威騰電子 (WDC) 2012 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 2012.

  • 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.

  • - VP, IR

  • Thank you.

  • As I begin, I want to mention that we will making forward-looking statements in our comments and in response to your questions concerning industry demand on the December quarter and the industry's ability to meet that demand, the impact of the flooding in Thailand on the industry, and on our business on the December quarter and beyond, including our HDD capacity, our planned operations recovery efforts and the cost and expenses incurred in connection with these efforts, and our ability to complete these recovery efforts.

  • The expected completion and the timing of our planned acquisition of Hitachi GST, growth opportunities in the industry, our product offerings in the near-line enterprise market, OEM inventory levels, and our financial results expectations for the December quarter, including revenue, gross margin, expenses, tax rate, share count, and loss 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 12, 2011.

  • We undertake no obligation to update our forward-looking statements to reflect new information or events, and you should not assume later in the quarter that the comments we make today are still valid.

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

  • Reconciliations of the differences between the historical non-GAAP measures we provide during this call to the comparable GAAP financial measures are included in the investor information summary posted in the Investor Relations section of our website at WesternDigital.com.

  • The forward-looking guidance we provide during this call excludes acquisition-related expenses that we expect to incur in connection with and following the planned acquisition of Hitachi GST, and unusual charges and expenses related to the flooding in Thailand.

  • Because these acquisition-related and unusual expense items are not known to us at this time, we are unable to provide guidance for or a reconciliation to the most directly comparable GAAP financial measures.

  • The impact of these excluded items may cause the estimated non-GAAP financial measures to differ materially from the comparable GAAP financial measures.

  • As a reminder, until our acquisition of HGST closes, WD and HGST remain independent companies, so we will not be taking any questions about HGST's business or financial performance.

  • We ask that analysts limit their comments to a single question and one follow-up question.

  • I also want to note that copies of remarks from today's call will be available on the Investor section of WD's website immediately following the conclusion of this call.

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

  • - President and CEO

  • Thank you, Bob.

  • Good afternoon, and thank you for joining us.

  • With me are COO Tim Leyden and CFO Wolfgang Nickl.

  • As you can imagine, the WD team has been consumed recently in dealing with the relentless flooding in Thailand and its significant impact on our employees, their families, and our suppliers, as well as on the business infrastructure in the region.

  • We are grateful that the WD employees in Thailand are safe at this time, although many of their lives and homes have been disrupted and damaged.

  • This is a disaster of unprecedented scale.

  • With over 317 fatalities so far reported, over 9 million people affected, 700,000 homes, and 14,000 factories flooded, and over 660,000 workers out of work.

  • The overall impact to the people of Thailand is immeasurable, and our hearts go out to them in these trying times.

  • Having addressed the safety of our people, and put in place programs to continue supporting them in this crisis, we have now turned our focus and energies to maximizing our capability to meet our customers' needs in the near term and to return our operations to normal as soon as possible.

  • Full recovery will be a multi-quarter challenge.

  • We believe the unconstrained HDD demand for the December quarter is flat to slightly down from September quarter ship levels.

  • Having said that, due to the concentration of HDD supply chain factories in various industrial parks in the flooded area, it is apparent that the HDD industry will become strained in meeting that demand.

  • Since WD has greater direct manufacturing exposure to the flooded areas, we believe the impact on our business in the short term will be greater than to other HDD manufacturers.

  • In their remarks, Tim will provide a summary of how we are dealing with the operations challenges presented by the flooding, and Wolfgang will provide a current quarter outlook.

  • Turning back to the September quarter, it materialized very much along the lines we expected.

  • Industry shipments came in at 176 million units, just above the high end of our estimate entering the quarter.

  • This is a record quarterly shipment level for the hard drive industry, demonstrating the value of hard drives in the overall digital universe, even in an environment of broad-based low growth and global economic uncertainty.

  • While the industry experienced a reasonable back-to-school season, contributing to record quarterly shipments, the quarter-over-quarter growth was nevertheless muted by historical standards.

  • We believe this is a reflection of the overall macro uncertainties, the slow growth being experienced in many mature markets and the PC industry's continued shift to a higher usage of sea freight instead of more expensive air freight, which has time-shifted, typical seasonal linearity.

  • WD's financial results and share growth demonstrate continued strong execution at a time when we have also been highly focused on our planned acquisition of HGST.

  • We continue our work with the regulatory authorities around the world to obtain approval of our planned acquisition of HGST.

  • Our integration planning activities are progressing well.

  • Although we believe the acquisition should be cleared unconditionally, we have submitted a proposed confidential remedy to the European commission to address issues raised in the course of its review.

  • We now expect the European commission to issue its decision on the transaction by November 30.

  • We anticipate the other agencies reviewing our transaction will make their final determination within a similar time frame.

  • Therefore we are maintaining our target for closing the HGST acquisition by the end of the calendar year.

  • Our analysis of the tremendous underlying long-term need for cost-effective mass storage in both developed and developing regions of the world underpins our continued enthusiasm for this business.

  • We believe our model of providing high-quality product with speed, flexibility, and low cost structure is a path to long-term success and shareholder value creation in this dynamic market.

  • While the flooding in Thailand presents us with a series of daunting challenges during the next several quarters, I'm highly confident in the abilities of the dedicated WD team, with its strong execution skills, to complete our operations recovery effectively and efficiently.

  • This is a short-term challenge in what we continue to believe is a great long-term opportunity for continued profitable growth at WD.

  • Before turning the call over to Tim for his operations review, I want to pay tribute to the WD team for their heroic efforts in dealing with this adversity.

  • A Company leader could not ask for greater effort and commitment than we have seen from this team.

  • Tim?

  • - EVP, CFO

  • Thank you, John.

  • Firstly, I will cover our fiscal Q1 performance and then give a status update on the impact of the Thailand flooding on our business.

  • WD shipped 57.8 million units in the September quarter, up 7.4% sequentially and 14% from the year ago period, as we stayed focused on executing well in our core businesses, where our value proposition continues to resonate with our customer base.

  • Higher volumes, favorable mix, pass-through to customers of a portion of our rare earth material cost increases, and minimal price declines, delivered revenue growth of 12.1% quarter-on-quarter and 12.4% year-on-year.

  • Gross margins improved by 60 basis points, to 20.1%.

  • Price declines for the quarter were at a minimal level and were less than the seasonal norm.

  • Product mix was favorable.

  • Effective cost management and improved utilization enabled us to come in at the upper end of our implied gross margin guidance.

  • Revenues totaled $2.7 billion, net income was $239 million, and cash flow from operations declined sequentially from $447 million to $352 million, as we invested funds in working capital to establish a solid entry foundation for the December quarter.

  • Now turning to market segment performance.

  • In the compute space, industry shipments increased to $119 million from $118 million in the June quarter, and were up from $115 million in the year-ago quarter.

  • WD shipped 41.2 million units into the compute space in the September quarter, compared to 39.2 million units in the June quarter, and 37.5 million units in the year-ago quarter.

  • We grew market share by approximately 30 basis points sequentially, and 190 basis points year-on-year.

  • Consumer activity was stronger, although this seasonal uplift was more muted than we have seen historically in a typical fiscal Q1.

  • The near-line enterprise market was up sequentially from 6.4 to 6.8 million units, and up from 5.8 million units year-on-year.

  • This market continues to benefit from the momentum of cloud computing.

  • The traditional enterprise market at 7.9 million units was down from 8.3 million units in the June quarter and was up year-on-year from 7.2 million units.

  • WD shipped 2.4 million units into the combined enterprise markets in the September quarter, down from approximately 2.5 million in the June quarter, and up from 2.3 million units in the year-ago quarter.

  • We remain on plan to bring our third generation 2.5-inch SAS product to market within the calendar year.

  • HDD manufacturer shipments in the branded product segment came in at 14.4 million units, up from 12 million units in the June quarter, and up from 11.6 million units in the year-ago quarter, as the sequential demand increase followed typical seasonal patterns.

  • Year-on-year unit growth in this segment was strong at 24.1%.

  • WD shipped 7.1 million units into this market in the September quarter, up from 5.7 million units in both the June and year-ago quarters.

  • WD's strong brand equity and broad product line enabled us to recover some of the market share position that we had lost due to supply constraints in the aftermath of the Japanese earthquake.

  • In the DDR market segment, shipments were an estimated 14.1 million units, down sequentially from 14.4 million in the June quarter, and up from 13.2 million in the year-ago quarter.

  • WD shipped 7.2 million units into this market in the September quarter, up from 6.5 million in the June quarter, and up from 5.2 million in the year-ago quarter.

  • Our performance in this segment reflects strong customer preference for WD's appealing product lineup.

  • The remaining balance of the industry shipments is represented by gaining automotive and 1.8-inch drives.

  • Inventories in the HDD supply chain exiting the quarter were below historical run rate levels in each segment.

  • Now turning to the December quarter.

  • We believe that the unconstrained HDD demand time will be around 170 million units.

  • We also believe that the industry will be supply constrained due to the flooding in Thailand and the concentration of HDD suppliers and factories in various industrial estates in the flooded and flood-threatened areas.

  • I will now address the specific impact of the flooding on our business.

  • We suspended production in all of our Thailand facilities from the beginning of last week in order to protect our personnel, and to move as much equipment as possible to locations less likely to incur water damage.

  • At this point, we are thankful that all our employees are safe, and we moved much of the equipment which had been situated on the ground floors to higher floors.

  • Despite the heroic efforts of our team, over the past weekend rising water, which had first penetrated the Bang Pa-in Industrial Park flood defenses, inundated the Company's manufacturing facilities there and submerged the remaining equipment on the ground floors.

  • At the other Company manufacturing in Thailand, Navanakorn Industrial Park, the park flood defenses were breached on Monday morning local time, and water began to flow into our buildings late on Tuesday night.

  • The flooded buildings in Thailand include our HDD assembly, test, and slider facilities, where a substantial majority of our slider fabrication capacity resides.

  • In parallel with the internal slider shortages resulting from the above disruption, we are also experiencing other shortages on component parts from vendors located in several Thai industrial parks that have already been inundated by the floods, or have been affected by protective plant shut downs.

  • We are evaluating the situation on a continuous basis, but in order to get these facilities back up and running we need the water level to stabilize, after which point it would take some period of time for the floods to recede.

  • We are assessing our options so that we can safely begin working to accelerate the water removal and either extract and transfer the equipment to clean rooms in other locations, or prepare it for operation on site.

  • As a result of these activities, at this point in time we estimate that our regular capacity, and possibly our suppliers' capacity, will be significantly constrained for several quarters.

  • We are working with our suppliers to effect the recovery of their supply chain, and to ramp existing capacity in other locations.

  • We are proceeding with all possible haste and ingenuity to address the situation, because we are mindful of the impact on our employees, customers, suppliers, shareholders and the communities in which we operate.

  • We are also pursuing all possible options to maximize our Malaysian facilities throughput.

  • 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 of fiscal 2012.

  • - CFO

  • Thank you, Tim.

  • As a reminder, a summary of historical financial information has been posted to the Investor Relations section of our website.

  • In my remarks, I will first summarize our financial performance for last quarter and I will provide a range of expected financial results for the December quarter.

  • For the September quarter, revenue was $2.7 billion, up 12% from the prior year and the June quarter.

  • Outright average selling price was approximately $46 per unit, flat with the year-ago quarter and up $2 from the June quarter.

  • Revenue from sales of our branded products was $489 million, up 15% from the year-ago quarter due to the continued strong customer preference for the WD brand.

  • Branded products revenue was up 28% from the June quarter.

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

  • Demand in Asia remains strong at 59% of revenue, up from 54% in the prior year and down slightly from 60% in the June quarter.

  • Europe came in at 22% of revenue, down slightly from 23% in the prior year, but up from the 20% reported in the June quarter.

  • America, at 19% of revenue, was down from both last year's 23% and June's 20%.

  • OEM sales represented 53% of revenue, up from 50% in the prior year.

  • The OEM sales percentage was down slightly from June, 55%.

  • Retail sales as a percent of revenue were 18%, flat to the prior year, but seasonally up from June, 16%.

  • Our gross margin for the quarter was 20.1%, up from 18.2% in the year-ago quarter and 19.5% in the June quarter.

  • The quarter-over-quarter increase in gross margin is a function of an improved business segment and product mix.

  • Overall, like-for-like costs increased slightly as higher costs of rare earth materials were not fully offset by savings in other areas.

  • As outlined during our last investor call, we implemented a series of offsetting measures, including significantly increasing our use of ocean shipments, before passing along a portion of these cost increases to our customers.

  • Ultimately, this contributed to relatively flat like-for-like pricing between the June and September quarter.

  • While we have achieved the gross margin level that was implied in our guidance, it is important to point out that we are still operating below the midpoint of our target business model.

  • R&D and SG&A spending totaled $282 million in the September quarter, as compared to $226 million and $297 million in the year-ago and June quarters respectively.

  • The September quarter included $18 million for acquisition-related expenses and unrelated litigation accruals, whereas the June quarter included a combined $32 million for these items.

  • Excluding these items, R&D and SG&A would have totaled $264 million, or 9.8% of revenue in the September quarter, versus $226 million or 9.4% of revenue in the year-ago quarter, and $265 million, or 11% of revenue in the June quarter.

  • The quarter-over-quarter increase is primarily a function of increased investments in product portfolio expansion and technology development.

  • Net interest and other non-operating expense was $1 million, including $3 million for commitment fees on the credit facility related to the pending acquisition of Hitachi's drive business.

  • Excluding these fees, net interest and other non-operating income would have been $2 million.

  • Tax expense for the September quarter was $19 million or 7.4% of pre-tax income.

  • This includes a $2 million favorable adjustment to tax accruals for settlement of IRS claims related to Komag, the magnetic media company we acquired in September of 2007.

  • Our net income for the September quarter totaled $239 million, or $1.01 per share, as compared to $197 million, or $0.84 per share for the year-ago quarter, and $158 million, or $0.67 per share in the June quarter.

  • September quarter included $21 million for acquisition-related operating expenses and bank commitment fees and unrelated litigation accruals, whereas the June quarter included a combined $35 million for these items.

  • Excluding these items, non-GAAP net income for the September quarter totaled $260 million, or $1.10 per share, as compared to $197 million or $0.84 per share in the year-ago quarter and $193 million, or $0.81 per share, in the June quarter.

  • Turning to the balance sheet.

  • Our cash conversion cycle for the September quarter was one day.

  • This consisted of 46 days of receivables, 27 days of inventory, or 13 turns, and 72 days of payables.

  • We generated $352 million in cash from operations during the September quarter, and our free cash flow totaled $218 million, reflecting strong sales linearity and tight asset management.

  • We made a conscious decision to increase ocean shipments as an offset to the cost increases we are experiencing for rare earth materials.

  • This is reflected in an increase of our finished goods inventory by $58 million.

  • Capital expenditures for the September quarter totaled $134 million.

  • Depreciation and amortization expense for the first quarter totaled $158 million.

  • We made a $31 million debt repayment during the September quarter, and thereby reduced our debt balance to $263 million.

  • We exited fiscal Q1 with cash and cash equivalents of $3.7 billion, an increase of $185 million from the June quarter.

  • Approximately $3 billion of our ending cash balance was offshore.

  • Let me now provide some context for our guidance for the December quarter.

  • From a market perspective, we believe that starting inventory in the distribution retail channels was very lean, and we believe there were no further increases of the inventory levels that our OEM customers hold.

  • We estimate that approximately 40% of all drives in the industry are produced in Thailand, with Western Digital being overweight at approximately 60%.

  • With respect to our specific situation, there are a number of significant factors that are impacting our guidance and that will influence our financial performance in the December quarter.

  • We have shut down our Thailand factories and are at this point not in a position to establish when they will recommence operations.

  • Furthermore, some of our key suppliers have ceased production as well, and are significantly impacted.

  • We are working diligently with them, but at this point in time we do not yet fully understand the timeline for their full recovery.

  • Both of these conditions will likely continue into the March quarter and possibly beyond.

  • Costs will be impacted negatively by the significant under-absorbtion of our [assets] and infrastructure.

  • We also expect to incur additional costs in restoring supply.

  • We will also forego planned ocean savings in favor of air freight in order to increase immediate availability for our customers.

  • On the OpEx side, we will continue to invest in growth areas such as our enterprise, SSD and branded product businesses.

  • We will continue to see acquisition-related expenditures during the quarter.

  • We expect to incur unusual challenges in expenses related to the impact of the flooding on our operations, including items such as fixed asset impairments, inventory write-downs, charges related to cancellation of purchase order for excess materials, service charges for reclaim and recovery work, and foreign currency losses to settle forward exchange contracts that exceed our current requirements.

  • With this in mind, our guidance for the December quarter is as follows.

  • This guidance does not include acquisition-related expenses and the unusual charges and expenses that I just referred to.

  • Further, this guidance reflects our current assessment of the Thailand situation, and as we have said, that situation and our understanding of its impact on our business continues to evolve.

  • We expect hard drive shipments of between 22 and 26 million units.

  • We expect revenue to be in the range of $1.05 billion to $1.25 billion.

  • R&D and SG&A spending will be approximately $230 million, excluding acquisition-related expenses and unusual charges.

  • We expect tax expense of approximately $10 million.

  • We anticipate our share count to be approximately 234 million.

  • Accordingly, we estimate a non-GAAP loss per share of between $1.10 and $1.50 for the December quarter, which excludes acquisition-related expenses and the unusual charges and expenses related to the flooding in Thailand.

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

  • Operator

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

  • (Operator Instructions)

  • Sherri Scribner, Deutsche Banc.

  • - Analyst

  • Congratulations on the quarter.

  • I wanted to apologize for the problems that you're seeing in Thailand and we are all very sorry to hear about the issues with employees there.

  • In terms of understanding what's going on in Thailand, do you have any sense of the impact to the total supply chain?

  • And by asking that, I mean what do you expect the industry's ability to ship products to be in the December quarter?

  • - EVP, CFO

  • As we pointed out in the scripts, it is a very live situation.

  • We are the mechanical components are the ones that seem to be the most impacted at this stage when we look at the external components.

  • In our own case, we are impacted internally through the slider fab, because the vast majority of our product, of our internal sliders, are made in Bang Pa in the ground floor of which is now inundated with water.

  • We also process small percentage of WD wafers through a slider fab in the Philippines, which we will be ramping up.

  • In addition, you will recall that our long-term model for finished heads is to purchase 10% to 20% from the merchant market.

  • In our case, the slider fab is the limiting situation, and we see mechanical components and motors significantly impacted.

  • We are not able to provide insight into how that impacts the rest of the industry.

  • It would be merely speculative on our part at this stage.

  • - Analyst

  • Just thinking about your facility in Malaysia, how much extra capacity do you have in Malaysia that you could utilize?

  • Do you have plans to buy equipment to go into Malaysia, or to move equipment there?

  • - EVP, CFO

  • We're looking at every possible option to improve our capacity, but right now we're more constrained by material and component availability.

  • There is plans underway to be able to react and to increase our production in the Malaysian factory, and indeed to extract the equipment from the buildings that are currently inundated and put them in other clean room locations.

  • The planning for that is underway.

  • As you can imagine, with the infrastructure and logistical problems there, it is not an easy task, because the water is still surrounding our facilities, so we have to figure out a way to extract the water or figure out a way that we can use the water in order to extract equipment.

  • As well, we are looking at new -- at purchasing equipment, et cetera, in order to make sure that we can react to our customer needs, because this is a significant issue for all of the constituents involved -- customers, employees, ourselves, the community, and shareholders, we understand the seriousness of this.

  • Operator

  • Rich Kugele, Needham & Company.

  • - Analyst

  • I will add to Sherry's comments as our thoughts and prayers are with the Thai people and your employees.

  • I know it's a dynamic situation, but in terms of the equipment itself, what happens when water touches it?

  • Is it even recoverable?

  • Are all of those suppliers still in existence or what has to happen from an equipment standpoint if they are not?

  • - EVP, CFO

  • There are people that we are able to engage to provide an evaluation of similar situations, which we are pursuing.

  • In many cases we removed the electronics from the heavier equipment and got it up to higher ground.

  • It really is going to depend on an assessment once we get in, have a look, and see what sort of impact from the water and any other mud or whatever else is in there.

  • We're looking at the equipment manufacturers and the people that would be able to provide equipment.

  • We're looking in the used market.

  • We're looking at every possible option.

  • - Analyst

  • From an insurance standpoint, can you talk about to what degree you're insured against these losses?

  • Is there equipment inventory, or is it also some level of business continuity insurance?

  • Was it insured despite being around flood plains and such?

  • - EVP, CFO

  • We carry flood insurance for both our equipment and inventory, and we also have business interruption insurance.

  • Operator

  • Scott Craig.

  • BNY Mellon.

  • - Analyst

  • Tim, I don't want to put words in your mouth, but when you talk about multi-quarters, and you looked at what Seyyon semiconductor said this morning, it looks like this is going to take a year for yourselves and the industry to recover.

  • Is that the right time frame, even if you are capable of setting up shop elsewhere or transferring equipment and stuff like that?

  • Secondly, around the Malaysia facilities, can you provide a little more detail as to what sort of capacity utilization that facility was running at, and how quickly you can transfer stuff over to that facility, recognizing that there is some components constraint issues as well?

  • - EVP, CFO

  • I can't speculate on the length of the period.

  • The WD team has effectively in times past been able to take facilities from just a shell and bring it up and get it up to high volume in a relatively short period of time.

  • Certainly well within the period that you mentioned.

  • As far as Malaysia is concerned, as you can well imagine also, there does have to be some reconfiguration.

  • We have to make sure that we can run all the different array of products in there.

  • There has to be some reconfiguration, but again, that's something that we have done before, and something that the team is very skilled at.

  • We've got a very dedicated team, and they're looking at every possible option in order to get the plant up and running.

  • Right now, our biggest constraint is component.

  • Operator

  • Ben Reitzes, Barclays.

  • - Analyst

  • Can we talk about inventory a little bit, John?

  • I'm a little confused.

  • I guess there is OEM inventory.

  • There is distributor inventory.

  • Then there is your inventory.

  • You have finished goods that you said was a lot of rare earths.

  • Can you talk about what kind of buffer, if there is any in the industries out there, from a distributor and OEM level?

  • How many weeks can the industry and yourselves operate based on what you see out there?

  • - President and CEO

  • We think the distribution inventory exiting last quarter was in the 4-week range.

  • We believe that the OEM GitHub inventories would be in about the 2-week range.

  • Then our own inventories, the majority of which was on boats, at quarter-end, I think probably about 1 week.

  • Our competitors, as you know, tend to run a little heavier on inventory than we do.

  • I would think that the distribution comment, industry level and WD levels are equivalent.

  • I think in the OEM Git situation, you probably around that same number with a larger number of weeks in enterprise inventory.

  • Then I think internal Company inventories you could readily see from a review of their financials.

  • - Analyst

  • And then can you talk about the cash impact you are looking at?

  • I don't think you mentioned the CapEx, and it may be hard to say, but it looks like you've got to spend money on equipment on this.

  • Is the cash flow impact more than the loss, and to what degree?

  • Then you have insurance, so I assume there's some cash recovery.

  • I guess your best guess on cash, the puts and takes and what we should deduct?

  • - CFO

  • I can give you some guidance there.

  • You start at the last levels that were specified.

  • Depreciation runs at about $160 million that you add back.

  • For the capital that we have already received and that we are obligated to pay and that we will pay, you can assume roughly $150 million.

  • That does not include replacement capital.

  • It's simply impossible for us to estimate that at the current point in time.

  • As you know, we have about $31 million of scheduled debt repayment every quarter.

  • And we do expect some impact on the working capital, in particular as we support some of the suppliers that are hit very, very hard by this.

  • If you assume $100 million impact just as a working assumption, you would see that our cash impact, based on the guidance we have given, is anywhere between $375 million and $475 million.

  • Again, that excludes the one-time expenditures that we will incur for services, replacement equipment, et cetera.

  • Operator

  • Mark Moskowitz, JPMC.

  • - Analyst

  • If WD had all of your facilities in Singapore, Malaysia, what would be the relative decline sequentially in units due to components because of the Thailand flooding?

  • I'm just trying to get a sense of what the ramifications are for not just WD, but for the broader industry.

  • Would you still guide to 22 million to 26 million units, or would it be a little higher?

  • - President and CEO

  • Tim indicated that the immediate constraint for us as we enter November here is the slider fab capacity that is currently off-line.

  • We're making concerted efforts to take that away from being the first constraint item.

  • Next are components, and as Tim said, I think it's too early.

  • We are beginning to develop a reasonable understanding of how that component availability and the actions entrained in our supply base affect WD.

  • It's still ongoing in terms of many supplier facilities are shut down in order to assure the safety of their employees and to allow time to try to protect equipment and so on, but those facilities may or may not be subsequently inundated, and the surrounding roads and access may or may not be passable in the near future.

  • It's a very developing situation that we are watching.

  • Right now, there is a significant degree of uncertainty as you saw in Wolfgang's numbers, around our estimates as to what we can accomplish.

  • Frankly, we're much more concerned about that and our ability to support our customers and to restore our business than we are in looking at what's going on in the rest of the industry.

  • - Analyst

  • I appreciate that.

  • Best wishes, too, I know it's a very difficult environment.

  • Maybe if we can focus on the fundamentals from the prior quarter, September quarter.

  • Can you just weigh in, in terms of the desktop trend line.

  • Desktops seem to be a little different than usual in terms of the sequential movement.

  • Was that related to more and more ocean shipment than the prior quarter for back-to-school and the holiday season?

  • What was going on there?

  • - President and CEO

  • I don't think there was anything out of line with expectations.

  • We saw flattish from the desktop and a little bit of growth in notebook.

  • But pretty much in line with expectations right across the mix of products and markets, and I think we had said $170 million to $175 million.

  • We came in at $176 million for the market, and I don't think there was anything significant in pattern changes within that market.

  • Europe was maybe a tad stronger than we expected, and the US was maybe a tad weaker than we expected.

  • Operator

  • Jayson Noland, Baird.

  • - Analyst

  • Thank you, and our sympathies also to your employees there.

  • Is it fair to assume that March quarter constraints could be more severe than the December quarter, just given you're entering this quarter with an inventory buffer?

  • - EVP, CFO

  • I think the inventory buffer is right through the pipeline, so you would have to estimate that would be the case.

  • In our case, some of our inventory obviously is compromised because of the flooding; in others, they probably have more inventory and the pipeline can use it.

  • The same thing for the suppliers.

  • They had inventory in the pipeline that is currently getting used.

  • You would have to surmise that it would be more difficult in the next quarter than in the current quarter.

  • Plus I think people in this quarter tend to bring a little bit heavier inventory of finished goods because it's front-end loaded.

  • Consequently there's probably a little bit of a tailwind from that, too, that mightn't be there from other quarters.

  • Yes, I believe so.

  • - Analyst

  • Is there anything you can say at this point on the timing of what the integration with HGST would look like and how much exposure does HGST have to Thailand?

  • - President and CEO

  • We're eagerly awaiting for the time-out of the EU process, 30th of November.

  • We're working very hard with all of the other regulatory authorities to try to bring them to a conclusion around about the same time.

  • We will, as soon as we have regulatory clearance, be looking to consummate the transaction as soon as possible.

  • In terms of Hitachi's footprint in Thailand, we believe they have 2 facilities.

  • Significant, probably a little less Thailand output relative to total output than WD.

  • Those facilities are outside of the current flood area.

  • As to their supply lines and so on, we have no information.

  • Operator

  • Keith Bachman, Bank of Montreal.

  • - Analyst

  • I wondered if you could just speak to what you think happens to pricing.

  • If the TAM is, call it 170 million units, but components -- there are some components that are 60% out of Thailand.

  • There's going to be a material gap in the availability of drives.

  • What happens to pricing in the December and March quarters, with what looks like to very severe shortages of drives?

  • - President and CEO

  • We're going to have to look at the basics behind what drives pricing.

  • And obviously supply is a significant factor.

  • But as well as that, there will be extraordinary efforts carried out by everybody in order to try and see if they can get as much volume into the supply chain as possible, and that will require expediting charges.

  • It will require logistical charges, and it will require significant amount of extra effort, probably extra overtime working, just to mention a few.

  • So that will have to be recovered in the pricing by the people that are doing those extraordinary efforts.

  • We will have to give some monies to the suppliers in order to be able to do that also.

  • There will be upward pressure on pricing right through the supply chain.

  • - Analyst

  • If you took the choice of buying new equipment and trying to integrate equipment in dry facilities, what's that process time line?

  • - President and CEO

  • It depends on the type of equipment.

  • If it's test equipment for instance, in our case if you look at what has been submerged, the slider fab equipment has been submerged.

  • Obviously, we've had some tester equipment submerged, although we have the electronics removed from that, and some HGA equipment, although that's a relatively small percentage of our total volume.

  • So in the case of test equipment, it probably can be done if it's to replace with new equipment probably can be done in 3- to 5-month region.

  • Assembly equipment can probably be done, again making assumptions that the people that make these -- this equipment are not dependent on componentry and slide chain around the affected areas.

  • Then if it has anything to do with wafer and fab-type equipment, it's obviously a longer lead time, probably you're talking about somewhere in the 9- to 12-month region, in that particular case.

  • Operator

  • Bill Shope, Goldman Sachs.

  • - Analyst

  • How should we think about how this potentially impacts your future product transitions and the road map through 2012?

  • Or at least, how should we think about this, and I recognize that this is an unprecedented and very unfortunate situation to try to make these types of predictions.

  • - President and CEO

  • I think that's an area we're also very focused on.

  • I think Wolfgang's OpEx guidance gives you some hint as to how we're thinking about that.

  • We're viewing this entirely differently from the 2008 economic collapse, where we were looking at a projected fall-off in demand, and sizing our business appropriately.

  • We're looking at this as a short-term interruption of our ability to manufacture.

  • The demand side of our equation continues to be highly robust, and our challenge is how to address that as quickly as possible, and as effectively as possible.

  • We are committed to ensuring that when we get back into full production, we're producing up-to-the-minute products that are responsive to customer need at that time.

  • We are continuing our investment in engineering.

  • We're very focused on expanding activity here in the short term in our US prototype manufacturing facilities, and we will be carving out a piece of the Malaysia manufacturing capacity, which is currently dedicated to future products and product development.

  • That will be maintained, focused on future product development.

  • Operator

  • Kevin Hunt, Auriga.

  • - Analyst

  • I just have a follow-up question on the Hitachi transaction.

  • Would there be any reason why the issues in Thailand would affect that -- and how.

  • Maybe you can help us understand how that might impact your integration of Hitachi.

  • I assume it would have some impact.

  • - President and CEO

  • The flexibility that a post-combination environment gives us relative to mixing and matching all available parts and all available production, tooling, et cetera, getting this deal done quickly is very beneficial to the overall return of industry supply, and therefore very beneficial to customers.

  • All of the things that we said about the deal and why it was good for our customers, good for us, good for our employees, good for our suppliers, all of those things hold true and have been amped up by the current situation.

  • We are very eager to get to grips with this and immediately move into a consummated deal if we can get regulatory approval.

  • Operator

  • Ananda Baruah, Brean Murray.

  • - Analyst

  • Thanks, guys and again good luck with the challenges that are taking place right now.

  • Is that another way of saying that this could actually help push the deal through or push it through faster than 4 weeks ago?

  • - President and CEO

  • I would certainly hope so, in that I believe the regulators view their role as being to protect the consumer.

  • I see no better way to protect the consumer than making high quality product highly available.

  • I would hope that they would adopt that view.

  • We will certainly be pushing in that direction.

  • We continue to work with them to propose what we believe are clear benefits of the deal.

  • - Analyst

  • Recognizing that there's not great visibility into this yet, given the circumstances, to what extent if any, might the situation in Thailand impact what you and Hitachi had envisioned together in terms of production integration, sharing, things of that nature, as being an important part of the accretive benefit of the deal?

  • - President and CEO

  • We did the deal as a long-term deal, and we believe that the current situation is a -- I don't want to downplay it.

  • It's very serious situation, but it's short-term in nature and we will recover from it.

  • We view the benefits of the deal as long-term, but the quicker we get the deal done, the faster we're going to access those benefits and pass them on to our customer base.

  • Operator

  • Joe Yu, Citi.

  • - Analyst

  • I want to go back to the inventory levels at the OEM GitHubs.

  • You talked about 2 weeks, but my sense is that during the end of the quarter, generally that inventory level goes down seasonally because OEMs pull more inventory than usual.

  • Is that a correct assessment?

  • - President and CEO

  • It's probably correct that some of the OEMs tend to skinny out inventory a bit at the end of their quarter, but most of the OEM volume that we support has different quarter ends than us.

  • They are offset by a month.

  • A number of the major OEMs are this month, are in their run-in to the end of their quarter.

  • - Analyst

  • Wolfgang, if you look at the revenue and the unit guidance, am I correct in calculating that ASPs will actually go down meaningfully sequentially.

  • I wanted to reconcile your comments on pricing potentially being favorable with your ASP sequential decline.

  • - CFO

  • I think you need to review the math.

  • In the revenue guidance, first of all there is a small portion of product that are not price-dependent in there as well, but implied in our guidance is marginally increased pricing.

  • Operator

  • Aaron Rakers, Stifel Nicolaus.

  • - Analyst

  • Thanks, guys, and also my sympathies.

  • Beyond the equipment restart time, what is the process as far as you guys having roughly 50% of your revenue coming from 10 key customers, what's the process of qualification, or the cycle for that matter, as you turn facilities back on?

  • Some of the OEMs qualify not only just the drive, but the actual manufacturing facilities, the equipment, and even the upstream suppliers.

  • How does that factor into the time to recovery?

  • - President and CEO

  • Typically, yes, we have an internal qualification process that as we bring up any new facility or any new piece of equipment there is a prescribed process that we go through to validate it.

  • And I'm very confident, given the discussions I've had with all of our major customers over the past several days as this situation has emerged, that with the strong support we are receiving from all of our customers we will work out a parallel process where our bring-up qualifications are done in parallel with the customers' requirements.

  • As we are ready to press the go button, everybody will be satisfied that is a controlled high-quality ready for mass volume situation, and we won't lose any time by overlapping -- by doing those qualifications sequentially.

  • - Analyst

  • Looking at the guidance again.

  • Looking at the numbers, it's pretty clear that you're assuming no, if not a negative gross margin.

  • Historically, Western Digital has been very effective in leveraging a variable cost structure.

  • Can you help us understand how much of your cogs line is variable in nature relative to fixed, and gauge that overhead that lack of utilization presents on a gross margin line?

  • - CFO

  • First of all, you are right, the guidance implies negative gross margin.

  • We are dealing with a substantial portion of what we will call fixed costs.

  • You know what the depreciation is, but there is a very significant factory infrastructure that will stay there since this is more a short-term issue to deal with.

  • Then we're also dealing with certain costs that you would ordinarily describe as variable, but they're really sticky, because we're paying our work force in Thailand for instance.

  • Then you're dealing with costs related to your input materials, both from a mix between internal and external components,, and then a general expediting of input materials and that's all affected in the math.

  • But you're right, it's a negative gross margin.

  • Operator

  • Katie Huberty, Morgan Stanley.

  • - Analyst

  • I understand there is really no historical precedence for this, but how do you and the industry decide over the next couple of quarters how to allocate the much smaller number of units across the various channels, OEMs, distribution, and retail?

  • It seems like OEMs could gobble up everything that's available and still be supply-constrained.

  • Is the strategy to give everything you can to OEMs, or do you feel like you need to fairly balance the units available across all of the channels?

  • - President and CEO

  • In looking at satisfying our customer base, we will focus on being fair and equitable to all branches of our business, the business that's prosecuted directly under the Western Digital brand, as well as that of our OEMs and that of our distribution partners.

  • To that end, we stopped shipments last weekend in order that we could get our arms around where everything is and ensure that as we began shipping again that product was allocated appropriately to the long-term established business partnerships in our customer base.

  • - Analyst

  • I think you said the vast majority of your slider production is in Thailand.

  • Is that to the tune of 90%?

  • Is it that high?

  • Are there third parties that you could work with that could supply you that component?

  • - President and CEO

  • It's not that high, but it is the substantial majority of our production, and yes, we are working with partners, have been working with partners for some time to rapidly ramp our partnership-accessible capacity.

  • Also, we're working to execute plans to bring some of our own capacity back up in short order.

  • Thank you all very much for tuning in to the call today.

  • As you can imagine, we will be highly focused in the weeks and months ahead to ensure the continued well being of our employees, and to complete our business recovery from this significant but temporary setback.

  • We will keep you informed of our progress.

  • Thank you.

  • Operator

  • Thank you for participating in today's call.

  • You may disconnect at any time.