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WD soaks up $2bn in Thai flood aftermath

Coyne still faces HGST deal approval

Western Digital and its supply chain have pulled out all the stops and delivered a decent profit in the last quarter of 2011, the one in which some of its Thailand plants were inundated by deadly flooding.

For this quarter, its second fiscal 2012 quarter, WD pulled in revenues of $2bn – compared to $2.5bn a year earlier – and generated $145m profits ($225m a year ago). It shipped 28.5 million disk drives, almost half of the 52.2 million delivered a year previously.

How did it manage this magical trick? Its gross margin rose to 32.5 per cent from the 20.1 per cent seen in the previous quarter and that must have helped.

There are are several obvious questions that spring to mind. What about regaining full manufacturing levels? How is the HGST acquisition approval process going? What about that pesky half billion dollar arbitration award to Seagate? And then there are other questions about things such as hybrid drives. A look at the canned release and then the earnings call transcript gives us WD's view of these things.

The canned statement said: "The company ... has made significant additional progress to restore its manufacturing capacity following the recent flooding in Thailand. It has continued to ramp HDD production in Thailand and yesterday resumed slider production which had been suspended since October 10. The company now believes its manufacturing capacity will be back to pre-flood capabilities in the quarter ending September 2012." That's a long time still but at least there is an end point.

HGST approval

Here's JC – CEO John Coyne – talking about the HGST approval processes: "We have several full approvals, we have several conditional approvals, conditional approvals from EU, Japan and Korea, and we continue to work with the FTC in the US and with China to gain approval there. And we believe that we will be in a position to meet the conditions of the approvals granted by the authorities that have granted conditional approvals so far. And we believe that we will achieve approvals from the – to China and the US before March."

If the approval processes don't complete by 7 March there will be a $250m termination fee to be paid to HGST.

There seem to be only two potential buyers for the slug of 3.5-inch disk manufacturing capacity WD has to offload to get EU and Chinese approval, and these would be Seagate and Toshiba. Both are smart cookies and could be saying: "Nope, don't need it, don't want it. Let me get this straight. You stand to fork out $250m termination fees, so anything less than that is a win, right? Tell you what; we'll take it off your hands if you pay us $240m. Is that fair?"

Cue gnashing of teeth in WD's HQ and then some.

Seagate arbitration and hybrid drives

Next, Coyne's view on the Seagate arbitration award which he'd said WD would appeal: "I can confirm that we have filed the petition since the start of this call. And we believe that the ... when that goes to court, as the court reviews that and considers the law, that the arbitration award will be vacated on that basis. We have made no accrual for that award in the current accounts. So that – I guess you have – paying is in our belief does not arise [sic]. We can't assure you of success, but that's our position today."

He's so confident that WD isn't putting any money aside for the possible eventuality of losing, and that could cost $630m, which added to the HGST termination fee totals $880m – a sizeable chunk of change at risk.

Seagate is making a big pitch for hybrid drives, disk drives with on-board NAND cache, for ultrabooks to provide near-SSD speed and HDD capacity at an affordable price point. So far Seagate is flying solo on this one.

What does WD think? JC said: "I expect ultrabooks to have both hard drives, traditional hard drives and hybrid hard drives and SSDs. So I think there will be, depending on the specific version of ultrabook ... all three solutions and even in certain models, choices between those solutions in the same model.

"And we think that the SSD penetration profile will be in very low single digits in a mature ultrabook environment. And then we see an emerging position for hybrids a little early to develop a view on exactly what percentage of penetration, but we see hybrids as a very compelling alternative on the performance side to solid state on bang for the buck. And we anticipate that in large capacity environments, traditional hard drives will continue to be the compelling solution."

A "very compelling alternative" – hmm, there is a hint here that WD is looking at making hybrid hard drives.

Coyne's high wire walk

WD has done very well to get its earnings to this state and there was much public thanking of customers and WD's workers and supply chain partners. There is a huge amount of work still to be done and the dratted HGST approval processes and damned Seagate arbitration awards could have come at better times, all things considered.

If Coyne's crew can hold their nerve, navigate the high wire they are on, and do their steady thing – and if their lawyers are right – then WD won't have to stump up $880m, stockholders will sigh an absolutely massive sigh of relief, and John Coyne will be an executive superhero – JC indeed. If WD doesn't pull it off then he will be as quickly forgotten as Bill Watkins.

Who? Didn't he run Seagate once?

Signs are JC's going to do it. ®

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