Western Digital Corporation (WDC) Q2 2013 Earnings Report, Transcript and Summary

Good afternoon, and thank you for standing by. Welcome to the Western Digital's second quarter financial results for fiscal year 2013. [Operator Instructions] As a reminder, this call is being recorded. And I would now like to turn the call over to Mr. Bob Blair. You may begin.

Thank you, and good afternoon. 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 and our position and opportunities in the industry, HDD demand for the March quarter and calendar year 2013 and our financial results expectations for the March 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-K filed with the SEC on November 2, 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 investor summary posted in the Investor Relations section of our website. The forward-looking guidance we provide during this call excludes certain items such as amortization of intangibles and other charges. Because the amount of these items is not fully 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. [Operator Instructions] I also want to note that copies of remarks from today's call will be available on the Investor section of Western Digital's website immediately following the conclusion of this call. I would now like to turn the call over to President and Chief Executive Officer, Steve Milligan

Good afternoon, and thank you for joining us. After my opening remarks, CFO, Wolfgang Nickl, will provide additional commentary on our December quarter results and outlook for the March quarter. I am pleased with our financial performance in the December quarter. The quarter exhibited continued soft industry demand driven by macroeconomic uncertainty, weak PC demand and inventory rebalancing by our customers. Over the last several quarters, both of our subsidiaries have done an excellent job of managing through challenging market conditions. This is particularly noteworthy given our company's specific cost challenges associated with the recovery from the Thailand floods. We have continued to focus intensely on those variables we control, allowing us to produce better-than-expected revenue and profitability and strong cash generation. In calendar 2013, we have several opportunities to improve our business. We believe that the overall market for hard drives is beginning to stabilize. We expect demand for the first half of calendar 2013 to be flat to slightly down compared with the back half of 2012. However, we are cautiously optimistic for the back half of 2013 for the following reasons: Worldwide economies continue to expand, albeit at a slow pace, with signs of further improvement in developing regions. OEM customers have largely worked through their inventory rebalancing. Accordingly, we have improving visibility with regards to true customer demand. Our customers are accelerating their product innovation with thinner and lighter designs, coupled with touch-enabled features and there are early indications of consumers' stronger intentions to purchase new PCs this year. I am most pleased with Western Digital's leadership position in the storage industry. We sit at the center of a vast ecosystem where data growth continues unabated. In this context, we continue to have multiple opportunities to create value for our shareholders, customers and employees. We are working to develop and bring the market innovative solutions in 3 areas: the public and private clouds, thin and light client systems and the Connected Life or personal cloud for homes and small businesses. Specifically, in the cloud environment, demand for our high-capacity drives remained strong. Total cost of ownership is a significant issue for our customers in the high-capacity market, and we have seen broad interest in our new 7 disk helium-filled drive. This innovative solution will deliver 40% energy savings over current offerings. Our expanding portfolio of enterprise class solid state drives continues to gain increasing acceptance with our customers. For the third consecutive quarter, we had double-digit revenue growth with our SSD enterprise drives. In the thin and light category, customers are increasingly deploying our 7-millimeter hard drives, and enthusiasm for our new 5-millimeter and solid state hybrid drive platforms is high. And for the Connected Life, we continue to develop solutions that help consumers manage, store, access and experience their personal and professional content seamlessly. With more ways to create and share content, consumers are increasingly turning to external drives as the best storage choice. For example, we see tablets with USB ports driving adoption of direct attached devices. We are also seeing tablet users increasingly adopt our network attached storage for added capacity. In my new role as the CEO of Western Digital, I am excited to be leading this great company at such a compelling time of change and opportunity in the storage industry. With our HGST and WD teams, we have the people, the platform, the technology and the financial engine to innovate and address changing customer needs. We will continue to lead by innovating, executing and allocating capital in a thoughtful way. Wolfgang will now provide our report on Q2 and our outlook for Q3.

Thank you, Steve. I will first summarize the total market demand and I'll consolidate the financial performance for the December quarter and then conclude with a range of our expected financial results for the March quarter. The HDD market shipped approximately 136 million units during the December quarter, slightly less than the 140 million units we anticipated in our guidance. We saw continued inventory rebalancing at our OEM customers and our distribution retail channel inventory continues to be lean. By challenging market conditions, both from a macro and IT perspective, we delivered very strong financial results. Revenue for the quarter was $3.8 billion. Excluding shipment to Toshiba under our divestiture agreement, we shipped a total of 59.2 million hard drives. Our average HDD selling price was $62, flat with the prior quarter. Favorable mix offset modest like-for-like price decline. Our gross margin for the quarter was 27.7%. Excluding $38 million of amortization expense related to acquired HGST intangible assets, non-GAAP gross margin was 28.7%. Non-GAAP gross margin was approximately 70 basis points better than what was implied in our guidance, which was a function of lower-than-anticipated price declines and better-than-expected mix. R&D and SG&A spending totaled $540 million for the December quarter. SG&A included $11 million of amortization expense related to acquired HGST intangible assets. We incurred charges of $41 million in the December quarter reflecting continued discipline in aligning our operations with anticipated market demand. As a reminder, we've already incurred charges of $80 million and $26 million in the June and September quarters, respectively. Net interest and other nonoperating expense was $10 million. Tax expense for the December quarter was $133 million or 28% of pretax income. Tax expense included a one-time charge of $88 million due to the passage of Proposition 39 in California. Without this one-time charge, tax expense would have been $45 million or 8% of non-GAAP pretax income. Our net income for the December quarter totaled $335 million or $1.36 per share. On a non-GAAP basis, net income was $513 million or $2.09 per share. Turning to the balance sheet. We generated $772 million in cash from operations during the December quarter and our free cash flow totaled $526 million. Our CapEx for the December quarter totaled $246 million. For the full fiscal year, we expect to be at the upper end of our CapEx model of 5% to 7%, including approximately $200 million for expenditures related to the floods in Thailand. Excluding the flood-related spending, we would be close to the bottom end of our model range. Consistent with our capital allocation strategy announced in September, we repurchased 4.2 million shares for $146 million. As of the end of last quarter, an authorization of $2.4 billion remains available for future repurchase. In addition, we declared the dividend in the amount of $0.25 per share or a total of $60.2 million which we paid on December 26 to shareholders of record as of December 14. On October 15, we also paid out the first dividend in company history in the amount of $0.25 per share or a total of $60.9 million, which are all declared during the September quarter. We exited fiscal Q2 with total cash and cash equivalents of $3.8 billion, of which $1.4 billion was in the U.S. Subtracting our total debt of $2.1 billion, our net cash balance was $1.7 billion. I will now provide our guidance for the March quarter. We expect a total available market flat to slightly down when compared with the December quarter. Revenue in the range of $3.55 billion to $3.65 billion reflecting the current demand environment, the seasonal change in business mix and the conclusion of our 3.5-inch contract manufacturing arrangement with Toshiba. Gross margin of approximately 28% excluding the amortization of HGST intangibles. We expect R&D and SG&A spending to be approximately $540 million, excluding the amortization of HGST intangibles, a tax rate of approximately 7% and a share count of approximately 244 million. Accordingly, we estimate non-GAAP earnings per share of between $1.65 and $1.80 for the March quarter. Operator, we're now ready to open the call for questions.

[Operator Instructions] Our first question comes from Ananda Baruah from Brean Capital.

Steve, Wolfgang, just 2 if I could. I guess the first is on the mix dynamic that you expect to -- you experienced in the December quarter and expect to experience in the March quarter. Can you talk to some of the specifics of what you're seeing. And I mean, I guess to the extent you can talk about what, how, I guess what would you expect kind of as we go through the year, if we should expect what's going to happen in March to extend beyond that, and I have a follow-up.

Ananda, yes, the December quarter was favorable and mixed both from a product mix perspective and also from a business mix perspective. You can see that also from our Investors summary page. Notebook and desktop were combined slightly down when compared to the September quarter, enterprise and branded were up quite a bit. So you can see we had a quite significant positive impact from a business mix, which led to us maintaining the $62 ASP. When you look into the March quarter, you usually see PC sales just seasonally going down by some percentage, probably 6% to 8% if you look at history. And in the branded sales, it's slowing down a little bit after the holiday season. So those are the 2 major impacts that, just from a mix perspective, weigh in on the ASP.

Got it, okay. And I guess as far as benefit from mix, as you move through the year, your major competitor has kind of been talking about they expect industry mix dynamics to lean more positive as you move through the year both within the books and then also with hybrid being introduced in May. Just interested in getting your thoughts on, I guess, how sudden the mix can be as we go through the year and the impact that could have on the industry business model.

Yes, I'll take that question. I think that, I mean, one of the things that we have to keep in mind, I mean, really 2 comments: I mean, one, mix is always a bit of a dynamic thing and it's something that we, from a business standpoint, actively manage to improve our overall financial performance. So there's a lot of, call it, tactical things that we do within a quarter to make sure that we are getting an appropriate amount of mixup with our customers and with our products and that sort of thing. But the other thing that I think that we have to keep in mind, which is a very important point in that the secular changes that are occurring within the industry are actually very favorable from a mix perspective. So clearly, where we've seen pressure from a volume perspective has been on the client space. That traditionally has -- carries a lower ASP, a lower mix. But where we continue to see very solid growth, although at a lower unit number, has been in the higher capacity enterprise space, particularly the cloud. And then not only that, in terms of the branded business or the personal cloud or Connected Life. And so those things, as you move through the year, and not only that but I think as we move forward into the future, we'll continue to benefit our business both from a average selling price perspective or a mix perspective and then accordingly, if we continue to do our jobs appropriately, from an overall margin perspective.

Our next question comes from Rich Kugele of Needham & Company.

The yen, the changes in the currency relative to the dollar, did that help or hurt the business in the quarter? And I have a follow-up.

It was a little bit of a help for us on the OpEx side. And going forward, we're including the yen in our hedging program. So it should have minimal impact on ongoing results.

And then in terms of your own procurement from a component perspective over the balance of '13, can you just update us on your own progress on internal production levels or capability?

Yes, we're planning on steady progress and towards the latter end of the year, we'll be in within our purchasing parameters and also mixing into the new areal density. So we're making steady progress there.

So we have some more work to do.

By the end of the year, do you mean the fiscal year or the calendar?

I think we'll make progress throughout the calendar year.

Okay. And let me just ask one on the OpEx. You guided to $540 million, which is obviously up when you adjust out for the items. Presumably the $540 million is exiting items. So where is the increase sequentially?

Yes, Richard, what we do is, I mean, we talked before that we have a pretty -- focusing on operating our OpEx pretty variable and we have 6 months incentive programs and since -- when we set them on the July time frame, our expectation of total market demand was different. They didn't quite payout at the level that we anticipated originally and that's why we guided to $525 million. Obviously, we performed better than our guidance. So they paid out a little bit higher and then we have the said impact from the yen, well, that will get us to the $529 million. So the $540 million is a bit of progress compared to the $550 million run rate that we referred to earlier, but the main difference is incentive payouts, Rich.

Our next question comes from Aaron Rakers of Stifel, Nicholas.

I think you alluded to a little bit of it in the last question, but when I look at your gross margin and I think about it from a COGS per unit basis, it looks like it was up sequentially this last quarter and actually getting close to that, what would be historically a high level. So I guess my question is you mentioned areal density and you'd make progress towards that. Could you talk a little bit about where you're at on that areal density curve and when those yields start to show up? And how maybe we should think about the COGS per unit number as a function of gross margin?

Yes, again, I mean, both Steve and I commented on business mix changes. We got to be really, really careful with the COGS per unit because there's so many different businesses blended in. Again, I'll point you to the enterprise and branded numbers where we disclosed the volume and you'll see that we had pretty good sequential increases there. In terms of the areal density, we have said before, partly due to the flood, we're behind on deploying those. We're nowhere close to being done on this and, again, I don't think we'll make progress there throughout the fiscal year -- calendar year. Steve?

Aaron, let me add a comment there. I think that relative to -- there's a lot of things that are going on in terms of our cost, and I just want to give you my perspective. One of the things -- and let's be realistic with regards to ourselves. We have seen versus where we were before, and this is an industry statement, a pretty significant decrease in volumes. So if we -- it would be unfair to isolate per se cost opportunities that we have to areal density alone, right? We have -- we obviously have more capacity than what we're producing because we're throttling it to what we see as demand. But we are taking actions to reset our capacity potential to a more appropriate level given what we view the secular changes in terms of the overall demand profile for the industry, not that we don't expect to see growth but not at the same rates than what we've historically done. So the point being is that there are multiple opportunities that we have as an organization to continue to improve our cost structure. And it's an area, it is probably other than innovation and those kinds of things and introducing some of the new products that we've talked about, getting traction in regards to that as we move to the back half of the year, and continuing to improve our cost structure on multiple fronts is one of the larger opportunities that we have as an organization.

As a follow-up, obviously, there's a lot of talk about hybrids. You talked about 7-millimeter, a lot of interest. Where do you stand on the current 5-millimeter platform? And should we expect those to start to materialize from a volume or design cycle basis by the end of calendar '13?

Yes. So what we talked about before and it continues to be the case is that right now what we're doing is we're shipping engineering samples to customers. We're actively engaged with them in terms of working with them as to how to utilize the new form factor as well as the solid state hybrid drive. We're making good progress in that regard. But we don't expect any revenue to materialize until we move into the back half of calendar 2013, with hopefully it being more of a meaningful contributor particularly as we move into 2014, calendar.

Our next question comes from Cindy Shaw of DISCERN.

If you could give us an update, I'd appreciate it. You mentioned it. It sounds like you still -- like you've got a better sense of cyclical versus secular. If you could give us some color on any changes in that and how you're feeling about it and then I have a follow-up.

I think that the 2 secular things that we're really dealing with and, obviously, they're related is, one, reset of overall volumes, and I talked about that earlier. And oh by the way, we talked about it at the Investor Day overall. We are not going to put our head in the sand and disregard the changes that are occurring around us, and so volume levels are lower than what we had seen, call it, pre-flood, and it's not just a flood dynamic obviously. It's changes that we're seeing within the overall IT space. And so we're dealing with that in terms of how we react from that perspective. And then additionally is where we are seeing growth in data and the innovations and the products that are required, and so we're seeing -- and that's when we talk about the 3 areas of investment in terms of the Connected Life, in terms of thin and light, and then as well in terms of the public and private cloud. So we're repositioning and continuing to reposition our roadmap and repositioning our investments to those areas so that we're appropriately optimized in those regards.

And then as we do look at some of those investment areas, the thin and light, I know expectations are going into the Windows 8 launch were, for many people, quite high. If you could give us any sort of updated view that you might have on that. And also elaborate to Connected Life, if you have done any sort of -- and I know that's historically sort of looking out into this kind [ph] a little bit, but any sort of sense for someone moves up of a PC and onto a tablet, what happens to sort of gigabyte demand if they go to a personal cloud or start storing things in the enterprise? Does that drive demand for more gigabytes or less or how should we think about that?

Yes, I think that in terms of the 5-millimeter, the thing that we have to keep in mind, and this is related to not only the 5-millimeter form factor but also as it relates to solid state hybrid drives, is that there are design windows to work with our customers on. And so we did not -- well first off, product is not generally available or shipping, it's still under development, but we are sampling with our customers. But we also have to hit the design time frames, design windows with our customers, and so that's why I go back to the point that we do not anticipate there being any shipment of those both from a development standpoint and from a design in perspective until the back half of 2013 with an all likelihood of being a more meaningful contributor in 2014. And so that's the 5-millimeter story, but we are encouraged with the progress that we're making and the interest on behalf of our customers. On the Connected Life, I mean, frankly, it's a little bit too early to call out specific data. And so -- but clearly one of the issues that's going on from a tablet perspective, I mean, tablet -- and I alluded to it in our prepared remarks, is that the storage capability on tablets is not that great, but yet the density, particularly, when you're talking about high def kind of content, video content, requires higher storage capacity and so, therefore, particularly as it relates to Win 8 and things like that or Android tablets is that they are USB enabled so that people can store more data on hard drives giving them, enabling them to access content at that higher video quality, thus increasing their experience from a consumer standpoint. But it's difficult to cite specific data as to how that plays out. But fundamentally, our job is to provide solutions to our consumers and to our customers that facilitates more and more data growth, and that's what we're trying to do.

Our next question comes from Sherri Scribner of Deutsche Bank.

I was hoping you could give us a little bit of detail on the different end markets in the past. I think you've given some comments about how those performed, so I was hoping you can give us some detail on the overall market.

I can give you a few points. Like I said before, if you dissect the 136 for the December quarter, desktop was pretty much like we expected it somewhere in the 44.5 million range. Notebook was a little bit weaker than we expected because there was inventory rebalancing going on, but approximately the same 44.5 million to 45 million units. Enterprise was solid, 2 million quarter-over-quarter and improvement there to 15.5 million. I think, we're mostly through the inventory situation there. So that was solid. CE, which includes gaming, was about 15 million units and then branded products, like we said, and it's also driven by the desire to back up and attach DAS and NAS products was 15.5 million units or so, which was also very solid. And we have performed well in all of these areas. Our company share is about 44% and we have more or less around 40% to 46% in all of these areas. So that's pretty much the market, for example, last quarter.

That's helpful. And then just as a follow-up, is there any extra inventory that you see in the various channels? I know you commented that disti is relatively lean, but we've had some inventory overhang. You've made some comments on the different segments. But just wanted to get an overall sense of work done with the inventory. And in the March quarter, do you expect to maintain your share? Or do you expect to lose or gain share?

Yes. So Sherri, I'll address the inventory and the share question. I think we said that the inventory rebalancing is largely complete, which means that it's not -- it's been reduced. There are small pockets, very small pockets. There's always small pockets where there might be some inventory corrections but nothing that we can tell and we don't have perfect visibility through all of the supply chain because it's not just our inventory or even our customers, it can be customers' inventory in the channel, but we don't believe there's anything meaningful from an inventory perspective. And then share, I mean, obviously our goal is to do the best job we can with our customers. And we believe that if we continue to do a great job with our customers, we're going to continue to do well from a share perspective, and where that leaves us, we'll have to kind of figure that out.

Our next question comes from Jayson Noland out of Robert Baird.

Steve, you mentioned better visibility, was that a comment on inventory? Or was there something more there?

Well, I think what was happening, as you go back to the past, I mean, the past several quarters, there was a much more meaningful overhang of inventory. The other thing is that we have to keep in mind is that our customers have been going through a significant product transition in terms of Windows 8, Windows 7, and then you got all the macroeconomic concerns and all the uncertainty associated with that. There wasn't -- I mean, so those things are beginning to lift. Accordingly, that gives us better visibility.

Okay. And there was some talk maybe a quarter or 2 ago about a 600 million TAM for cal '13 is that -- that seems tough, I guess, at this point?

Yes, I mean, in Steve's remarks, he said that the first half of calendar '13 would be roughly flat to slightly down with the second half of calendar year '12, and I think there was 275 million or so. And then we feel cautiously optimistic about the second half of the calendar year, but will it give us a lift to 325? Probably not. So 600 seems like a high number at this point.

Okay. And last question for me, Wolfgang, as data storage slowly drifts towards the cloud in different applications at a different pace, could you talk about your enterprise business and the strength there? Are those cloud buyers or is that traditional enterprise? And what are the expectations going forward?

Well I think that, I mean, the primary area where we're seeing growth is in high-capacity enterprise and that's really across the board. I mean, obviously, and we don't talk specifically about customers and things like that. But generally, we're seeing strength across the board in that regard and so -- but the performance, traditional performance enterprise, is a pretty stable market, not necessarily anticipating there to be meaningful growth in that regard, but still a great part of the market for us and for the industry. And in terms of how we feel like we're positioned, we feel like we're very well positioned in multiple regards. We talked about where we have our existing products. We're very strong in terms of the enterprise SSD market, not necessarily that material within the whole grand scheme of things but certainly helps us from an overall portfolio perspective with our customers in terms of offering them solutions. And then with the introduction of the helium-filled drive and that innovation, we really feel very, very strong not only about our existing portfolio but about where we're going in the future.

Our next question comes from Scott Craig of Bank of America Merrill Lynch.

Steve or Wolfgang, can you maybe talk about your utilization you think that you're running the factories at right now and maybe sort of the industry utilization. And then when do you expect to make decisions or the industry make decisions on how you should adjust capacity as you sort of head into the back part of the year. If things don't quite work out, how you're viewing them right now? And then along the lines of the CapEx, Wolfgang, why wouldn't CapEx be below the bottom end of the range given the significant, probably overcapacity, that's in the industry right now?

I'll give you a few pointers and I'll let Steve add on. I mean, as Steve indicated earlier, with the volumes being lower, I mean, despite the fact that we are adjusting our capacity at a reasonable pace, you should assume that we have more capacity than we need at least in certain aspects of our business. It's always a little bit difficult to answer because it's not like one big box that you're utilizing, you have a wafer fab and you have HTA [ph] and you have media, et cetera. But you see that we're very, very active in rightsizing the capacity and I gave you the jobs that we took. So we're doing that in a reasonable, realtime fashion and that's one key contributor how we continue to stay in the margin model. In terms of capital, we're doing a capital spending as realtime as possible. We are focusing our capital spend entirely on areal density progression, on technology advancement, on supply flexibility. For instance, we had only one slide of app [ph] and now we have, I think, 2. So we're not investing in capacity. With the exception of test, as we move more into these capacity enterprise rise, they just require a longer test time, and those are the key components that made our capital spending, and we continue to do what we have always done. We will manage this very, very tightly and realtime.

It comes from Steven Fox from Cross Research.

Just 2 quick questions from me. Given the strength on the branded business in the fourth quarter and given how the floods may have affected your production during the year, is there any chance that may be you left some money on the table in terms of consumer demand with branded? And if so, is there any -- how would that impact this calendar year? And then secondly, just a little bit more color on enterprise, if possible. I'm just trying to get a sense for whether you're seeing enterprise demand that is seasonally in line with expectations above, below. Any kind of color there would help.

Can you clarify the question on leaving money on the table. I wasn't quite sure I...

Well, I'm wondering if you were able to meet demand on branded products across all your retail partners or whether maybe there was more demand at the end of the year that maybe you anticipated.

I don't believe that was any issues with that, not to my knowledge. But if you know of anything, we'd be happy to support it. So and then I'm sorry, now, I got distracted on the second part of the question.

Yes, that's okay. I'm just trying to understand the March quarter seasonality on the enterprise class drives especially high-capacity drives. Are you seeing typical seasonality from your enterprise customers? Or is it better or worse start to the year?

Yes, in general, what we expect for the March quarter, flat to slightly up. But again, if you look at this in the midterm, the capacity enterprise is what we believe is going to grow double-digit and the performance enterprise is more growing with the GDP at a lower rate.

Our next question comes from Keith Bachman with BMO.

The first is on pricing. Within the guidance you've provided for the March quarter, could you talk specifically about what your expectations are for pricing. And then more importantly, as to extend Ananda's question, as you're thinking about the next couple of quarters, how are you thinking all the various forces will impact your pricing assumptions?

Yes. Like-for-like modest declines. It's still a competitive market. Our absolute price will be impacted by segment mix, and then going forward, it's a little bit tough to tell. I mean, we're looking at where we are as it relates to our business model and we're committed to be in the 27% to 32% range and that will govern our pricing.

Okay. Well, any responses -- Seagate specifically talked about pricing. They think it could indeed be flat sequentially for the next couple of quarters. Any reaction to those comments, specifically?

Well, I mean, you have to ask Seagate about that. I mean, obviously, we're trying to manage all the variables that we have, including pricing, to continue to improve our overall business performance and that sort of thing. We factored in some assumptions in terms of what will happen, and we'll have to see how that plays out in terms of how we move through the quarter, but I'm not going to comment specifically on Seagate's pricing.

Okay. Then more broadly my follow-up question, if I could, is you provided gross margin color for the near term March quarter. Could you just help us think about as you look, say, the June quarter or even within the March quarter, what are the -- outside of the pricing, what are the key areas that we should be really focused on or that you guys were focused on between mix and restructuring at Hitachi and the demand that would impact the gross margin to keep within the range that you've talked about?

Well, I think that there are a few key things. I mean, first off, we will be very careful about what business we take and what business we don't take and that sort of thing, so being selective within reason with regards to that. The other thing is to continue to manage our operations very closely from a cost and efficiency perspective and then particularly continuing to make improvements there. That's a very big opportunity for us across the board. And then the last thing which is what benefited this quarter is to continue to push our mix, both in terms of the capacity mix that we're shipping and selling but also in terms of the segment mix that we have overall. And again we do believe that the secular trends in that regard are moving in a positive direction. So we've got a little bit of wind at our back, if you want to call it that, in regards to that.

Our next question comes from the Nehal Chokshi with Technology Insight Research.

So in the industry segment detail that you gave us, looks like the enterprise hard drive segment increased about 15% Q-over-Q and your own enterprise hard drives increased 11% Q-over-Q. So can you just discuss what was the driver for the underperformance relative to the industry. And if possible, can you give us some additional detail on a subsegment basis on the relative performance. And I have another question about the Arkeia acquisition.

Yes, I mean, on the enterprise, and we gave you rough numbers. Our enterprise market participation was as expected. There's always a little puts and takes, but our share is more or less flattish quarter-over-quarter.

Okay. All right. So this Arkeia acquisition looks like a nice acquisition that can build some value in the SMB segment and start to blur the lines at some of your enterprise customers. But in order to successfully do that, I think that you're going to have to build the brand value of Arkeia. So is that the intention of that acquisition? And if it is, can you discuss the investment that Western Digital is willing to make in order to build that value, that brand value, to realize full potential of this acquisition?

First off, it was not a significant acquisition from a dollar amount perspective, but it does add the building block to our product capability in the SMB market and so really what we're trying to do is continue to improve our offering. And obviously, as we improve our offering, we're going to have to make other investments, prudent investments, to increase our presence in that marketplace. But this is -- we're just continuing to take it a step at a time in terms of enhancing our competitive position in that marketplace.

And our next question comes from Ben Reitzes of Barclays Capital.

This is Eric Sterling for Ben Reitzes. In light of your expectations for demand in the first half of the calendar year, are you backing away from the $10 EPS target that you had put out earlier in the year?

That's a good -- that's a safe assumption, yes. I mean, we expect the $10 EPS target in the July time frame and at that time we were anticipating what we thought was -- frankly, was conservative for 5% growth in the market, which would have gotten you to some 630 million for the fiscal year. And when you do the math now based on what I -- what Steve said earlier, we'll probably land somewhere on 550 million, that's a very, very significant reduction in volume. What we have achieved with everything else was the product offering we achieved the gross margin models. But with a TAM that low, it's unrealistic and you can do the math, what we would have to achieve in Q4 so we don't think that's realistic anymore.

Right. And in terms of buybacks for the March quarter, how should we think about that?

That's just -- we're executing to our capital allocation strategy which, as a reminder, called for 50% of the free cash flow to be spent on share buybacks and dividends, and we're going to execute into those metrics.

Our next question comes from Rob Cihra from Evercore Partners.

Two questions, if I could. One, Steve, you had talked about the visibility getting better now that inventories have been worked down, which makes sense because at least you get a truer view in the demand. But can you talk about your OEM customer visibility? My sense is that they don't normally have a lot of visibility this time of the year, and that this year it may even be worse than usual. I mean, do you get a sense that they have any visibility past, say, February. And are your comments of visibility actually implying that maybe their visibility is starting to get a little better here too or where do they look. And then separate from that, just a question on branded, your branded business is getting back to where it was pre-flood. You said inventories were lean there. Wondering if you're still sort of catching up, if you've caught up? And what do we need to see to get that market back to being a good growth market like it had been pre-flood?

I think it's difficult for me to comment specifically on the customers have better visibility. I mean, the reality of things from a customer perspective is that there's still a fair amount of cautiousness out there, conservatism, if you want to call it that. I mean, it's been a tough year and there's a lot of transitions going on but I think that -- and obviously there are, and this is always true, but maybe particularly given now there's always winners and losers, if you want to call it that, and so depends upon who you talk to and their level of confidence. But I think when we evaluate demand, we obviously don't, and no disrespect to our customers, we don't just listen to our customers. There's lots of things we triangulate to try to get a sense for where we think things are going to fall out. And it's those things, coupled with conversations with customers and to your point, the easing of the inventory overhang that gives us increased visibility and confidence with regards to how we see things playing out.

And I can answer the branded question. I mean, last quarter, the market for branded was higher than pre-flood. So that market was totally recovered and if you recall from our September Analyst Day and Investor Day, branded is clearly one of the areas along with capacity enterprise where we believe we will see solid growth for the coming years, both on the DAS and the NAS side and that's driven by the desire and need to backup and, it's also driven by the data growth in general.

Our next question comes from Mark Miller of Noble Financial Capital Market.

One thing that you seem to be a doing a very good job on is keeping your markets up, ASPs were flat this quarter, the channel has also been lean as you noted. Is there reason to believe there are other factors just besides behaving well in terms of internal cost cuts and reducing your cost per prime unit that will also support higher margins in 2013? I know they went up significantly after the acquisition of Hitachi, but there were a lot of moving parts there with the flood, and I was expecting I think you said we can't expect that to come down.

Yes, I think, Mark, just to kind of comment on that, there's always multiple levers that we have to influence our business outcome. And I know that a lot of times the market, and I'm referring to, call it, Wall Street in this case, will focused on one particular variable or what have you or whether it be demand, or it be pricing data points that are out there and say, well, you know, margins must be going down or this creates this kind of problem. And we obviously have a very holistic way in terms of the way that we manage our business and a lot of levers that we can pull, including improving our cost, improving our mix. The selection of what business we accept or don't accept with our customers and then obviously pricing. So there's lots of different things that we can do. And to your indication or to your point, we do believe that we've done a reasonably good job, and that's reflected in our gross margin performance and not only that, our guidance, and we expect to continue to do that going forward. And that's why we've stated the fact that we're confident that we're going to continue to stay within this gross margin range of 27 to 32, and that it's not just a set of aspirational goals. It's the way that we're going to manage the business.

Because of the flood, your competitor signed up a number of its customers to long-term agreements, and it seems to me a lot of these agreements should be patiently done with. And I'm just wondering are these agreements expiring or are there opportunities for you as these agreements expire or these agreements are still -- some of these agreements are extending well into 2013?

Yes, just to correct one thing, Mark. We did not sign or have a lot of -- we didn't have any meaningful, if you want to call it, LTAs with our customers. So this is based upon -- there's no contractual lockup, if you want to call it here, that's compelling our customers to pay us higher prices than otherwise they would desire. This is just good old hard work in the way that we're dealing with our customers and how we're managing our business.

Well my point was more with your competitor, which had stated...

I'm sorry, with our competitor. Yes, I mean, those have been expired. We don't have all the details, but they've been expiring over time and you'd have to ask Seagate more details about it. All right, I'd like to thank you again for joining us. In closing, I also want to thank all Western Digital employees for their dedication and outstanding performance and our customers and our suppliers for their support. We look forward to being in touch with you. Thank you.

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