威騰電子 (WDC) 2012 Q3 法說會逐字稿

Good afternoon and thank you for standing by.

Welcome to Western Digital's third-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'll 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 in response to your questions concerning growth in the storage industry, the timing of our pending divesture transaction with Toshiba, capital spending and industry conditions, and our financial results and expectations for the June quarter.

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 January 27, 2012.

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

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 investors information summary posted in the investor relations section of our website.

The forward-looking guidance we provide during this call excludes charges related to the Thailand flooding, net of recoveries, expenses related to the HGST acquisition, and any impact from the pending divesture transaction with Toshiba.

Because of the amount of these items, it is not known to us at this time, but 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.

We ask that analysts limit their questions to a single one today 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 will now turn the call over to Chief Executive Officer of WD, John Coyne.

Thank you, Bob.

Good afternoon and thank you for joining us on today's call.

After my introductory remarks, Wolfgang Nickl, our CFO, will review our Q3 financial performance and the outlook for the fourth quarter.

We are delighted to report these exceptional financial results for the March quarter, demonstrating the potential of the new WD with just 3.5 weeks of HGST results added to the standalone WD business.

Competing in the marketplace through our WD and HGST subsidiaries, we now have the product portfolio, technology resources and the people to focus on serving the needs of a significantly expanded customer base and to better address the tremendous growth opportunities in the storage industry in the years ahead.

IDC expects the amount of digital storage capacity shipped across all digital storage media will more than double by 2015 from 767 exabytes in 2012 with HDD storage responsible for roughly 70% of exabyte shipments over this time frame driven by mobility, connectivity and the cloud.

These dynamics create the need for an increasingly diverse set of products and technology capabilities from storage solutions providers.

Rotating magnetic storage continues to be the dominant technology in these highest-volume, high-capacity storage markets, based on availability, scalability, usability, and value.

A recently updated IDC forecast calls for hard drive unit volume growth of 10% per year from 2011 to 2016.

Another indicator of the tremendous growth opportunity at hand for the new WD.

When we announced the HGST acquisition in March, 2011, we emphasized that this would be the hard drive industry's first-ever transaction involving two profitable and growing companies.

And that this was significant because of the resultant customer breadth and product breadth, depth of technology, people and scale.

We're highly focused on what we believe is a tremendous revenue opportunity for the new WD based on the value proposition offered to our customers by each subsidiary.

We aim to continue the strong track record of customer delight and superior financial performance of each subsidiary while delivering efficiencies consistent with regulatory requirements.

It is noteworthy that during more than 12 months of regulatory reviews and two natural disasters, the WD and HGST teams maintained full engagement with customers and continued to invest and execute, to develop and deliver multiple innovative products.

I call your attention to an impressive list of recent innovations outlined in the expanded quarterly investment summary report on our website.

Some examples include the shipment of the industry's first 2 terabyte 2.5-inch My Passport hard drives for multiple personal storage; the industry's first 1 terabyte 10,000 RPM 2.5-inch WDS Velociraptor hard drive for high-performance workstations and extreme gaming platforms; the industry's first 4 terabyte 7,200 RPM 3.5-inch Ultrastar drive for the capacity enterprise and cloud infrastructure markets; the industry's first SaaS enterprise-class SSD to use 25-nanometer single-level cell NAND Flash technology, the 400 gigabyte Ultrastar SSD; the industry's first 7,200 RPM 2.5-inch 7-millimeter 500 gigabyte Travelstar mobile hard drive.

Extending our lead in the low-profile drive market, where to date, we have shipped more than 25 million 7-millimeter hard drives for use in slim notebooks and ultra books.

We also announced the formation of a consortium with SanDisk, 20th Century Fox and Warner Brothers to advance digital distribution and consumer ownership of high-definition movies.

With the HGST acquisition now closed, we're working closely with China's Ministry of Commerce to finalize our operations plan in compliance with the remedy outlined in MOFCOM's approval decision last month.

Concurrently, Toshiba is awaiting the completion of the regulatory review process associated with its agreement to acquire certain WD and HGST assets; a process that is expected to be completed within the next 90 days.

In the meantime, we continue to support customer demand for the products covered by the anticipated Toshiba transaction.

I'm also pleased to announce today that the recovery activities related to both WD operations and those of our supply chain partners impacted by the Thailand floods have reached a point where we now have the capability to adequately meet anticipated customer demand in the current quarter and beyond.

Our subsidiaries are now focused on profitably serving customer needs in terms of both mix and volume.

We have navigated successfully through a series of significant events in the last year, including the earthquake and tsunami in Japan, which had a substantial supply chain impact on both HGST and WD.

And the floods in Thailand which knocked out almost 90% of WD slider availability and 60% of WD drive assembly capacity, and a substantial portion of the industry supply chain.

Concurrently, we completed the largest acquisition in the history of the hard drive industry.

I want to thank our customers and suppliers for their strong support throughout this time and to congratulate and thank all of our employees whose dedicated efforts have delivered such outstanding results.

As I look at the opportunities for Western Digital in the quarters and years ahead, I cannot think of a more exciting time to be leading this talented team.

We have just delivered the strongest revenue and profit performance in the Company's 42-year history with the contribution of less than one month of HGST performance.

We have a series of upside opportunities that have energized our teams.

Against a backdrop of a recovering industry TAM in the near term, and the storage industry's significant growth opportunity in the long term, we are focused on delighting our customers with an improving mix of compelling products, growing to full utilization of our installed capacity over time, and continuing the measured deployment of our newer technologies.

With that I will turn the call over to Wolfgang for a review of our Q3 financials and our outlook.

Thanks, John.

The summary of historical financial information has been posted to the investor relations section of our website.

We've also included a detailed GAAP to non-GAAP reconciliation in this package.

I would also like to remind you that we have announced our Investor Day to be held on September 13, 2012 here in Orange County.

On that day we expect to discuss our strategy for our core business, growth opportunities, our go-forward business model, and our cash utilization strategy.

Today I will first summarize our financial performance for last quarter and will then provide a range of expected financial results for the June quarter.

The data for our third fiscal quarter includes HGST results from the acquisition date of March 8 through the end of our quarter.

Revenue for the March quarter was $3 billion including $614 million for HGST.

We shipped a total of 44.2 million hard drives at an average selling price of approximately $68.

OEM sales represented 64% of revenue, distribution channel sales were 28% and retail sales were 8%.

The retail channel percentage was lower than prior quarters due to a total available market that is running at about 50% of last year's run rate and Hitachi's lower presence in that channel.

Our gross margin for the quarter was 32.2%.

This includes acquisition accounting-related adjustments.

Excluding these adjustments, non-GAAP gross margin was 35.5%.

Average cost per unit continues to run above pre-flood level due to lower capacity utilization, increased use of air freight, a higher mix of externally procured heads, and higher costs for other components as a result of the flood's impact on our supply chain partners.

R&D and SG&A spending totaled $420 million for the March quarter.

SG&A included acquisition-related expenses of $33 million and $3 million of amortization expense related to intangibles recorded through the purchase price allocation.

R&D and SG&A spending reflect continued investments in new product and market development, particularly in the branded and enterprise areas.

Flood-related expenses totaled $36 million, which was offset by $21 million in insurance recoveries and other cost reimbursements.

During the quarter we filed a significant claim for property damage, which is currently in the early stage of evaluation by our insurance carriers.

We also expect to file business interruption and other claims.

Net interest and other nonoperating expense was $4 million, including $1 million of credit commitment fees prior to the acquisition.

Tax expense for the March quarter was $55 million or 10.2% of pre-tax income.

Our net income for the March quarter totaled $483 million or $1.96 per share.

On a non-GAAP basis net, income was $619 million or $2.52 per share.

Turning to the balance sheet, we generated $1.2 billion in cash from operations during the March quarter.

And our free cash flow totaled $1.1 billion, significantly enhanced by the timing of the acquisition.

Capital spending and depreciation, amortization for the March quarter totaled $139 million and $188 million, respectively.

Through the first nine months of fiscal 2012 we have spent $393 million on capital.

We expect capital spending of approximately $357 million for the current quarter bringing the total for fiscal year 2012 to approximately $750 million, inclusive of HGST capital spending for the June quarter.

Capital expenditures for the June quarter will be driven by flood recovery, technology investments, investments in process capability as opposed to capacity expansion.

As a reminder, we report capital spending based on cash disbursements, thus the capital disbursements expected for the June quarter primarily reflect capital that was received during the March quarter.

Our conversion cycle was a positive five days.

The DSO, DIO and DPO calculations, as well as inventory turns, are skewed by the fact that our March ending balance sheet includes full HGST account receivable, inventory and account payables.

But our revenue and cost of sales include only 3.5 weeks of HGST operations.

We exited fiscal Q3 with total cash and cash equivalents of $3.4 billion.

With approximately $1.3 billion in the US and $2.1 billion offshore.

Subtracting our total debt of $2.7 billion results in a net cash balance of $634 million.

The HGST purchase price for accounting purposes was approximately $4.7 billion.

Our purchase price allocation included goodwill of approximately $1.7 billion, and other intangibles of about $800 million.

On a full-quarter run rate basis, we expect the intangibles to drive amortization expense of approximately $50 million.

These amounts are preliminary.

Updated amounts will appear in the 10-Q we will file in early May.

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

We expect the TAM for the June quarter in the range of 155 million to 160 million units.

We believe there is sufficient capacity in the industry to support this demand.

From a volume perspective we have modeled the previously-announced divesture of certain 3.5 inch assets to Toshiba to close towards the end of May.

With regards to pricing, it is important to note that our WD subsidiary was the most heavily impacted of any drive company by the floods in Thailand last October.

WD asked for and received customer support to enable a rapid recovery.

Now that this recovery is essentially complete, WD is forecasting pricing reflective of current market conditions.

After we closed the acquisition we learned that our HGST subsidiary, which was not directly impacted by the flood, had implemented multi-quarter agreements with certain customers that provided for June pricing below March pricing, subject to the achievement of certain volume goals.

The WD subsidiary continues to operate with substantial under-utilized capacity, and the supply mix of external heads in excess of the subsidiary's strategic sourcing model.

Both sectors lead to a cost disadvantage of several dollars when compared with pre-flood levels.

While we are identifying OpEx synergies that are consistent with regulatory requirements, we are not factoring any of these synergies into our guidance, as we are currently walking with China's MOFCOM to finalize the operations plan which we submitted earlier this month.

In addition, we are continuing investments in strategic growth areas such as SSD, hyper drives and the digital home.

From a cross-margin perspective, we believe that product mix and cost will provide significant future upside potential for our businesses as they manage the deployment of new aerial densities in a measured fashion.

I also want to note that our guidance is on a non-GAAP basis.

It excludes amortization of intangibles related to the HGST acquisition of approximately $40 million in cost of sales and $10 million in OpEx.

It also excludes any P&L impact from the pending divesture of 3.5-inch assets to Toshiba, and any potential restructuring activities.

Our forecast does not include any acquisition of flood-related expenses, nor does it factor in any flood-related insurance proceeds during the quarter.

With these factors in mind, our June quarter guidance, including a full-quarter of HGST, is as follows.

We expect revenue to be in the range of $4.2 billion to $4.4 billion.

R&D and SG&A spending will be approximately $550 million.

We expect our tax rate to be approximately 9% of our taxable income.

We anticipate our share count to be approximately 269 million.

Accordingly, we estimate non-GAAP earnings per share of between $2.35 and $2.55 for the June quarter.

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

(Operator Instructions) Keith Bachman with Bank of Montreal.

John, I wanted to get your take on the status of the inventory deficit in drives.

CEH talked a lot about their perspective on how short the industry is on drives.

Yet when the OEMs talk, they seem to have more than enough drives.

The ODMs in Taiwan have similar comments.

If you could just speak to where is the deficit in drives.

And if there is such a deficit, how long do you think it persists?

Thank you.

Sure.

I think in terms of mobile 2.5-inch drives for the PC industry, I think we're in reasonable balance.

The difference from traditional situation is that the inventory, instead of being in HDD industry GitHubs is in the OEM's own inventory, the PC manufacturers and the ODMs.

So, as of today, I believe the majority of that business is being done on a direct ship from factory basis.

So that, that inventory shifted from HDD-owned to customer-owned.

And we think that business is in reasonable balance relative to supply and demand and traditional inventory levels.

The desktop, we think, is still a little short.

And from an OEM perspective will take through this quarter to approach a balanced situation.

Likewise, on the enterprise side, we think performance enterprise is reasonably balanced.

Capacity enterprise demand continues to exceed supply.

And then when we move into the distribution channels, we're looking at inventory levels in the distribution channel that are substantially below those that were the norm pre-flood.

About 50% the level that was typically carried pre-flood.

And when we look in the retail channels, a similar situation, inventory still somewhat light.

So I think we're going to see --.

(Multiple speakers)

Very helpful, John, thank you.

Just my follow-up, then, would be is what's your expectations for September quarter, the ability to drive manufacturing?

What would you say the unit TAM for output would be for the September quarter?

And then I'll cede the floor.

Thank you.

I think we're looking at a difficult to predict situation in that this quarter our estimate of the TAM supposes a 10% quarter-over-quarter growth.

If we looked seasonally on a traditional basis, we would have expected a flat to down demand relative to last quarter.

We think that's a pent up issue that creates that growth back towards normal.

We're still, I think, about 4% on a year-over-year basis.

The 160 million unit number for the June quarter would be compared with 166 million a year ago.

So there's still a little bit of catch-up to do.

Then we expect in the back half of the year we'll see typical quarter-over-quarter progression that tends to be in the 10% range.

And that will translate into very substantial year-over-year increases, obviously, because of the flood impact in October.

Okay.

Many thanks.

Rich Kugele with Needham.

Just wanted to make sure I understood your comment about being able to meet demand in the quarter.

Is that much more of a function of, whether it's sourcing from TDK heads or Hitachi's in-house ability to meet its own needs versus actually building all those sliders out of Thailand and back to pre-flood production capability in-house?

Yes, Rich, the comment relates to our ability to satisfy customers with drive level product through both our subsidiaries.

And we believe we'll be in a good position this quarter to turn our focus from building raw capacity to turning our focus to matching mix requirements within the overall capacity required by our customers in the current quarter.

As, I think both I and Wolfgang noted in our prepared remarks, we still have a significant installed capacity under absorption issue from a cost perspective in the WD sub.

And we are currently sourcing above the typical WD external/internal head sourcing rule or business model that we have set for the long term.

However, as we look forward, we forecast continuing TAM growth each quarter through the balance of the year.

And then sustained growth in the industry as we move forward from there.

So looked at in a medium- to long-term perspective, we're very excited by the opportunities.

And we see substantial opportunity for us to continue to improve performance as those cost drags on the business are eliminated with growth as we move forward.

Okay.

And then just secondly, regarding your comment about Hitachi signing a few LTAs at lower prices than March.

Can you give some quantification of just how far below.

And what markets might have been involved.

And more importantly, your ability to perhaps prevent that type of decision-making in the future within the confines of the Chinese regulators?

I think you characterized that, that might have not been a desirable action.

I believe it was a highly desirable action, to provide assurance of security of supply to customers and to be competitive in addressing market opportunity.

Thereby increasing business with certain customers and securing that business into the future.

So while the prices are lower in the June quarter than they were in the March quarter, based on the total package offered to those customers.

The business is highly desirable and significantly accretive to the overall well-being of the business.

So we're explaining the dynamics of the current market, not indicating any problem.

Okay.

Thank you very much.

Aaron Rakers with Stifel Nicolaus.

I don't know if you can do this or not, but last quarter you talked about an expectation that your average capacity per drive would be down sequentially in the March quarter.

Can you provide us any color on what that looked like this quarter as we think about optimizing the mix and what you're expecting that to be into the June quarter?

And then I do have a follow-up.

Yes.

The average capacity last quarter was indeed down.

And that's for the WD business.

Low single-digit percentage.

And we expect that mix to pick up this quarter for the WD sub.

The HGST sub mix is a little bit impacted since the June quarter is a quarter where the gaming business picks up.

And there's more substantial volume of gaming units and that impacts the mix there.

But you should also assume that as we move through the balance of the year, we will return -- and both businesses likely operate, at market mix.

Okay.

And then my follow-up question is, on your slide deck, you have a highlighted business model.

Gross margin, which looks like it's the prior model of 18% to 23%, 9% to 10% OpEx to revenue.

I'm curious, is that the model you're out and want to talk to the street about?

Or is that just a reference to the old model?

Because I think you guys had given flavor for higher gross margins in particular post the Hitachi deal.

Any color on how you're thinking about the long-term model in the context of that?

Good observation there.

It's the old model.

We haven't officially updated our model.

We expect to do so at our September Investor Day.

We've given some directional color in the supplemental information that we provided right when the acquisition closed on March 8, I believe.

And from that directional guidance you can imply that we believe that the gross margin is likely higher than the original 19% to 24% that we said a year ago.

And we also highlighted that the OpEx might be a little bit higher and we'll have to wait for the outcome of the operating plan -- operations plan, that we're concluding with MOFCOM to specify that.

And, again, the go-forward model will be communicated at the Investor Day on September 13.

And on that, it looks like you're implying about a 30% to 31% for gross margin current quarter.

Is that fair?

For guidance for the current quarter, that's correct.

Rob Cihra with Evercore Partners.

Two questions, if I could.

One, I'm just wondering -- I know you didn't do this, but I'm wondering if you're planning to or not to report or give even any color on the split between WD and HGST units.

And then separate from that, if I look at your OpEx guide of $550 million, it would imply no cost savings from HGST.

Which I get, and I understand, as you guys have communicated that obviously the regulatory constraints.

But is there not even any amount of OpEx cut there or savings or synergy that you think you're actually going to be able to get near term before two years?

Thank you.

On your first question, we're not planning in the future to split out the two businesses.

We're going to split out what the SEC requires.

In terms of the $550 million in OpEx, like we said, we have submitted the operations plan to MOFCOM.

We're working on certain synergy proposals that are compliant with this plan.

And we're going to report what these synergies are when we finalize the plan with China's MOFCOM.

Okay.

So that's your most conservative take at this stage or your most realistic, the $550 million?

I think it's realistic for the current quarter in that we have to complete our negotiations.

Also, I think Wolfgang mentioned, we are continuing to invest in emerging opportunities for hard drives and beyond the hard drive.

So we're continuing to, actually to increase spending in certain areas of the business from an OpEx perspective.

Great.

All right.

Thank you very much.

Scott Craig with Banc of America.

Two questions.

John, can you first address the TAM of 155 million to 160 million units and circle that around with the comments that you think you'll be able to meet full customer demand?

Because I would have thought, given inventories in the distributor being 50% the level of normal, and a TAM prior to the flood level of hanging around that 170 million mark, that you wouldn't be able to meet customer demand here in the near term.

And then, secondly, Wolfgang, on the guidance for the June quarter from a revenue perspective can you provide a little bit more granularity on that, with maybe ASPs and units?

And a mix where you think that's going to be from a customer segment?

Thanks.

All right.

This is John.

And my comments on the inventory versus demand, I think we'll be able to meet the true market demand.

I don't think we'll do much in the way of rebuilding inventories or recreating the traditional model of where those inventories are, and the timing between cutting an order and delivering the product to where it's meant to be.

We're using air freight almost exclusively today.

The velocity through the distribution channel is very high.

And I think, as the momentum builds in distribution, and the volumes get back to pre-flood levels, and as momentum builds back in retail back towards pre-flood levels, I think that's the first order of business is to fuel that growth and support it.

And then the second order of business, which comes later in the year, possibly early next year, is to see the inventory and distribution models revert to a more normal level of inventory and velocity of that inventory.

Yes.

On your revenue question on the $4.2 billion to $4.4 billion, I highlighted a few elements regarding to a WD situation now being more recovered from the flood.

And having pricing reflective of current market conditions.

John and I both commented on the multi-quarter agreements that Hitachi has put in place.

We also talked about the mix on the HGST side, reflected by gaming.

And all you need to take into consideration, that some volume goes away with the Toshiba divesture that we're planning for the end of May for this guidance assumption.

And overall, like we said before, we're overall, we're operating below market mix.

Like John said, we think that we'll make this up over the next couple of quarters, but those are some of the assumptions that went into revenue guidance.

Thank you.

Ananda Baruah with Brean Murray.

Along those same lines but on the gross margin line, can you give us some sense of how long the Hitachi units run for?

Should we think of them as through the balance of this year?

And now that you guys think that we're going to be moving at market pricing here for the non contract business.

Should we think of the June quarter gross margin guidance as being a baseline to work from for the balance of the year?

Then we can use our assumptions around channel pricing and mix for the non contract portion to guide our models?

Any color there would be helpful.

Thanks.

I think there's two elements.

As always, there's two fundamental elements to margin.

One is ASPs and the other is unit costs.

The ASPs are going to be what the market dictates they be.

And on the cost side, we currently have some cost adders to our business that are a result of the floods.

Some of those are industry-wide and are being reflected on through into an overall step-up in ASPs.

Some of those are Company-specific.

The Company-specific ones will be addressed by a combination of addressing a growing TAM.

And if we do that, and execute against the opportunity as well as we have in prior years, we should expect that we will grow with the TAM or ahead of the TAM.

And that will address some of the under-absorption issues we have.

Will also help with the ratio of external heads to internal heads and improve the utilization of our head component business.

And consequently improve our cost structure there.

So there's substantial opportunity there.

Also, as a result of the floods, in order to focus on supporting our customers' immediate requirements, and utilizing our assets and our supply base as effectively as possible, we delayed some deployment of our newer technology products.

Which, as we move up in our deployment of the newer technologies, as a proportion of our total shipments.

Again we expect to see a substantial impact on our cost profile in that.

So I'm very encouraged by, when you look at the guidance, and you look at our relative competitive position on margin, and then see that we have substantial opportunity to improve our cost structure as we move forward throughout the year.

I think you see that our comments in the supplementary information, March 8, where we indicated with a profile of the business on a post-acquisition basis being very close in terms of participation in different market segments, being very close to that of our largest competitor, that we expected that the metrics driving the business would be equally close.

And so it will take us a few quarters to get there, but I'm highly confident that we have what it takes.

And I think we've got a track record to demonstrate that, that confidence is not misplaced.

Fantastic.

Thank you very much.

Mark Moskowitz with JPMC.

John, I want to come back to your commentary about you have a series of upside opportunities that excites the team.

Some of the research we've been doing suggests that the enterprise system OEMs are a little frustrated by one of your major competitors in terms of pricing environment over the last few months.

Are you, either with WD or Hitachi subsidiaries -- or both subsidiaries, seen incoming opportunities for dual and triple sourcing for these system OEMs?

Yes.

We believe we've got a tremendously strong enterprise portfolio between the two subsidiaries.

We believe we have a marketplace that is ripe with opportunity and we're going to pursue it vigorously.

Then the follow-up just around CapEx.

Have there been any instances where Western Digital or Hitachi had to capitalize some of your Tier 1 or Tier 2 suppliers who were hurt by the flood?

And how did that play out?

That was not any big numbers there.

We supported some supplies very early on with early payments, but it was very immaterial.

Okay.

Thank you.

Ben Reitzes with Barclays.

Can you guys just get a little more granular about ASPs?

When you back into the numbers, it would seem that you are thinking about a double-digit decrease, anywhere, like up to 15% sequential decrease in pricing.

And I just wanted you guys to expand upon that.

And then I have a follow-up.

Yes.

We didn't imply any percentage increase.

We didn't give a volume number.

I think we explained what the assumptions are for the ASP that goes into our guidance.

The other question I had is that, prior to the flood, you were doing 58 million in volume and Hitachi was doing close to 30 million.

What is the run rate number we should assume?

I think people are assuming around 6 million drives for the desktop assets that's been sold.

So what is the full capacity of the new company, and the run rate full demand in terms of units?

And what you're able to do once we get to the September quarter?

I think it's fair to, in terms of capacity -- to assume that from an invested capital perspective you're correct, in 58 million and 30 million facilitization that was in place pre-flood.

You're also correct in looking at the divesture to Toshiba.

Now over many years, I think we have demonstrated that the installed capacity, it's relevant in terms of the depreciation number.

It's not relevant in terms of how we utilize that capacity.

We plan capacity utilization based on our read of market requirement.

And whether that is as we are at the current moment, planning in this quarter to run less than the installed capital base would allow, in order to match the demand that we perceive to be available to us profitably.

We've also demonstrated in history a very good capability to scale our business upward as demand appears.

And to do that in a very timely manner and a very efficient manner from a dollar per incremental output perspective.

So I do anticipate we'll have some drag of overall invested capital and hence depreciation over the next several quarters as the TAM rebuilds.

And as we earn our share of that TAM.

And I think, as we look at the longer term for the overall business, we will, in calendar '13 and beyond, be looking at deploying those previously-demonstrated skills of adding judicious capacity to meet opportunity in a timely manner.

Okay.

The final thing is, just with regard to, you generated a ton of free cash flow, $1.1 billion.

If you have a few more quarters like this, you're going to put away a lot of cash.

Is there any additional thinking on returning cash to shareholders at the Company?

That's it for me.

Yes.

Let me first comment on the free cash flow for last quarter, which was untypical and highly related to the timing of the acquisition.

The way how you should be thinking about free cash flow -- and you're right, this Company has the potential to create a lot of cash.

If you just take this quarter, for instance, at the midpoint of our guidance and 269 million shares, if you apply the gross margin and deduct the OpEx.

And then take the $350 million CapEx, or $357 million CapEx, total amortization and decrease, excluding the intangibles that we just added, somewhere in the $280 million range.

If you assume a constant working capital, no investments in working capital, that gives you a free cash flow around $600 million or so.

So you're right, that's very substantial.

We're actively looking at the cash utilization strategy.

And I pointed out, that's one of the topics that we're going to cover in September and we'll update you then.

Thank you.

Scott Schmitz with Morgan Stanley.

Thanks, guys.

Now that the industry is able to meet demand, do you have a time frame for when you think your market share normalizes back to the normal levels, if you consider Hitachi and WD combined?

The market share is about earning customers' business.

And we think we're pretty good at that.

We're going to try very hard to be good at that, and continue to be good at that.

And I expect that will be reflected in the position at the end of the June quarter, which will be the first quarter of execution with both subsidiaries under Western Digital ownership.

And I think that will give a baseline starting point from which excellence in execution from a technology deployment, product portfolio, service levels and value will then drive forward from there.

And when you get to that normalized market share level, what does pricing look like?

Are we back to pre-flood levels?

Are we reset a little bit higher?

Any other comments you can give on the pricing side.

I think we've indicated previously, and I'll reiterate.

The expectation that the costs incurred by the industry, both to recover the lost capacity relative to the flood, and to de-risk the business for our customers in terms of moving the supply chain around to create a much less concentrated profile, those things have costs attached to them.

And I believe that will be reflected through to the customers.

So we expect that pricing in the drive industry will continue to be elevated relative to pre-flood levels.

Nevertheless, that elevation of pricing notwithstanding, we believe that hard drives still represent the best value in the technology supply chain for the industries we support.

And that, that value needs to be reflected in the business model of the hard drive company, like ours.

And the return to our investors for developing and deploying technology at this level.

Okay, thank you very much.

Sherri Scribner with Deutsche Bank.

I just have two clarifications.

Wolfgang, in terms of the interest expense for next quarter, I don't think that you said anything.

Can you just give us some sense of what you expect that to be with the new debt?

Sorry, I didn't catch, interest expense?

Yes.

It's right around $15 million.

$15 million, okay, thanks.

And then in terms of the units that you shipped this quarter, can you give us a sense of how many of the units were SaaS and fiber channel?

So pure enterprise versus near-line products, either Western Digital and Hitachi combined, or separate, or whatever.

We're usually not breaking out that piece.

We've always just given the enterprise number.

Will you break that out in the future?

I have no current plans, but we're thinking about it.

Okay, thanks.

Jayson Noland with Robert Baird.

I wanted to come back to the retail TAM being 50% what it was a year ago.

I assume some of that's availability, but is some of it also cloud storage?

No.

I don't think it's cloud storage.

I think it's, when you think about the retail channel, the price of the product on the retail shelf is dominated by the cost of the hard drive within that package.

Consequently, the increases in hard drive pricing, immediately post-flood, there were two impacts on the retail channel.

One was availability.

The second was that the price increases on drives were immediately reflected in the full level of the increase to the consumer.

If you look at all our other markets for hard drives, the hard drives incorporated in a larger system, where the hard drive is maybe 10%, 15%, at most 20% of the system value bill of material.

And consequently, the price increases in those markets had less chilling effect on purchasing behavior.

So I think there's a two-part element.

The third element that affected the retail channel was that, absent a clear visibility into supply, the retailers were reluctant to place ads and give prominence to the category because they were not sure that they could fulfill the demand that they would create by doing those promotional activities.

So you take those three elements, have contributed together.

We believe the demand for personal ownership, availability, security of content, and the value proposition of owning a terabyte of your own secure accessible data for less than $100.

Compared with renting that same capacity at 10 or 20 times that cost over a reasonable expectation of lifetime of that data in the cloud.

We believe the personal content ownership, both from a safety and security and keeping other people's eyes off it, as well as the value proposition, offer a compelling value.

And so we believe we're going to see the retail market rebound as the constraints I outlined go ahead away.

And, in fact, we see the way that the cloud enables mobility, and the way that it enables people to easily generate content on mobile devices and consume content on mobile devices, all plays into a significant increase in demand for personal storage for personal content.

And home-based personal network attached storage, or personal cloud storage.

And we're addressing both of those markets.

Now just to hedge our bets, of course, we're very strong players in the cloud market.

In fact, the entire cloud would not exist were it not for the backbone technology of performance and capacity enterprise product.

So either way we win.

Thanks for the color, John.

And a follow-up with Wolfgang on synergies between the two subsidiaries.

Could you talk about that a little bit generically?

I assume some of it could include minimizing product overlap.

But not really sure what you can and can't do there with the regulator.

Yes.

I think we'll address that once we have the operations plan finalized with China's MOFCOM.

Okay.

Thank you.

Mark Miller with Noble Capital.

There's a previous comment.

There's been a lot of figures thrown around for the percent of drives that are going to be divested.

I think someone mentioned previously it was 6 million.

Can you give us any ballpark figure because we're hearing numbers all over the place?

Would 6 million be in the ballpark of the drives divested with Toshiba?

If you go to the FTC's website, there's actually a pretty good description of the divesture.

And from the number of lines that are being mentioned, you can conclude that it's anywhere in the 5 million to 6 million per quarter capability.

And that's probably the best number for you to use, that the assets that we're divesting can output in the quarter.

I attribute this more to their greater percentage of long-term agreements.

But Seagate stuck its neck out and said they thought margins would stay above 30% throughout this calendar year.

You're saying pricing will stay up.

Can you go any further than that?

Well, I can't talk to Seagate margins, but what I can tell you is that we have substantial opportunity on the cost side of our business to enhance our margins.

And we will compete in the marketplace to provide value to our customers on a consistent and continuing basis.

And we believe that's what we've done profitably for 10 years and hopefully we'll continue to do it profitably for at least another 10 and beyond.

Thank you.

So thank you all for joining us today.

As I hope you can tell, we're very excited about the growth opportunities in the data storage industry.

And about the new WD's ability to participate in this market as a leader in the years ahead.

I look forward to updating you on our progress.

Thank you.

This does conclude today's conference call.

You may disconnect at this time.