasonally weaker March quarter.

  • We believe this set the stage for a time in the December quarter that will be essentially flat with the September quarter.

  • We believe that HDD hardware and software are pivotal to the data and content management infrastructure ecosystem.

  • The value delivered is not proportionally rewarded in the broader marketplace.

  • Particularly even in the level of unique skills and investments in technology and capital are taken into consideration.

  • Consequently we are in the midst of reviewing the comparative returns on investment that we are currently achieving across our customer and product ranges with a view to reaching the levels of ROI we need in order to continue investing and to provide the product availability that the market demands.

  • As the industry's lowest cost provider, we believe that it is in the best interest of our customers and shareholders that we offer products at a price that covers the cost of doing business and provides the margin and the funding required to continue investing in order to remain a valued HDD supplier on a long-term sustainable basis.

  • Looking out our served markets in the September quarter, in the compute space space, we saw a continuation of softness in consumer demand in all channels.

  • With somewhat of an offset coming from healthier desktops and commercial notebook demand.

  • We expect desktop demand to be marginally down and notebook demand to be marginally up in the December quarter.

  • In the enterprise segments, we saw continued demand strength particularly in enterprise data with the traditional enterprise segment being essentially flat sequentially.

  • We expect overall enterprise demand to show some modest growth in the December quarter.

  • In the non-compute space, we saw the CE market volumes decline marginally quarter on quarter as the market track to starts in seasonal demands pattern.

  • At the same time, the brand of products market showed seasonal demand strength for both 3.5-inch and 2.5-inch categories showing growth.

  • We expect the non-compute space to be essentially flat in the December quarter, and healthy volume increases in branded NCE are offset by the seasonal decline in gaming volume.

  • Geographically, Asia has a showed continued strength.

  • Europe showed the best comparative improvement from the previous quarter, helped by the currency appreciation, while the US market was up modestly from the prior quarter.

  • We shipped 50.7 million units in the September quarter, up 15% from the year ago period while the overall market grew by 8%.

  • Revenues totaled $2.4 billion, both margin with 18.2%, and we remain solidly profitable with net income of $197 million.

  • Importantly, we continue to generate strong cash flow from operations of $390 million.

  • We continue to invest in the business and are doing so by improving and expanding our operations and by enhancing our product lineup.

  • Both in our industry leading hard drive offerings and in the nations with promising markets for management of content in the home.

  • In our traditional businesses, we deliver new models of our popular MyBook and MyPassport external hard drives with USB 3 connectivity and up to three terabytes of storage.

  • Significantly improving content transfer speed and providing our customers with future proofing as newer PCs and other devices begin shipping in volume with USB 3.

  • And in the component space, we began shipping the highest area density 3.5-inch hard drive in the industry.

  • The WD caveat -- Green three terabytes which fits 750 gigabytes on each of its four platters.

  • Reflecting our increasing focus on enabling a comprehensive and easy-to-use experience for management of content in the home, we have added several new products and features including the WD LiveWire powerline AV network kit, a home plug AV compatible solution that enables consumers to use their existing electrical wiring to extend secure, high-speed Internet connection throughout the home.

  • The MyBook Live home network drive, which gives consumers the fastest storage of, and access to their content and provides a seamless setup centralizing digital media in the home.

  • The one-terabyte WD Elements Play Multimedia Drive with high-definition capability onboard and we also recently introduced the newest version of WD Photo, our photo viewer application now optimized for the iPAD, the iPhone 4, and iPod Touch.

  • WD photos enables users to view photos stored on their WD home network drive from any location.

  • I will now turn the call over to Wolfgang Nickl for a review of our Q1 financial performance and our outlook for the second quarter.

  • Wolfgang Nickl - CFO

  • Thank you, Tim.

  • I would like to refer you to a new and expanded summary of financial information that has been posted to the Investor Relations section of our website.

  • Much of the data that we have recited during past conference calls is included in that fact sheet.

  • During my prepared remarks, I will focus on highlights and significant changes in some of our key metrics.

  • At the end of this call, the summary of financial information will be updated to include our Q2 guidance which I will discuss in a few moments.

  • The September quarter was characterized by unusually aggressive pricing that lasted throughout the quarter, with like-for-like prices declines in excess of 8%.

  • Pricing pressure was most prevalent in the 2.5-inch segment.

  • We made a conscious decision to limit our participation in this segment in an effort to optimize profitability.

  • Our selectable operating model allowed us to adjust our operating expenses to offset the impact of pricing on operating margins.

  • In close, the quarter neared the midpoint of our EPS guidance range.

  • We actively managed capital receipts and working capital and generated significant free cash flow.

  • Revenues for the first fiscal quarter was $2.4 billion, up 9% from the prior year and 1% sequentially.

  • This included $51 million of sales of media from our newly acquired Singapore media facility to fulfill contractual obligations carrying over from [Foya's] existing sales commitment.

  • We do not expect any external media sales in Q2.

  • [Authorized] shipments totaled 50.7 million units, up 15% from the prior year period and 2% sequentially.

  • Revenue from sales of WD TV media players, WD LiveWire network kit, and solid-state drives totaled approximately $33 million, roughly flat with the prior year and up 22% from the June quarter.

  • Average hard drive selling price was approximately $46 per unit, down $3 from the year ago quarter, and down $1 from the June quarter.

  • Revenue from sales of our branded products including WD TV and WD LiveWire products was $425 million, up 11% from $382 million in the year ago quarter, and 6% sequentially from $400 million in the June quarter.

  • There was no customers that comprise 10% or more of our total revenue.

  • Our first margin for the quarter was 18.2%, down from 23.3% in the year ago quarter and down from 22.5% in the June quarter.

  • The lower than expected gross margin percentage was primarily due to the price decline I referred to earlier.

  • Product and segment mix, as well as product cost decline were largely in line with our expectations.

  • Total R&D and SG&A spending was $226 million, or 9.4% of revenue.

  • This compares with $195 million, or 8.8% of revenue, in the year ago quarter, and $242 million, or 10.2% of revenue, in the June quarter.

  • As a reminder, total operating expenses for the June quarter included $27 million of litigation settlement.

  • Operating income was $211 million, or 8.8% of revenue.

  • This compares with $319 million, or 14.4% of revenue, in the year ago quarter and $293 million, or 12.3% of revenue, in the June quarter.

  • Net interest and other non-operating expenses wer less than $1 million.

  • Tax expense for the September quarter was $14 million, or 6.6% of the pretax income.

  • Our net income totaled $197 million, or $0.84 per share.

  • This compares with $288 million, or $1.25 per share, and $265 million, or $1.13 per share, in the year ago and June quarters respectively.

  • Turning to the balance sheet, we generated $390 million in cash flow from operations during the September quarter.

  • Our cash conversion cycle for the first quarter was a negative three days.

  • This consisted of 50 days of receivables outstanding, 26 days of inventory, or 14 turns, and 79 days of payables.

  • Capital additions for the September quarter totaled $200 million.

  • Lower than our July projections of $275 million as we scale back in line with lower shipments.

  • Depreciation and amortization expense for the first quarter totaled $150 million.

  • We continue to expect our capital expenditure for fiscal 2011 to be between 7% and 8% of revenue with an additional $200 million related to our 6-inch to 8-inch wafer conversion, and some expenditure to optimize the output from our recently acquired media facility in Singapore.

  • Depreciation and amortization is expected to be at about $630 million for the fiscal year.

  • We made $25 million of debt repayment installments during the first quarter and thereby reduced our debt balance to $375 million.

  • We exited fiscal Q1 with cash and cash equivalents of $2.9 billion, an increase of $124 million from the June quarter.

  • During the quarter we repurchased 1.8 million shares at a total cost of $50 million.

  • The balance remaining on our stock repurchase authorization is $416 million.

  • From a balance sheet strategy perspective, our first priority is to create shareholder value through strategic investments both in markets currently served and adjacent markets.

  • Any larger scale share buybacks would be considered only after we have started our strategic options.

  • Now turning to our expectations for fiscal Q2.

  • Historically, industry shipments increased by 5% to 7% from the September to the December quarter.

  • As Tim mentioned, we have seen approximately twice the shipment volume in the last week of last quarter than an average of the preceding twelve weeks of the quarter.

  • We believe that customers will not want to carry extra inventory into -- inventory into the March quarter, and therefore expect some inventory correction.

  • We consequently assume that the December quarter industry [tam] will be roughly flat with the September quarter at around 165 million units.

  • Some of the aggressive pricing we have seen last quarter has carried over into this quarter and our guidance includes like-for-like price declines of approximately 5%.

  • We are actively reviewing our planned shipment portfolio to identify business that is not meeting our business model requirements.

  • Where contractual obligations do not exist, we may review our shipments to low contribution -- of low contribution products and seek to shift sales to more profitable segments.

  • As previously indicated, we are currently calibrating our new Singapore media facility to our own recipes and as a result we are experiencing the dilution of gross margin of 50 basis points during this quarter.

  • Accordingly our guidance for fiscal Q2 is as follows.

  • We expect revenue to be in the range from $2.3 billion to $2.4 billion.

  • R&D and SG&A spending is expected to total approximately $230 million.

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

  • Expect our tax rate to be within our business model of 6% to 9%.

  • We anticipate our share count to be approximately 235 million.

  • We estimate earnings per share of between $0.50 and $0.60 for the December quarter.

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

  • Operator

  • (Operator Instructions) One moment please for our first question.

  • Our first question comes from Rich Kugele with Needham & Company.

  • Your line is open.

  • Rich Kugele - Analyst

  • Thank you.

  • Good afternoon.

  • A few questions.

  • I guess first, regarding the 13th week extra shipments that you are referring to, did those go to OEMs or did they go to the channel?

  • Any color on the types of products lines where we are really talking about?

  • John Coyne - President & CEO

  • Hi, rich.

  • Those shipments went mainly to OEM.

  • Rich Kugele - Analyst

  • Okay.

  • With a desktop or notebook?

  • John Coyne - President & CEO

  • Mainly notebook because notebook is, as you know, has got a heavy OEM presence.

  • Rich Kugele - Analyst

  • Okay.

  • And then in terms of the raw materials, and Tim, this is probably best for you.

  • I am sure you have seen the news about the raw materials, the rare earth metals coming out of China.

  • Do you have any thoughts on [serium] shortages affecting the substrate world?

  • And are you protected against that because of the Hoya relationship?

  • Any, any comments?

  • John Coyne - President & CEO

  • We do not really have much insight into that at this particular point, Richard.

  • But we are, we are looking at how it might impact us and we've got pretty good relationships with our vendors so we are, we are looking to leverage those in (inaudible) to make sure that we are minimally impacted.

  • Rich Kugele - Analyst

  • Okay.

  • Then, just lastly, traditionally the industry has been able to offset price declines by moving to new product lines.

  • There has been largely an absence of new products here in the second half of calendar '10.

  • They are supposed to be some new products coming out in the first half of the '11.

  • Do you think that that's the opportunity to go and maybe reset this cost price situation?

  • Or, any -- any thought that when we're might, might be able to see a stabilization of the pricing environment?

  • John Coyne - President & CEO

  • What we have seen previously from history is that the stabilization of the pricing environment comes when demand exceeds supply.

  • And that has generally been, according to the seasonal cadence, as generally being in the September and December quarters.

  • So with the -- working off of the inventory that has occurred during the course of the September quarter and with the HDD market being up about 5% versus what would normally be a much stronger position, somewhere in the 10% to 12% I would imagine, and going into a December quarter that is essentially flat, we think that the, the opportunity will come more from supply, demand -- supply chasing demand again.

  • So we think that this will -- the industry will have to manage the inventory supply demand equilibrium and stabilize that situation.

  • And that will have more of an impact on us than any of the new products (inaudible).

  • Rich Kugele - Analyst

  • Okay.

  • Thank you very much.

  • Operator

  • Aaron Rakers with Stifel Nicolaus, your line is open.

  • Aaron Rakers - Analyst

  • Yes, thanks guys.

  • So, just a backwards mask given what you guys just said about the guidance, it would appear to me that you are guiding a gross margin number somewhere in that 16% range, so I think in the context of pricing and the context of a flat TAM assumption, if I'm correct, can you help me bridge the gap on top of that 50 basis point impact from kind of ramping the Hoya facility?

  • And then I have a follow-up.

  • Wolfgang Nickl - CFO

  • Aaron, this is Wolfgang.

  • Your math is obviously correct.

  • Gross margin is a function of business segments mix, cost declines and price declines.

  • And the 5% like-for-like price decline that, that I quoted compares to a regular price decline in, in this quarter historically that we are seeing in the 1.5% to 2% range and I would say this is the main contributor to the decline quarter over quarter.

  • Aaron Rakers - Analyst

  • Yes.

  • And then the follow-up questions, first of all, on the $27 million of litigation expense are you assuming that that continues here going forward?

  • And then finally, I appreciate the more detailed breakdowns that you guys are giving.

  • Actually breaking out an enterprise shipment number.

  • Is that inclusive of both SATA and SAS drives into enterprise?

  • I am just trying to understand maybe the ramp in the traditional enterprise that you guys are seeing, when we might be able to point to kind of an inflection point to some appreciable market share gains there.

  • Thank you.

  • Tim Leyden - COO

  • Yes, Aaron, I take the enterprise question.

  • Yes, that is correct, the enterprise number would be comprised of all of our enterprise shipments including traditional and our RE products.

  • And I will let John take the litigation question.

  • John Coyne - President & CEO

  • Yes, the litigation is a one-off.

  • Aaron Rakers - Analyst

  • Okay, so, so with $27 million out, why is the expense then on a, on a normalized basis going up?

  • John Coyne - President & CEO

  • The expense going up if you take the $242 million from the June quarter and normalize for the $27 million and then the increase in expense comes mainly from an adjustment in our incentive accruals, and then from investments in our research and development teams and in our sales teams to increase our market reach.

  • Aaron Rakers - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Sherri Scribner with Deutsche Bank your line is open.

  • Sherri Scribner - Analyst

  • Hi, thank you.

  • I was curious if you would want to make comments on the recent news the Seagate announced that they might be going private?

  • And would it be something that you guys would consider doing?

  • John Coyne - President & CEO

  • Hi, Sherry.

  • This is John.

  • You know, we have, we have seen Seagate as a formidable and respected competitor both in public and private ownership previously, and so we, we have no reason to believe that that will change whether they are public or private.

  • They will remain a respected and formidable competitor in the space.

  • Sherri Scribner - Analyst

  • Is that something you would consider doing if they were private?

  • John Coyne - President & CEO

  • We do not think the ownership structure is, is significant.

  • That business model is what we are focused on.

  • We believe our business model that we have been refining for the last ten years is the appropriate one for success in this market.

  • Sherri Scribner - Analyst

  • Okay.

  • And then in terms of the gross margin now being down below your targeted range, we are heading into -- after December, we are heading into the March and the June quarters when industry demand is typically down.

  • I am trying to get a sense of how long do you think it will take before we get back into your targeted ranges for gross margins?

  • It seems like that won't happen until the second half of 2011 at the earliest.

  • Wolfgang Nickl - CFO

  • Wolfgang again.

  • As I mentioned, price decline is a very important to contributor to this equation.

  • We are in control of our cost declines and we are working on our channel mix.

  • So, it will come down to when the supply/demand situation will allow pricing to stabilize.

  • And we are not making any predictions when, when that would happen, but we all know that the margins for June quarter usually are seasonally soft.

  • Sherri Scribner - Analyst

  • Do you -- I guess, just quickly do you have any sense of what the industry capacity is right now?

  • Would you say that it's 10% higher than the TAM or 20% higher than the TAM?

  • Just trying to get a sense.

  • John Coyne - President & CEO

  • We are just going on what expectations were like.

  • I think coming into the year there was expectations that the industry demand would be somewhere in the 170 million units, or 180 million units.

  • That type of number.

  • So, consequently when we're running at about 165 million units, and if you take the midpoint of the 170 million units to 180 million units, you are probably looking at being somewhere between 90% and 95%.

  • And if you just take the straight math, 165 million units to 175 million units, it's about 94%.

  • So you're probably somewhere in there -- 90% to 95% range.

  • Sherri Scribner - Analyst

  • Okay.

  • Great.

  • Thank you.

  • Operator

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

  • Keith Bachman - Analyst

  • Hi, Tim.

  • I guess this is for you.

  • On the, the TAM, I just want to make sure I am doing the numbers right.

  • If -- it sounds like September came in kind of $164 million, and normally I think you indicated that the, the bump in units would be call it 3% to 5%, so maybe it's a low $170 million.

  • So does that suggest that that math, that you have about 7 million units to 8 million units out there as, as the extra inventory that needs to get worked off?

  • Tim Leyden - COO

  • Yes, probably.

  • It's right around that number.

  • Maybe marginally higher than that.

  • Keith Bachman - Analyst

  • Okay.

  • And is it, is it -- I think you said it was more notebooks, but what is its collective, so to speak?

  • I know you guys said you've elected not to participate.

  • But was it a -- were there many fingerprints on, on the drives?

  • Tim Leyden - COO

  • We did not actually mention that we elected not to participate, we mentioned that we selectively stepped back.

  • So, in addition to that you know, even though it is a higher number than what we would normally see, there is always some extra amount that gets shipped in at the end of each quarter.

  • So, the excess over and above what would normally happen is probably somewhere in the region of about 5 million units or so.

  • And so, that has to get worked off, obviously, going into a quarter which is front-end loaded as opposed to the previous two quarter which has been heavily back-end loaded.

  • So there is an opportunity for bad inventory to, to get burned off early, we just have to wait and see what happens.

  • Keith Bachman - Analyst

  • Okay.

  • Well, then my follow up then, Tim, is, just curious of your discussion with the OEMs as it relates to the demand on the notebook side versus the potential conflict, or demand conflict with, with tablets.

  • How are, how are the OEMs characterizing it, and how does that make you think about the seasonality in notebook drives in the March quarter?

  • And that's it for me.

  • Thanks.

  • John Coyne - President & CEO

  • This is John.

  • I will take this tablet question.

  • You know, from everything we can gather with multiple different source reporting on, on tablets, I mean we see the first two quarters of the iPad had about 8 million units.

  • Keith Bachman - Analyst

  • Right.

  • John Coyne - President & CEO

  • Compares -- to, to put it in context, that compares with the first two quarters of the EPC Netbook emergence, which was 5 million in its first, first two quarters.

  • So everything hear indicates that roughly half of the iPad sales are to existing Apple households.

  • And that somewhere in the region of 13% to 15% of the folks buying iPads admit to substituting the iPad for a previously planned PC purchase, and some 23% of purchasers indicate that they are buying an iPad as an alternative to a Kindle or other eReader.

  • So, what we see, I think, is a complementary additional device sale to the overall ecosystem of content consumption.

  • We think that, when you look at the numbers, certainly there has been some falloff in Netbook over the last couple quarters.

  • They're also -- you have to take the price point of the iPad into account.

  • It's likely that over the next several quarters as other tablets emerge, they will address lower price points than the iPad currently occupies.

  • But on overall assessment, we are seeing, maybe somewhere in the 10% to 20% impact range on the growth of low end notebook/netbook products.

  • Keith Bachman - Analyst

  • Okay.

  • Fair enough, thank you very much.

  • Operator

  • Ben Reitzes with Barclays Capital, your line is open.

  • Ben Reitzes - Analyst

  • Hi, thank you very much.

  • I wanted to ask about going beyond the December quarter, if you could, just about some dynamics that are setting up.

  • There's Intel's Sandy Bridge, which may affect some of the builds from OEM customers, and then there is the emergence of China, which is kind of changing the seasonality of the whole world.

  • So is there a chance that TAM is, is flattish like of was again, you know, like it was last year in the March quarter?

  • And is, is, does the March quarter potentially represents a light at the end of the tunnel here after this big quarter of adjustment in December?

  • Tim Leyden - COO

  • Yes, I think there is a chance.

  • I mean, March quarter traditionally, if we go back to the more pre-recession cadence, was flat to slightly down.

  • Somewhere in the maybe 3% region.

  • And from a going forward seasonal viewpoint, it does look as if the strength of China is changing that dynamic.

  • So there is opportunity there for the, for the situation to improve.

  • So we'll, we will wait and see.

  • But, I mean, there is, it's all dependent on the working through the infantry that the PC -- that the OEMs have, the PC OEM's have built up and how they manage that.

  • And then how the different fares in the disk drive industry and manage the shipments going into the market.

  • So there is a lot of dynamic on it.

  • But the -- but there is an opportunity considering the changing the variables that are going in such as the Intel Sandy Bridge, the Chinese New Year, and, and the strength of post-Christmas sales as well.

  • So there is opportunity and we will have to wait and see.

  • Ben Reitzes - Analyst

  • Okay.

  • And then I wanted to just address the demand issue again.

  • Perhaps with Apple having an event tomorrow where they might introduce more NAND into the MacBook Air and, and whatnot.

  • Just -- is there, is there, has there anything changed more in the mainstream PC market, or is there any worries about what Apple may do actually more the mainstream PC market with NAND?

  • Or is that a status quo still right now, where it's too expensive, and it's not going to happen and it's just going to be in the iPad market, or the tablet market?

  • John Coyne - President & CEO

  • Yes.

  • We believe that the solid-state solutions are, are not competitive in the mainstream PC market.

  • Weather laptop or desktop, the economics just do not work out.

  • Where the storage element is constrained by form factor than on the high price point devices, solid state is an appropriate solution.

  • And where, in the very small form factor devices, like PDAs and MP3 players and so on, it's clear that small amounts of solid-state memory are the solution to fit in the form factor and fit in the budget.

  • Ben Reitzes - Analyst

  • Okay.

  • Thank you very much.

  • Operator

  • Nehal Chokshi with Technology Insights Research, your line is open.

  • Nehal Chokshi - Analyst

  • Yes, I got two questions actually.

  • Your enterprise units are down Q2 compared to what is typically and up Q.

  • Can you talk about what drove that?

  • John Coyne - President & CEO

  • Yes, we are going through some product transitions in there.

  • We had a very strong product lineup and we are now moving into a period in which we would have some product transitions.

  • We expect to work through those in two or three quarters.

  • Nehal Chokshi - Analyst

  • Okay.

  • Is that a SAT space transition, or is that a base transition?

  • John Coyne - President & CEO

  • It's a SATA base transition.

  • Nehal Chokshi - Analyst

  • Okay.

  • All right.

  • And then at the beginning of the call, John, you talked about how you're putting a little bit larger focus on some strategic direction.

  • It seems like you're trying to talk about more focus on the users that implies greater focus on software.

  • Can you discuss some metrics that verify that this is being the case.

  • Possibly maybe number of software engineers at WD, how that's growing, or maybe R&D spend dedicated software.

  • Can you talk a little bit to that?

  • John Coyne - President & CEO

  • I'll not give you specifics on that for competitive reasons.

  • But I -- if you look at the thrust of our product offerings in our branded business, you'll note that we have, we have migrated the backup software on all of our drive products, the MyBook and My Passport lines, which used to be a purchase software solution, we have migrated to an internally developed solution so that we can better own the total customer experience there and the interaction of the customer with the device.

  • If you look at our complete range of WD media players, the TV Live line and the Elements Play line, there again you will see significant software content in those products.

  • And then you look at the -- our recent (inaudible) with the WD photo app for the iPad, iPhone 4, and iPod Touch, again an in-house developed software product.

  • So, also some years ago you recall we bought a company called [MioMat], which was a software play that we have developed into the major engine that creates the connectivity and accessibility for all of our products as the interplay for remote access.

  • So, yes, we are putting significant emphasis on software these days.

  • Nehal Chokshi - Analyst

  • Okay.

  • Thank you for that.

  • Operator

  • Rob Cihra with Caris & Company, your line is open.

  • Rob Cihra - Analyst

  • Hi, thanks very much.

  • Two questions, if I could.

  • One just on CapEx.

  • It did come in a little lower in dollar terms, and you had mentioned that you are still looking at the same target as a percentage of revenue and including the 8-inch wafer conversion.

  • But can you, can you tell us what you've seen, maybe from sort of across the industry in terms of other players?

  • If you're seeing people already cutting CapEx measurably, or just starting to a little bit including for example, Asian media suppliers.

  • Do you think that's going to help anytime soon?

  • Or are we too early for CapEx cuts to help?

  • And then separate from that, if I could just push maybe a little more, you did touch on the almost -- the $11 in cash per share that you have.

  • I am just wondering if you could push a little more in terms of what your priorities are in terms of buyback versus potential dividend versus acquisitions?

  • Thank you.

  • John Coyne - President & CEO

  • Okay.

  • From a CapEx viewpoint, we don't really have much (inaudible) competitors or we would imagine that by past history that people are -- since the volumes are coming in lower than what people had anticipated in September and December quarters, if our projections for '10 being flattish from September is correct.

  • We would imagine that everybody is moving to postpone and cancel where possible, and capital editions and managing it as prudently as they possibly can.

  • In our case, we are -- we have demonstrated that capability over long period of time.

  • We add capacity just in time.

  • And we have managed the capacity on an ongoing basis in order to cover the demand at that point in time.

  • Tim Leyden - COO

  • In terms of the balance sheet and stuff, we built a strategy, as John mentioned in his remarks, our prime focus right now is to evaluate strategic opportunities both in the HED as well as in adjacent markets, and we will use our cash and our borrowing capacity to accomplish that.

  • And once we have previewed all of these opportunities and (inaudible) solution that we can find anything appropriate, we will evaluate the best way of returning money to the shareholder and that can be in home or share buyback, and we will decide whether we do that in a unlevered or a levered fashion at the appropriate point in time.

  • Rob Cihra - Analyst

  • All right.

  • Thank you very much.

  • Operator

  • Mark Miller with Noble Financial, your line is open.

  • Mark Miller - Analyst

  • I want to go back and talk about pricing again because these margins were, I think, below most -- what most people thought you indicate in inventory.

  • How much -- you are roughly split 50/50 between the OEM and channel and retail.

  • How much of the pricing pressure, or the decrease margins is due to pricing from the OEM options?

  • And how much of it is your anticipated pricing pressures in the channel?

  • Tim Leyden - COO

  • I think their will be more pricing pressure coming from OEMs because during the four quarters of unprecedented demand outstripping supply, the OEMs got nervous about supply -- built up some inventory positions within their, their own internal inventory.

  • And then we came on a little consumer softness.

  • They, they let the inventory correct and then sat back and, and got some improved pricing conditions as a result of that.

  • And, so that dynamic is, is the more important one in the overall pricing movement.

  • There has been some pressure in the channel as well as in the last couple of quarters we've had different competitors trying to gain back market shares that they had lost in earlier quarters.

  • And it's put some pressure on the channel, but I think the OEM pricing pressure has been more significant.

  • Mark Miller - Analyst

  • Okay to just one final question.

  • You are going through a major ramp in your HiD fabs and also I think expanding into a new fab in the old Thermoway facility.

  • Have you had to buy more components externally then you have in previous quarters, or you are still supplying at roughly the same mix internally and externally, especially for HiDs, and as well as media, by the way?

  • Tim Leyden - COO

  • Yes, I mean we have very good relationships with the external merchant vendors and we've got our own internal components operating rather well, so we, we operate in order to -- we mix both in order to optimize the power profit objective.

  • And that fluctuates around, you know, from somewhere around 75% to 85% internal.

  • So we continue to work that.

  • That's not a, a perfect science as you can imagine.

  • So, it's -- we are continuing to work it as we always do.

  • Mark Miller - Analyst

  • So there is no major, no change in your mix?

  • Just relatively small change in your mix between internal and external component supply expected for the December quarter as what you've seen in the recent quarters?

  • Tim Leyden - COO

  • No.

  • Mark Miller - Analyst

  • Thank you.

  • Tim Leyden - COO

  • Other than, of course, the impact of the Singapore Hoya facility that will change the dynamic and increase the internal for media.

  • Mark Miller - Analyst

  • Thank you.

  • Operator

  • [Kasha Groi] with Wedbush, your line is open.

  • Kasha Groi - Analyst

  • Thanks.

  • So going back to the question of Seagate, how do you see the markets evolving if Seagate goes private?

  • I mean, do you expect less pricing pressure?

  • Or not really?

  • John Coyne - President & CEO

  • I -- Based on history we don't perceive that private or public ownership had any significant impact on how Seagate addressed the market, and how we addressed the market.

  • So we're -- I mean we're focused on how we continue to find a recipe that delights customers and does so based off having the lowest costs in the industry so that we can convert that customer delight, despite competitive environment into significant profitability and growth.

  • And so we do not see the company ownership piece as a significant -- very significant element in all of that.

  • Kasha Groi - Analyst

  • And then you said that SSD's are not competitive and on desktop and notebook, but can you comment on your progress on SSD's?

  • Are you willing to participate in the enterprise segment, or the small form factor segment?

  • Thank you.

  • John Coyne - President & CEO

  • Yes, we are -- the company we acquired a couple years ago, we have worked on that embedded market for Netcom and industrial controls and so on and we have grown that business since acquisition.

  • We are committed to that space.

  • We have produced products for the client space that is very low volume.

  • And we are working diligently on product for the enterprise space, which we believe is the most attractive application for solid-state drives.

  • Attractive to the customer because of the value it brings.

  • Attractive to us because of the value that we bring to the, the knowledge in the area of applications and management of media.

  • And so that is our primary focus for now is on the development trail to broaden our enterprise portfolio offering.

  • Kasha Groi - Analyst

  • Can you quantify the units or revenues in any way?

  • John Coyne - President & CEO

  • We think that the enterprise, solid-state enterprise market today is somewhere in the $800 million to $1 billion range.

  • And as we assess the various forecasts that are out there for multiple sources and our own take on that, you know, we are looking at that market as being a $3 billion to $5 billion market in three to five years.

  • Kasha Groi - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Next comes from Ananda Baruah with Brean Murray, your line is open.

  • Ananda Baruah - Analyst

  • Thank you for taking the question.

  • Hi, John, just wanted to ask your opinion on -- given that after this quarter, sounds like there's still going to be, I don't know, you say say 7 million to 10 million drives of excess inventory out there for the industry.

  • Might it, might it be, I guess, more prudent to ship, I guess, TAM down the December quarter versus September just to get that out of the way more quickly?

  • Or is there something structural just about the way, you know, that you take down -- the industry collectively takes down (inaudible) the quarter that precludes that from being done.

  • Tim Leyden - COO

  • You know, our take on the TAM and calling the TAM flat quarter to quarter here, we believe the underlying demand is up quarter to quarter.

  • We think there's -- it is seasonal and will likely be up in the 5% range on a quarter over quarter basis.

  • And we're, we're calling the drive industry TAM flat so that the inventory that has been built up can be absorbed (inaudible) market demand.

  • Ananda Baruah - Analyst

  • Got it.

  • Thanks.

  • And I guess just a quick follow-up on that.

  • Any sense -- is it too early to get a sense -- if taking out, you know, through the inventory that will be taken out during the December quarter by shipping the flat TAM, will that make a meaningful difference in the promotion of, you know, more normal seasonal pricing in the March quarter?

  • Tim Leyden - COO

  • I think March quarter, you know, the thesis is yet to be proven but we do believe that there is some shift to the overall traditional seasonality of the industry, and unfortunately the, you know, the timing of the big recession makes it -- and the recovery out of that -- makes it very difficult to clearly discern shifts in the multi-year seasonal patterns.

  • But we do believe that there is a (inaudible) of the, the rise of China as important market, creating demand in the first calendar quarter of the year.

  • We believe there is a shift from air freight to sea freight from Asia to the US and Europe causing a shift, a pull forward of back to school builds into the second calendar quarter of the year, and that we're, over time, the seasonality of the business will flatten out.

  • But it's, it's difficult to get a precise handle on that because of the massive disruption that the, that the recession put on top of those patterns.

  • Ananda Baruah - Analyst

  • Got it.

  • Okay.

  • Thanks a lot.

  • Appreciate it.

  • Operator

  • Mark Moskowitz with JPMorgan, your line is open.

  • Mark Moskowitz - Analyst

  • Yes, thank you.

  • Good afternoon.

  • Two questions if I could.

  • I want to come back to just what has been going on here over the past six months or so, John and Tim, if you could kind of weigh in here.

  • Is there something that's structurally wrong right now with the overall disk drive industry in terms of how the industry interfaces with both the OEMs and the distributors?

  • And I think back to 2004 how there was a lot of challenges and the industry participants worked to have greater transparency and greater dialogue to manage the inventories and supply demand and balances.

  • Because I just get confused when you can have this huge 13th week and then suddenly the spigot gets turned off again by the OEMs.

  • I mean, are they having these quick [sodig] demand cycles?

  • Who's, who's kid of at fault here in terms of what is going on?

  • John Coyne - President & CEO

  • I mean, what you're seeing is competitive behavior in a, in a slightly -- just slightly unbalanced supply demand situation.

  • It is very typical.

  • We saw -- we have never before seen in the industry four sequential quarters where the demand presented to the industry outstripped the industry's demand for supply -- ability to supply.

  • And it is pretty natural coming out of that that the pendulum is going to swing back a little the other way.

  • It is very difficult to land without a little over shoot.

  • And so I think what you have seen in the last six months has been, you know, the wealth created in the four quarter runoff allowed people to -- encourage everybody to get more invested in the industry.

  • And initially, as the demand softened, people have tried to maintain their momentum.

  • And it takes a little while for folks to realize that the -- if everybody overbuilds then there's going to be pressure and then there is going to be, you know, our customers are smart people.

  • They are going to take advantage of that, and we need to get things back in balance and move on with life.

  • And that is the cycle that has been played through.

  • I think if you analyze the numbers however, you will see that, you know things are not a disaster right now.

  • Where we finished last quarter above the bottom of our model, you can go back many years into the last ten years and find periods where we dropped out of the model for periods of time, and I would remind you that the model was a significantly lower bottom to it that it has today.

  • So the industry, and WD, have expanded gross margin model consistently over the last ten years, and we are still -- you know, yes, we do not like being under the bottom of the model and we are going to work to move ourselves back into it as soon as we can.

  • But we are also going to work to ensure that we have the right product set and the right availability and the right approach with our customers to have them prefer WD product over others, and continue to grow our business profitably.

  • Mark Moskowitz - Analyst

  • I guess as a follow-up then, so should, should the message be then to investors that we can see a Bell curve where you had four kind of medioric quarters, and now you're going to have four quarters of some pretty challenging times?

  • And I say that because if I think about the industry, to the industry's credit, you have a lot more efficient and effective participants now than we did say five years or six years ago.

  • And, and as Rich alluded to earlier, it is going to difficult to kind of reset the price curve, I think, for the time being.

  • So are we --

  • John Coyne - President & CEO

  • What I would say to investors is to look at the long-term demand for storage.

  • The fact that the most appropriate solution for mass volume storage is hard drives, and to look at the long-term progress the industry has made in the last ten years.

  • And I believe we will continue on that fundamental trend line over the next ten years.

  • Mark Moskowitz - Analyst

  • Okay.

  • John Coyne - President & CEO

  • So, in closing, I would like to thank all of you for joining us today.

  • We appreciate your questions and your interest in the Company and in the industry.

  • We look forward to seeing you again in another quarter.

  • Operator

  • Thank you.

  • This does conclude today's conference.

  • You may disconnect at this time.