威騰電子 (WDC) 2011 Q2 法說會逐字稿

Good afternoon and thank you for standing by.

Welcome to Western Digital second quarter 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 being recorded.

Now I will turn the call over to Mr.

Bob Blair.

You may begin.

Thank you.

I want to mention that we will be making forward-looking statements in our comments, and our response to your questions concerning a number of matters.

The total available market for hard drives and the March quarter and in 2011, industry capital expenditures for 2011, our growth rate and growth plan for 2011, our growth opportunities and the medium to long-term, our position within the storage industry, our inventory holding and supply demand balancing in the March quarter, our expected capital expenditures, depreciation and amortization and tax rate for fiscal 2011, our share repurchase plans, our financial results expectations for the March quarter, including revenue, gross margin, expenses, tax rates, 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 October 29, 2010.

We undertake no obligation to update our forward-looking statements to reflect new information or events.

You should not assume later in the quarter that the comments that we make today on this call are still valid.

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

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

Thank you, Bob.

Good afternoon.

Thank you for joining us.

With me on our Q2 call are Tim Leyden, our Chief Operating Officer, and Wolfgang Nickl, our Chief Financial Officer.

Calendar 2010 was a year of tremendous opportunity for the hard drive industry with 651 million drives shipped, that's 330 million terabytes of storage capacity sold into a broadening set of applications and markets.

At 16%, this was the industry's strongest full-year unit growth in five years.

Rotating magnetic storage remains the dominant technology solution for high volume, mass storage of digital content in both the consumer and commercial markets.

Full-year revenue for the industry expanded by some 13% to $34 billion.

However, it was also a year of significant missed opportunity as the industry's supply/demand dynamic deteriorated as the year progressed, resulting in sharply declining ASPs with the final quarter demonstrating a year-over-year decline in industry revenue of 7% on a unit increase of 4%, and an even sharper decline in profitability.

WD again outperformed the industry in calendar 2010.

We grew units 23%, revenues by 19%, and operating income by 12%.

The operating income number reflected the significant challenge of the industry's ASP deterioration that emerged mid-year.

While we improved our financial performance sequentially in the December quarter, we are far from happy that we failed to monetize our growth throughout the year and generate the kind of return needed to sustain robust investment in technologies and products to improve our customer's future experience.

In the coming year we expect the hard drive volume opportunity to approach 700 million units, representing a storage capacity of approximately 440 million terabytes.

Our estimate of the investment required by the hard drive community including our component suppliers to support this growth is approximately $5 billion.

Though the need for the industry to perform well enough to sustain its critical role in the digital ecosystem should be clear to us, to our customers, and to their customers.

In reviewing how we can improve our future performance, we have identified a misalignment in how our industry typically begins the calendar year from a production standpoint, in contrast with the underlying demand trend of PCs, our largest served market.

We are determined to start this year with the benefit of lessons learned from this analysis, and Tim and Wolfgang will elaborate on this approach later in this call.

In addressing the calendar year 2011 market opportunity, we expect to continue to grow faster than the overall market by providing greater customer value and satisfaction than competition.

We will continue to leverage our cost advantage and our relentless focus on high quality, reliability, and availability of product especially in the industry's fastest growing market segments.

We believe we can achieve this growth plan while at the same time improving the way in which we approach the supply demand dynamic from the outset of the year.

In the medium to long-term we are focused on multiple growth opportunities in both our core business and beyond.

First, as I have said, we intend to continue to grow in our existing hard drive segments by providing superior availability, quality, reliability, and value; a proven approach that has established us as a leading supplier in each of our served markets today.

Second, we will leverage that same approach into the underpenetrated markets for WD of gaming and traditional enterprise.

We have recently introduced our second-generation SAS product for the traditional enterprise market, along with our first SAS offering for the high capacity near-line storage market.

We believe our commitment and measured approach to these important markets will earn significant share as we deliver a succession of outstanding products to customers in the years ahead.

Third, we are focused on growing our storage presence beyond rotating magnetic media through our leadership in the embedded SSD space and our planned entry into the Tier 0 enterprise segment for SSD.

When that market evolves into a significant and profitable market opportunity.

In the context of solid state technology we also continue to evaluate the opportunity to combine rotating magnetic storage with flash into hybrid solutions.

Fourth, as highlighted earlier this month at our analyst briefing at the Consumer Electronics Show, we are expanding our TAM by addressing the connected digital home market with products that integrate and bring to life consumer's personal and premium digital content.

The acceleration of digital content creation offers almost unlimited opportunities for those smart enough to feel the pulse of the consumer and provide solutions to address the need to safely store, share, and experience this growing mass of content, both private and public.

This growth is being driven by relentless innovation in hardware and software which in turn is enabling and encouraging new usage models such as social media, which all compound to proliferate content and copies of content throughout the world.

At WD, we view every device or system which enables and encourages content creation or consumption including tablets as a potential opportunity for expanded market participation either directly or indirectly.

Since fiscal 2004, WD has been at the forefront of the still nascent market for branded storage and connected home products, with 85 million WD branded products sold to consumers including 2.5 million WD TV media players.

We believe this market has the potential to generate significant growth for WD in the years ahead.

We will continue to review opportunities to invest in and expand our presence in these and additional aligned markets in the months ahead as part of our strategic evaluation of how to best create value for our shareholders.

We're excited about the changing landscape of the digital ecosystem which we see filled with opportunity for WD.

Managing through changing times is in our DNA at WD.

We would like to remind investors that we are entering the fourth decade in the solution -- storage solutions marketplace with some valuable experiences and lessons learned along the way.

Very early on, we were one of the world's leading suppliers of specialized semiconductors to the calculator industry.

Beginning in the early 1980s we were the leading maker of standalone storage controllers for the original PC, before we entered the hard drive business in 1988.

Today we're the world's unit volume leader in hard drives, having evolved from an exclusively desktop player to a broad-based vertically integrated supplier to multiple market segments with an established consumer brand.

So we have seen change and successfully embraced it throughout our history.

We believe there is no one better positioned in the storage industry today than WD.

We have a track record of good, crisp decision making and execution, a healthy balance sheet to enable prudent and smart investments and a business model that has generated sustained and consistently profitable growth.

We remain focused on extending this trend.

Tim Leyden will now cover the operational developments and highlights of the December quarter.

Tim?

Thank you, John.

The December quarter industry TAM came in at 167.5 million units compared with the 165 million units that we had forecast.

Demand was reasonably linear and our expectation that industry participants would be cautious about carrying excess inventory out of the December quarter proved correct as we saw moderation of the overweighting of work-week-13 shipments that had occurred in both the June and September quarters.

Looking at our served markets in the December quarter, in the compute space, units increased from 114 to 118 million.

Commercial demand remained strong and while overall consumer demand was below expectations, demand for hard drives was further tempered by inventory reductions both in the system supply chain and in the distribution channel.

While OEM PC shipments increased by nearly 4% sequentially, HDD shipments increased by only 2%, leading to a reduction inventory within the PC manufacturers' pipeline.

We also saw better matching of build-to-true demand in the industry as a whole, which resulted in more linear shipments throughout the quarter and less pressure to ship higher volumes later in the quarter.

The near-line enterprise market was down sequentially from 6.1 to 5.7 million units.

We believe this was a reflection of the fact that this segment's demand is driven by large, discreet project expenditures which drives lumpier demand patterns.

On a full year basis this segment grew by 50% in calendar year 2010 and now accounts for around 40% of enterprise shipments, and will continue to be a high growth area of the industry.

After a three-year period below its previous demand high point, the traditional enterprise market at 8.3 million units returned close to its pre-recession level of 8.5 million, reflecting a continuing recovery in the commercial market.

For the first time shipments of the 2.5-inch platform exceeded shipments of the 3.5-inch form factor, validating our decision to direct our traditional enterprise investments towards 2.5-inch SAS.

The HDD manufacturers' TAM in the branded product segment was at 14.7 million units, up from 11.6 million units in the September quarter and 11.3 million units in the year-ago quarter, presenting further evidence of continuing strong consumer demand for personal storage.

In the DVR market segment, TAM was 12.1 million units down sequentially from 13.2 million and up year-on-year from 11.3 million units.

The balance of the TAM is represented by gaming, automotive, and 1.8-inch drives.

We shipped 52.2 million units in the December quarter, up 5.5% from the year-ago period and 3% sequentially while the overall market grew by 4.4%, and 2.1% respectively.

Revenues totaled $2.475 billion.

We expanded gross margin by 19.2%, and we remain solidly profitable with net income of $225 million.

Importantly, we continue to generate strong cash flow from operations of $505 million.

We are pleased that the moderating steps that we started in the September quarter relative to pricing production bills, inventory alignment and capital expenditures achieved the desired result of keeping us within our business model parameters in the December quarter.

Combined with the heightened emphasis on cost management, those actions contributed to our results being significantly better than we had guided in our October earnings call.

We continue to focus on satisfying customer needs, staying on the industry area density curve and providing competitive products while at the same time maintaining industry cost leadership.

Consistent with the plans that we laid out in our October call, we optimized our profitable participation in the market in the December quarter while continuing to satisfy customer requirements.

The adaptability of our business model enabled us to optimize mix, and that, together with pricing discipline and tight cost management including accelerated cost improvements, more recently acquired Singapore media facility, contributed to our better-than-expected gross margin.

Despite this, we still fell short of the profitability levels that we would normally have expected to achieve, in while it has traditionally been ours and the industry's most profitable quarter of the year.

This is a direct result of the cumulative impact of higher price declines than normal in both the June and September quarters.

As a reminder, based on historical achievements in past December quarters, ordinarily we would expect that the gross margin percentage would be above the midpoint of our margin-models range of 18% to 23%.

And we are not happy that our fiscal Q2 gross margin performance at 19.2% is well below the midpoint of that range as we head into the more seasonally challenging quarters of the year.

While inventories in the HDD supply chain exiting the quarter were well controlled in each segment, we still believe that despite a reduction of approximately two to three million HDDs in the PC supply chain, there is still an inventory excess of some six million to eight million HDD units in the PC manufacturers' pipeline, and this will place additional downward pressure on the HDD TAM in the March quarter.

Bearing that in mind, we intend to depart from what has been the industry's typical approach to inventory holding and supply demand balancing in the March quarter.

Historically over the last decade PC volumes have shown an average unit volume decline of around 9% sequentially, when March quarters are compared to the immediately preceding December quarters.

Despite that PC industry historical demand trend, the HDD industry has typically shipped volumes that were down approximately 4% sequentially during the same period, as HDD producers attempted to utilize the capacity that had already been put in place to service the seasonally stronger December quarter volumes.

The consequence of this mismatch in unit volume trends between the PC and HDD industries has been to put pressure on March quarter pricing, contribute to an inventory overhang exiting the March quarter, and consequently exert further pricing pressure in the June quarter which has repeatedly seen the weakest seasonal demand profile.

Consequently, although we believe that end-user demand will be around 160 million units, we are forecasting an HDD TAM of 155 million units for the March quarter, as we anticipate some further flushing of excess inventory in the PC pipeline.

Additionally we expect volumes in DDR, branded products and enterprise segments to be seasonally flat to down sequentially.

Despite the slower start to the calendar year, we expect to see mid to high single-digit HDD volume growth in calendar 2011.

Now turning to our product lineup, we continue to focus on opportunities in the fastest growing market segments which remains a key strategy for WD.

Since our last report we introduced new products and software that enable consumers to easily move data and content into, around, and outside the home; and experience their collection of movies, photos, and music as well as premium content on the Internet.

We launched a new flagship of our popular WD TV media player family of products, the WD TV Live Hub, which centralizes and streams movies, photos and music to any connected screen in the home with its one terabyte capacity, media server capability, and seamless connection to premium content services such as Netflix, Blockbuster on Demand and Facebook.

We updated our other WD TV products with premium online services first introduced on WD TV Live Hub.

With an update to our WD Photos application, we enabled Android Smartphone users with the ability to access all their photos residing on MyBook Live, MyBook World Edition and WD ShareSpace network drives from anywhere in the world they can connect to the Internet, a feature also available for the iPad, iPhone, and iPod Touch.

In our core hard drive business we began shipping the WD Scorpio Black Mobile Drive in 750-gigabyte capacity, for the road warrior who needs a 7200-RPM high performance and the capacity to carry an entire media collection while traveling.

Earlier today, we underscored our long-term commitment to the enterprise segment by bolstering our product portfolio with two new drive families.

Our second-generation 2.5-inch 10000 RPM WD S-25 SAS drive for mission-critical high performance server and storage applications available in both 450-gigabyte and 600-gigabyte capacities, and the new 7200 RPM WD RE SAS 3.5-inch drive available in 1-terabyte and 2-terabyte capacities for near-line applications, a large and expanding market serving IT data centers and Cloud computing applications.

I will now turn the call over to Wolfgang Nickl for a review of our Q2 financial performance and our outlook for the third quarter.

Thank you, Tim.

I would like to remind you that a summary of financial information has been posted to the Investor Relations section of our website, which will be updated with our Q3 guidance after this call.

Revenue for the second fiscal quarter was $2.475 billion, down 5% from the prior year and up 3% sequentially.

Hard drive shipments totaled 52.2 million units, up 5% from the prior year period and 3% sequentially.

Revenue from sales of WD TV media player, WD Livewire Network Kits and solid state drives totaled approximately $57 million, up 21% from the prior year and up 54% from the September quarter.

Average hard-drive selling price was approximately $47 per unit, down $5 from the year-ago quarter and up $1 from the September quarter.

Revenue from sales of our branded products including WD TV and WD Livewire products was $546 million, down 4% from the year-ago quarter and up 28% sequentially.

There were no customers that comprised 10% or more of our total revenue.

Geographically all regions contributed revenue gains, with Europe showing the best comparative improvement on a sequential basis.

From a channel perspective, OEM declined as a percentage of revenue as we actively managed shipments and inventory, and the retail channel increased along these known expectations.

We exceeded the upper end of our revenue guidance by $75 million which was achieved through a combination of remixing our product and business segments, improved pricing discipline, resulting in lower like-for-like price declines, higher volume due to a slightly higher TAM and moderate market share gains.

Our gross margin for the quarter was 19.2%, down from 26.2% in the year-ago quarter and up from 18.2% in the September quarter.

December's gross margin exceeded our implied guidance by about 320 basis points.

There were three main reasons for this.

First, our like-for-like price declines were better than we had modeled.

Second, we actively drove changes in our product and segment mix.

Last but not least, our relentless effort to optimize our product costs yielded larger than anticipated like-for-like cost improvements, with one factor being that our recently acquired Singapore media facility achieved accretion more quickly than anticipated.

We had modeled a 50 basis-point dilution for the quarter, but we are now experiencing the 50 basis-point accretion that we had built into our acquisition model.

Total R&D and SG&A spending was $235 million or 9.5% of revenue.

This compares with $214 million or 8.2% of revenue in the year-ago quarter and $226 million or 9.4% of revenue in the September quarter.

The quarter-over-quarter increase is primarily a function of increased investment in our branded products business.

Operating income was $240 million or 9.7% of revenue.

This compares with $473 million or 18.1% of revenue in the year-ago quarter, and $211 million or 8.8% of revenue in the September quarter.

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

Tax expense for the December quarter was $14 million or 5.9% of pre-tax income.

The rate for the quarter reflects the retroactive extension of the R&D tax credit that was signed into law during the December quarter.

Our net income totaled $225 million or $0.96 per share.

This compares with $429 million or $1.85 per share, and $197 million or $0.84 per share in the year ago and September quarters respectively.

Turning to the balance sheet, our cash conversion cycle for the second quarter was a negative two days.

This consisted of 46 days of receivables, 26 days of inventory or 14 turns, and 74 days of payables.

We generated $505 million in cash flow from operations during the December quarter and our free cash flow totaled $255 million.

Capital additions for the December quarter totaled $250 million.

Depreciation and amortization expense for the second quarter totaled $151 million.

We continue to expect our capital expenditures for fiscal 2011 to be between 7% and 8% of revenue plus up to $200 million for our 6 to 8-inch wafer conversion, and some smaller expenditures to optimized the output from our recently acquired media facility in Singapore.

Depreciation and amortization is expected to be about $620 million for the fiscal year.

We made $25 million of debt repayment installments during the second quarter and thereby reduced our debt balance to $350 million.

We exited fiscal Q2 with cash and cash equivalents of $3.1 billion, an increase of $252 million from the September quarter.

Let me now turn to our expectation for fiscal Q3.

As Tim indicated, over the last ten years, PC shipments have declined on average 9% from the December to the March quarters, yet hard drive industry shipments have historically decreased by only 4%.

This systematically creates a supply-demand dynamic at that leads to significant price declines in this and subsequent quarters as we have experienced this past calendar year.

Furthermore, despite the fact that the industry made progress towards balancing supply and demand in the December quarter, we believe that there still remains in excess inventory of six million to eight million units within the PC manufacturers' pipeline.

Also, our sense of the market indicates higher-than-usual PC inventory levels in both the distribution and retail channels.

With the objective of entering the June quarter with a more balanced inventory, we estimate that the hard drive industry TAM for the March quarter is unlikely to exceed 155 million units.

We strongly believe that the effect from fixed-cost under-absorption are of much lesser impact to the bottom line than subjecting the entire volume to significant price declines.

Having said that, since we operate in a highly competitive market with modeled like-for-like price declines of 5%, in line with pricing trends and prior March quarters, we believe our value proposition will continue to resonate with our customers and we will maintain focus on ROI through product and segment mix management.

We continue to strengthen our investments in R&D and market development to support the significant opportunities in our medium and long-term future.

Accordingly our guidance for fiscal Q3 is as follows.

We expect revenue to be in the range from $2.2 billion to $2.25 billion, R&D and SG&A spending is expected to total approximately $240 million, our net interest expense is projected to be about $1 million.

We expect our tax rate to be at the upper end of our business model of 6% to 9%, we anticipate our share count to be approximately 236 million, we estimate earnings per share of between $0.55 and $0.65 for the March quarter.

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

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

(Operator Instructions)The first question is from Sherri Scribner with Deutsche Bank.

Your line is open.

Thank you.

I was just curious on your comments about the TAM and the changes in the March quarter.

I mean, I think it is admirable to try to change the dynamics of the industry, but I am curious what you guys think you can do since the competitive market to really change how people build for the March quarter and if you said, you think there is excess industry units of six to eight million of hard drive specs and some excess PC units, how do you really change the behavior and get people to build to that 155 million TAM as opposed to a higher TAM?

Sherri, this is John.

I think the -- what we have done is to take a good look at the historical trends in the marketplace and the historical behaviors.

We have highlighted that there is a misalignment between the traditional market demand drivers and the traditional behaviors relative to supply and we have all seen what the outcome of that is in terms of those imbalances driving excessive inventories which in turn tend to drive significant price declines.

We are also looking at current situation in the marketplace and our read of what inventory levels are currently in place, and we're signaling our intent to do as much as we can in developing our build plans to eliminate those misalignments from the supply/demand dynamic.

What our competitors do is entirely up to them.

It is and has always been and I believe will continue to be a highly competitive marketplace.

We will track the market very closely.

We will defend our market share through the provision of a compelling value proposition to our customers as we have been doing for many, many years, and we will see how the market turns out.

We have been driving a significant profitable business over the last ten years on a very, very consistent basis.

We have consistently expanded market share, a recognition by our customers of the value proposition we offer which is based on a cost leadership position in the industry, and we will continue to operate, taking maximum leverage and advantage of the characteristics of our model and of our internal capabilities in the context of the market as we see it.

Okay.

That's helpful.

I think it is an admirable thing to do in terms of trying to change the behavior if there's extra drives that are being shipped in the first quarter.

In terms of build plans, I assume that , that means you're communicating to your suppliers you're going to ship less and you're structuring your factory so that you are not employing people to manufacture for as many hours, maybe you could just comment if I am correct

That's correct, Sherri.

In the approach to any quarter, we typically have a baseline plan which we communicate both to our internal and build our internal resources around, and calibrate our supply base around that base plan.

Again, I would remind you that our track record of responsiveness to market change is very swift and our focus in building our manufacturing model and our supply chain has always been on having a competitive edge in the speed with which we can react to both upside and downside changes around our base plan.

Okay.

We demonstrated pretty effectively an ability to do that, so again we have a base plan that is based on the 155 million unit TAM that Wolfgang and Tim have articulated, and we will observe how the market's progressing through the quarter and we'll take appropriate actions to ensure that we present our customers with opportunities.

And we present our business with the maximum opportunity to optimized our results.

If you feel that the industry is shipping more than it needs to, will you allow yourself to lose share or will you still try to keep share?

The customers will decide that at the end of the day, but we are a for-profit business.

We're not a charity.

Okay.

Thank you.

Our next question comes from Bill Shope with Goldman Sachs.

Your line is open.

Okay.

Great.

Thanks, guys.

Can you remind us where you are in respect to determining the appropriate uses of your cash balance and what factors there you are considering as you weigh your options?

Yes, Bill, this is Wolfgang.

Our view hasn't changed from what we have communicated in our October call and the subsequent conference in November in Boston.

Our prime focus is to deploy our cash towards strategic opportunities.

You will have noted the old change that we did in the first fiscal quarter with John focusing a lot of his time on strategic development, and we have also mentioned that we will be very careful with this review to make sure that we invest in adjacent markets where we have competencies.

And if we with determine after the appropriate amount of time that we can be an opportunity that holds shareholder value, we will be engaging in share repurchases.

We repurchased about $330 million worth of shares under our current authorization.

We have about $416 million left.

Okay.

Helpful.

Thanks.

Also on that margin trajectory for this year, I understand supply/demand balance is going to be the key swing factor, but can you help us understand how product cycles may or may not impact margins throughout the year?

Do you see any opportunities for WD to capture any sustained technology leadership as you look forward?

I think we would expect that our relative margins on an equivalent product mix will continue to be the best in the industry.

We manage technology deployment, the rate of technology deployment.

I think one of our key advantages over the years has been our ability to manage that transition from one technology to the next and to make good choices on which capacity points we serve with new technology and which capacity points we serve with current or older technology to maximize our profitability, maximize our ability to deliver consistent quality and reliability to our customers and maximize our availability and responsiveness.

So we think we have a pretty good model developed of how to balance all of those forces, and pretty solid track record indicating that, that model is very appropriate to the marketplace.

Okay.

Thank you.

Mark Moskowitz with JPMorgan, your line is open.

Thank you.

Good afternoon.

I share Sherri's confusion over the guidance and I am not going to go into those details.

I want to maybe shift the focus to longer term.

Could you maybe touch on, John, how investors should think about your opportunities in the enterprise going forward particularly if there is so much uncertainties around PCs and tablets, what have you, with the transition with exchange 2010 enabling folks to use SATA drives versus Fibre Channel and now you have EMC and primary storage really looking at SAS and SATA as a substitute for Fibre Channel.

This historically has not been your wheelhouse, this has been more of Seagate's and Hitachi's.

How should we think about this being the offset of the some of the other dynamics that you are talking about?

There is two elements to that question.

The first of those being in the what has been called a traditional enterprise space which was SCSI and Fibre Channel and more recently, SAS and had been predominantly 3.5-inch 10K and 15K product and transitioning to a 2.5-inch form factor 10K and 15K.

As Tim highlighted, the movement to SAS as the predominant interface in that segment continues and the transition from 3.5-inch to 2.5-inch form factor continues with 2.5-inch passing the 50% mark for the first time in the quarter just ended.

Our investments in that space, we saw those trends emerging over the last several years.

The three interfaces -- or two interfaces, SCSI and Fibre Channel converging on SAS and the 3.5-inch form factor transitioning to 2.5-inch and therefore over the past several years as we began to invest in preparation for entry into the traditional enterprise market as a one of the few remaining greenfield incremental growth opportunities for us.

We focused in on investment in the 2.5-inch SAS environment, and we announced this morning shipments of our second generation product in that space.

If you look at history, our history in our entry into the 2.5-inch mobile arena, many companies entry into the new segments within the industry over time typically you're in third or fourth generation products before you see significant market share traction.

You use the first and second generation products to establish your credentials and demonstrate your fundamental capabilities of understanding the market segment and having satisfied customers of that at relatively low volumes you then begin to gain traction into substantial presence.

We believe that we're on track to achieve that development within the 2.5-inch SAS enterprise, traditional enterprise market which by the time we gain that traction we expect that, that form factor and interface will command over 70% of that marketplace total demand.

Parallel to that, you have the growth area of near-line storage which is typically up until now has over the last five years has expanded using a 24/7 high reliability 3.5-inch SATA drives, what WD calls its RAID Edition products and we have generated a substantial market position in that segment.

And again as Tim alluded to, that's about a five million unit market that has shown a 50% growth rate year-over-year and represents 40% of the total enterprise environment, and that's been driven primarily by cloud computing applications.

And as we just announced this morning, a SAS product to service that market, and that demonstrates our ability to leverage core fundamental engineering investments and then once having -- once we had developed and launched our SAS interface into the market, now we are applying it to multiple platforms and multiple markets.

John, thanks for that great overview.

Look forward to monitoring the win rates going forward in the enterprise and maybe continuing the theme, though, of longer term and also your measured approach to business, historically as you just touched upon, WD has always done a very solid job in terms of entering new markets and having great success thereafter over the last ten years.

What insights can you share with investors that has given Western Digital really the courage and the focus here now to talk about the home storage and greater detail, the branded opportunity that we're mentioning at CES.

The reason I say this because there seems to be a lot of other providers like TiVOs of the world who have been trying to dabble in the market previously and you'd think they would already have good relationships built out.

So do you think you can talk about the momentum you established and the relationships you're building upon to really allow WD to start talking about this as a new adjacent market opportunity?

Sure.

Be happy to.

Again, really in our fiscal 2004 which is the end of calendar 2003 was when we began to put significant resource and attention on the personal storage opportunity of taking component level drives and by combining them with a stylish enclosure and some software taking them directly to the consumer to satisfy the need for incremental storage beyond the original content consumption and creation device storage capacity that he had initially purchased.

In the early days, the design and the software were pretty minimal.

However, as we began to focus on that business, we identified, I believe some critical success factors.

One was the need for stylish and identifiable product ID, and we, quite outside our experience to that point, engaged professionals in that arena and invested significant amounts of money in creating the WD My Book and My Passport design style which, based on market reaction, is quite compelling.

We made some small investment in a software company that several years ago that provides WD with the proprietary capability that drives the iPhone and Android apps that Tim described a moment ago and the ability to access any WD network connected device through the internet or throughout your home or office infrastructure.

We have continued to invest in software capability.

In our branded business, our engineering resources are 60% software and 40% hardware.

And then overlaid on top of that has been the development of a very strong channel both in the brick-and-mortar environment and the e-tail environment more recently where we have developed very strong relationships with our channel partners.

And it was -- it is really through those channel relationships that we should have identified the opportunity to expand the product offering to solve consumer's total in-home experience problem of how do you not only safely store the content but how do you then allow the consumer to easily experience that content?

And as we explored consumer's expectations, as we explored our channel partner's view of us, we discovered that we had built up quite an amount of brand equity, and that we were able to use that linked with the engineering resources and the software development resources that we put into the media players to achieve quite a significant level of success.

We think our 2.5 million units so far in that market in just a couple of years is pretty good.

And so encouraged by that, we have broadened our view of what the total home experience should be and what devices and services can enhance that experience and we're exploring ways to deliver those to our customers.

For instance, one of the inhibitors in the home is showing full HD video without jerkiness and without interruption is that in most homes the networking environment is Wi-Fi and you can't quite keep up with a full HD full motion video in a Wi-Fi environment.

Most homes do not have broadly embedded network -- dedicated network wires going to all the rooms, so we came up with our Livewire products, a networking product that uses the power lines of the home in a very convenient way for the user without any major infrastructure development they can actually transmit all their high definition video content to every screen in the home in a very cost efficient and very simple and consumer friendly way.

It is literally as simple as plugging the network wire into your router and plugging the plug into your electrical outlet, so we're continuing to look at that opportunity, and we're continuing to broaden out the total product portfolio offering.

The essence of it is simplicity.

The essence of it is liberating the consumer from closed environments that are specific to one vendor or another and allowing multiple formats from multiple sources to be stored, shared, and experienced.

Our next question comes from Richard Kugele with Needham & Company.

Your line is open.

Thank you.

Good afternoon.

I have more questions than we probably have time for here.

So I will just focus on one area here.

The TAM guidance.

In years past, especially recent ones, the first quarter -- first calendar quarter has fallen less sequentially also because of emerging market demand, other countries having holidays that aren't ours.

There has been other dynamics at work.

Is your guidance in some way signaling that perhaps that was false thinking and any thoughts on what perhaps ex-ing out your view of what is inventory some place and a finished PC or something, what the true decline would have been?

I think all of those patterns that relate to emerging markets and so on, they also affect the PC, and so that we're highlighting is a disconnect between the PC and the hard drive quarter-over-quarter declines, that is systemic, has been in place for ten years.

While all of these things were moving around and shifting and evolving, but the PC is -- even though we have significant markets outside of PC, DVR, personal storage which is really more of a linkage to install base than to the incremental new sales.

Nevertheless, PC is a large portion of our total target market.

Therefore, the way that the PC moves up and down it's, I believe now it is significant that we recognize that and attempt to manage the supply/demand in sync with that while also looking specifically at the other emerging and growing applications for hard drives and layering those on top of the PC driven demand to get their own specific cadence, and while we haven't talked about that in detail in this guidance, it is underlying this guidance.

We have looked at every market segment and formed a view about how it is going to perform, and matched our supply plan to the demand that we perceive in those markets.

So the -- we believe that, that fundamental disconnect and we can argue whether it is 9% versus 4% or whether it should be 9.5% versus 4%, but the fundamental piece is that over-building against the true demand is a recipe for incremental inventory overhang, creating pressure on the marketplace.

And that the price we pay in under-absorption to moderate our supply to match the true demand profile is a much smaller price than the price we have been paying by maintaining production velocity, increasing inventories and then applying extreme pricing pressure to the entire volumes that we produce.

Just one follow-up then.

With the guide then correcting -- well, I guess the question is, does that then correct for the six to eight million in the first quarter TAM and if so should we reasonably assume that the June quarter would be up as you come to meet where the PC demand actually is?

Yes, Rich.

This is Tim.

We believe that it corrects the 155 million TAM that we have outlined.

We believe that it corrects for about five million of that six to eight million, and if you take it from the volume that we have right now and then correct for the difference between PC and HDD, gets you down to around 160 million, and then there is five million inventory correction we believe are PC manufacturer's pipeline direction when we get down to the 155 million.

In that sense if that does happen, then it would mean that the comparatives between the March quarter and the June quarter should be more favorable than what they have been historically.

Okay.

Thank you very much.

Next question comes from Jayson Noland with Robert Baird.

Your line is open.

Thank you.

Just a question on the six to eight million excess drives.

Any more color you can add there?

Is that multiple OEMs or are those drives sitting on a boat right now and what's your confidence level that there are six to eight million drives?

I mean, it is an estimate on our behalf.

We don't really have great level of particular or very specific insight into it.

We did estimate in the September quarter that there were approximately around ten million drives in the PC -- excess drives in the PC manufacturer's pipeline, and we bled away about two to three million of those during the course of the December quarter which is where we get the six to eight million.

Okay.

You mentioned the December quarter was linear.

I guess it is fair to assume that the March quarter is going to be more back-end loaded and hard to know what the TAM is going to be until we get deeper in the quarter exactly?

Actually when you look -- if we look at historical linear demand trends, generally in the March quarter it tends to be also a little bit front end loaded because you are dealing with the number of different things.

You are dealing with the post-Christmas sales which drives some consumer demand, some extra consumer demand.

You are also looking at the lead up to Chinese New Year which tends to drive some extra command demand also, so then after Chinese New Year -- a couple of weeks after the Chinese New Year, the demand tends to [adapt] to the more seasonal profile beginning in March.

And then you head into the June quarter which typically has been on a repeated basis being the most, the weaker quarter, but front end there is a certain amount of front end loading in the March quarter.

Thanks, Tim.

Our next question comes from Steven Fox with CLSA.

Your line is open.

Hi.

Good evening.

Just one question which is on mix.

Can you just go into a little bit more detail on the mix benefit that you saw in the last quarter and then any color you can provide on how you're anticipating mix to play out for the current quarter?

There is two forms of mix.

This is Wolfgang.

One is the product mix, and mix of in the Christmas holiday quarter seeing strong and it was strong last quarter, and there is a segment mix between our business segments which we often talk about our margin in hierarchy and our branded business was about 22% of our revenue up from 18% of our revenue, so in that sense the business segment mix helped us as well in the quarter we just finished.

And so going forward, is there any major mix impacts that we should consider?

Yes, business segment mix changes throughout the quarters, and branded products is usually strong in January and February and then it tends to go up a little bit, so, yes, there are segment mix changes all the time in the quarters.

Okay.

Thank you.

Thank you.

Next comes from Aaron Rakers with Stifel Nicolaus.

Your line is open.

Thanks, guys.

I think the TAM discussion has been beaten to death.

But what I would like to ask is on your SSD strategy and I think for the first time it seems like you guys are open to talking about a strategy that involves hybrid HDD, so can you update us there?

What your thinking is, when we should anticipate without maybe announcing a product but when we should really anticipate Western Digital to move into that market?

And I do have a follow-up.

I think one of WD's characteristics is that we tend to serve markets which exist and which are substantial, and we do our best work in those markets, and so in our SSD participation today we participate and are in fact a market leader in the most mature SSD market there is which is the embedded device market.

We have taken a look at and in fact shipped product into the SSD in the client environment, and we don't find compelling value proposition there either for manufacturer or for customer because the economics don't work, the cost of the storage/performance is too high, and as we look at that client environment and look at what might be an attractive offering that combines the best of both worlds in terms of the performance of solid state with the capacity of rotating media at a balance of the two which provided an accessible price point.

As we look out into the future where such a device would be supported by operating system capability, which it is not really supported well today, as we look at that over the next couple of years, we see an emerging opportunity for such a device family to offer performance capacity and value.

And then in the Tier 0 SSD space, I think the performance delivery has been demonstrated, the continued development of operating system and tiered architecture enables that as a value proposition and we have a live investment engineering program currently underway to support that market.

The follow-up question is on the operating expense line.

With revenue and volumes down, can you help me understand why OpEx actually ticks up this quarter?

This is Wolfgang.

Again, we believe this is an inventory correction that depresses the TAM to 155 million and we believe in the long-term growth of the market.

We quoted 9% to 10% before on the long-term volume and 5% to 7% on the revenue line, and we feel it is prudent to continue to invest in our market development activities and in our engineering activities and hence, the increase from $235 million to $240 million in our guidance.

Okay.

Thank you.

Operator, we can take one more question.

Shelby Seyrafi with Capstone Investments.

Your line is open.

Thank you very much.

Two sub-questions here.

One on the enterprise, you were down sequentially in the seasonally strong calendar Q4.

Just want to know what happened there?

Why don't you answer that question and then I will let you have the second part.

So in our product, we had some markets we talked about it a couple of quarters ago where we had some market issues that we were working on -- we believe that we were working through them, and we're getting back to a point where we'll be able to get back to the cadence that we had previously, but we did talk about that a couple of calls ago.

Okay.

And the second part for me is you just basically beat your EPS guidance with I believe it was $0.50 to $0.60 for calendar Q4 by 75%, and you have the Singapore facility now being accretive to gross margins.

You're modeling a normal like-for-like price decline this quarter and you can do things with mix.

I am wondering why because this seems to imply -- your guidance seems to imply a gross margin decline to around, I think 17% to 18%.

Why you think margins will decline considering you basically have these swing factors going in your favor right now?

I think you got the math right.

It is somewhere around the 18% or lower end of our model.

We know that we'll reduce the volume and we know that has certain effects from fixed cost underabsorption.

We're managing that early on so that we can through linear builds smooth some of that out, but we have the assumption in there as well that price declines will for this quarter continue to what they have been 4% or 5%.

And furthermore, earlier on we talked about that there is a little bit of a channel business segment mix impact in the third quarter and if you take all of these things into consideration, you have a downward pressure on the margin and that's why we guided to about 1% to 1.5% down quarter-over-quarter.

Okay.

Thank you.

Thank you.

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 the industry, and we look forward to updating you next quarter.

Thank you.

Thank you.

This does conclude the conference.

You may disconnect at this time.