Special Note

Statements in these posted remarks that relate to future results and events, and other forward-looking statements in these remarks, are based on Western Digital Corporation’s current expectations.  Actual results in future periods may differ materially from those currently expected or desired because of a number of risks and uncertainties.  These risk factors include:

• the impact of current negative global economic conditions;
• supply and demand conditions in the hard drive industry;
• actions by competitors;
• unexpected advances in competing technologies;
• uncertainties related to the development and introduction of products based on new technologies and expansion into new hard drive markets;
• business conditions and growth in the various hard drive markets; pricing trends and fluctuations in average selling prices;
• changes in the availability and cost of commodity materials and specialized product components that WD does not make internally; and
• other factors listed in our periodic SEC filings and on this website in Risk Factors.

Robert Blair - Investor Relations

Before we begin, I want to remind you that we will be making forward-looking statements in our comments and in response to your questions concerning: demand in the hard drive industry; reductions in our expense and operations structure; our business restructuring plan and the associated impacts on our ability to maintain operating expense, align capacity with demand, and improve structural costs and gross margin range; the expected size, type and timing of charges and future annual savings associated with our business restructuring plan; our ability to deliver industry-leading performance; market opportunities for high capacity storage; our future investments; repurchases of our stock and management of our cash; goodwill impairment charges; our gross margin model, cost structure, and ability to remain profitable and cash flow positive; demand and pricing in the hard drive industry for the March quarter; and our financial results expectations for the March quarter, including revenue, gross margin, expenses, share count, restructuring costs, and earnings per share.  These forward-looking statements are based on management’s current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including those listed in our 10-Q filed with the SEC on October 31, 2008, as well as the additional risk factors reported in the press release included as Exhibit 99.1 to the Form 8-K we furnished to the SEC today. 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. Investors are encouraged to review the reconciliation of the differences between these non-GAAP measures to the comparable GAAP financial measures in our press release included as Exhibit 99.1 to the Form 8-K we furnished to the SEC today, a copy of which can be found under the “SEC Filings” link in the Investor Relations section of our Web site at www.westerndigital.com.

John Coyne - President & Chief Executive Officer

Thanks Bob.

Good afternoon and thank you for joining us today.

In our last conference call in October 2008, we were coming off a weak September quarter and accordingly, in contrast to historical norms of 7 to 10 percent quarter-on-quarter growth, we provided what we believed was muted guidance for the December quarter of approximately 5 percent unit growth in our served markets for 3.5-inch and 2.5-inch ATA drives. 

However, as the quarter developed, we saw unprecedented macroeconomic conditions depress these already muted expectations, with demand actually declining 14% sequentially, transforming the December quarter into one of the most challenging ever for WD and the entire hard drive industry. Instead of the 138 million units in served market demand which we expected, we saw a decline in industry shipments to 113 million — a negative swing of 25 million hard drives.  The timing of this sudden demand shift gave us and others in the hard drive industry just two months to react and adjust.

This rapid fall off in demand, amplified by customer inventory adjustments, further intensified the highly-competitive pricing environment we experienced throughout calendar 2008.

As we saw demand fall off dramatically in early November, we acted swiftly to align our production volumes and operating expenses, demonstrating the benefits of a well coordinated, capable and committed team executing to a proven, fast, flexible and responsive business playbook. Our response yielded positive results in comparative profitability, cash generation, asset management and increased customer preference.

While pleased with the performance of the team and the business model in addressing short-term conditions, our assessment was that this was not just a one quarter anomaly but rather a demand level reset which would become the new baseline for demand throughout calendar 2009.  Consequently we developed and put in motion a plan which resizes our expense and operations structure to a revenue expectation for calendar 2009 some 25% below that we achieved in calendar 2008.  The details of this plan, which involved headcount, compensation and work hour reductions across all areas of the company, as well as closure of facilities in both our component and hard drive manufacturing operations, were outlined in the Form 8-K we filed with the SEC on December 17, 2008.  These actions, which we expect to complete within the March quarter, are designed to maintain our operating expense in the range of 9% to 11% of revenues at the $1.5 billion level. 

The resizing of production capacity, through work hour and headcount reductions, facility closures, and equipment retirement is designed to align capacity more closely with our perception of ongoing demand, improve our structural cost and move us back towards our business-model gross margin range of 18% to 23%.

The hard drive is a high technology commodity.  The critical factors for success in this market are consistent high quality and reliability, large scale and low cost, focused asset management, effective technology deployment, product breadth and product availability.  WD’s consistent and profitable growth over the last seven years demonstrates our understanding of these key factors and our ability to deliver industry-leading performance across all of them, while executing within the financial model I outlined earlier.  We are focused on continuing to deliver outstanding customer value through consistent execution against this simple, yet effective, model.

Operating expense averaging 10% of revenue, over the last five years, has enabled expansion of our worldwide sales and support operations which has extended our ability to bring outstanding products to customers in every corner of the globe. 

It has funded the development of industry-leading component technologies in heads and media to underpin our customer value proposition and it has allowed us to develop a broad and diversified product portfolio serving the majority of the available ATA hard drive and external storage markets while also funding significant engineering activity in preparation for our entry into the traditional enterprise market. 

We continue to demonstrate the effectiveness of these controlled and focused investments, through the technology deployments and product shipments we have announced since our last conference call:

In the December quarter we believe that we shipped more 500GB 2.5-inch hard drives than all five of our competitors combined and shipped twice as many as our nearest competitor.  We brought the fundamental technology and system design to market at roughly the same time as key competitors.  However, it is the entire recipe of our approach to new product introduction and ramp that is evident in this level of market acceptance and our financial results. The ingredients include our process technology and new product deployment and our refinement of yield, utilization, cost and supply chain logistics, as we ramp into production, all the while maintaining the industry's leading quality and reliability metrics and lowest warranty expense.  

This week we began volume shipment of another industry first – the 2TB WD Caviar® Green™ 3.5-inch hard drive, employing our advanced 400Gb per square inch areal density technology, allied to our unique second generation WD GreenPower™ energy-saving technology. 

This same 2TB drive will also power a new capacity point in our My Book® line of personal storage products and enables an 8TB capacity in our WD ShareSpace™ NAS product line for home server, media center and small business applications.

In our Branded group, we launched several new Mac® products during the quarter, including the My Passport™ Studio™ with FireWire® 800 connectivity; the My Passport for Mac in 320 GB and 500 GB capacities; and the My Book Mac Edition at 1TB.

We also entered an entirely new Branded Product category with the launch of the WD TV™ HD Media Player—a device that allows easy playback, from any USB storage device, of music, photos and video directly onto televisions in full 1080p HD format.  This is the first in a line of WD Branded Products designed to bring users’ media content out of the home office and into the family room with a simple and elegant, PC-free, interface.

Tim Leyden will now provide our detailed report on the December quarter, our resizing and our outlook.

Closing
In closing, I want to thank the entire WD team. I am greatly appreciative of the loyalty and commitment to WD success displayed by all of our employees as we resize our business – those who are unfortunately leaving us and those who are staying with reduced compensation packages. Their integrity and class, their sustained focus, commitment to success and outstanding execution in these trying times is truly inspiring.  Our results, in such challenging market conditions, are a testament to their capability and tenacity.

Despite the current state of the economy, we remain very encouraged by the long-term market opportunities for high capacity storage in the years ahead. The applications driving the digitization of massive content are not going away.

We are taking what we believe are prudent and appropriate steps to size our business for the new economic environment we expect throughout calendar 2009.

We remain committed to provide the best customer value proposition in the industry, to deliver financial results which allow us to make the substantial investments required to continue to lead the industry in providing solutions to customer needs for high capacity, cost effective storage and to generate superior returns for our supply partners, our employees, the communities in which we operate and our shareholders.

I'd like to thank you for joining us today, I look forward to keeping you informed of our progress.

Tim Leyden - Executive Vice President & Chief Financial Officer

As John described, unprecedented macroeconomic conditions made the December quarter a challenging one for WD and the entire hard drive industry. Nevertheless, in the face of these challenges, the WD team took swift action to reduce expenses, cut production capacity, and minimize working capital investments.  As we entered the quarter, we had expected sequential quarterly unit growth of about 5% -- at the low end of historical seasonal trends. Instead we had to make course corrections during the quarter to respond to a decline in our total served market unit demand of approximately 14%, and desktop and notebook markets each declined about the same percentage.

Our revenue for the second fiscal quarter was $1.8 billion, down 17% from the prior year.  Hard drive revenue was down 13% from the prior year and 14% sequentially. Shipments totaled 35.5 million units, up 4% from the prior year but down 10% sequentially.  

Average hard drive selling price was approximately $51, down $2 from the September quarter and $10 from the year-ago quarter. Our Q2 ASP reflects a very competitive pricing environment as a result of all competitors having anticipated more robust demand and consequently having too much supply available for the demand that materialized.   

For the December quarter, we saw sequential declines in desktop, notebook and enterprise SATA unit shipments.  We experienced the first Q1 to Q2 decline in 2.5-inch drive market demand since entering the notebook market in September 2004. Our unit shipments of 2.5-inch drives were 13.8 million in the December quarter, as compared to 14.6 in the September quarter and 8.7 million in the year-ago quarter.

On the plus side, shipments of consumer electronics and branded products were up sequentially.  We shipped 4.1 million 3.5-inch drives for use in digital video recorders in the December quarter as compared to 3.9 million in the September quarter and 4.1 million in the year-ago quarter;  and revenue from sales of branded products increased 5% from Q1 and 10% from the year-ago quarter, to $403 million.

Hard drive channel revenue was 57% OEM, 21% distribution and 22% branded products in the December quarter compared with 56%, 26% and 18% in the September quarter; and 48%, 34% and 18% in the year-ago quarter, respectively. There was one customer - namely Dell - comprised more than 10% of total revenue.

The Q2 geographic split of our hard drive revenue was 23% Americas, 29% Europe and 48% Asia, as compared to 23%, 29% and 48% in the September quarter; and 32%, 32% and 36% in the year-ago quarter.  Demand strength in Asia continues to be driven by the concentration of global manufacturing in that region.

Our gross margin for the quarter was 15.9% versus 20.1% in the September quarter and 23.3% in the year-ago quarter.  Our December gross margin was impacted by the decline in overall market demand and the resulting competitive pricing pressures and factory underutilization. Our media operations continue to perform as expected, and we have achieved the 300 basis point cost savings objective outlined at the time of our acquisition.  

Total operating expenses of $274 million included $113 million of charges associated with the restructuring plan announced on December 17.  Excluding these restructuring charges, total R&D and SG&A was $161 million for the December quarter, $29 million less than the September quarter.  Our quarterly operating expense benefited from the reversal of variable compensation incentives amounting to $16 million that had been accrued in the September quarter, and the absence of similar accruals in the December quarter, and a $6 million insurance recovery.

Our resizing plan includes the closure of one of our hard drive manufacturing facilities in Thailand, one of our substrate manufacturing facilities in Malaysia and headcount reductions throughout the world.  We expect the plan to be implemented by the end of March 2009.  Planned headcount reductions of about 7 percent combined with attrition of 6% should result in total headcount reductions of about 6,500 by the end of March.  When combined with work hour reductions of about 7%, the result should be about a 20% reduction in total capacity.  The total cost of the restructuring is currently expected to be approximately $140 million, $113 million of which has been recorded in operating expenses for the December quarter.  The total cash utilized by the resizing actions is expected to be approximately $60 million, most of which will be spent in the March quarter.  There were no material cash expenditures related to the restructuring in the December quarter.  Annual savings from these actions are expected to be approximately $150 million.

Operating income was $16 million, or 0.9% of revenue, including the $113 million restructuring charge.  Excluding the restructuring charge, operating income on a non-GAAP basis was $129 million, or 7.1% of revenue. 

Interest and other non-operating expenses were approximately $9 million. This includes about $6 million of unrealized losses on our previously disclosed investments in auction-rate securities. These investments totaled $19 million at the end of the quarter.

The company recorded a net tax benefit for the December quarter of $7 million.  This consists of a tax provision of $6 million, offset by a $6 million tax benefit related to the extension of the R&D tax credit, which was enacted into law in October 2008, and a $7 million favorable adjustment to previously recorded tax accruals to reflect a change in the company’s outlook for future income before taxes. 

Net income totaled $14 million, or $0.06 per share. Excluding the $113 million restructuring charge and the related tax benefit of $4 million, non-GAAP net income was $123 million, or $0.55 per share. 

Turning to the balance sheet, our cash and cash equivalents at the end of the quarter totaled $1.4 billion as compared to $1.2 billion at the end of September. 

We generated $300 million in cash flow from operations during the December quarter. 

Capital expenditures for the December quarter were $140 million and our non-cash charges for depreciation and amortization expense totaled $122 million. 

Capital expenditures for fiscal 2009 are expected to be about $500 million.  This is consistent with the update we gave on December 17, when we announced a significant reduction from our prior forecast of $750 million. Depreciation and amortization for fiscal 2009 is expected to be about $480 million.

We did not repurchase any shares of stock during the December quarter.  We believe that in times of economic uncertainty and tightness of credit that a robust cash balance is an important strength.  We will continue to manage our cash accordingly during these uncertain economic times.

As of the end of December, we had 46 days of receivables outstanding, 27 days of inventory, or 14 turns, and 64 days of payables. This resulted in a cash conversion cycle of 9 days. 

In accordance with the accounting rules prescribed by FAS 142, we reviewed the value of our goodwill and concluded that our goodwill was not impaired as of quarter end.  This review must be done annually, or whenever events or changes in circumstances indicate that goodwill may be impaired. It is possible that an impairment charge under the FAS 142 rules could occur in future quarters.
 
Before I discuss the March quarter, I would like to make a few comments about our stated business model.  As John indicated, we continue to believe that an 18 to 23% gross margin model is appropriate given our level of vertical integration, the amount of investments in capital and R&D required to continue to provide the products demanded in the marketplace and to generate an appropriate return for our shareholders.  As outlined in the restructuring plan, we have resized our cost structure with the objective of remaining profitable and cash flow positive at a $1.5 billion quarterly revenue run-rate.  The critical remaining pieces of the equation are a balanced supply/demand environment and a product and segment mix that will support a revenue level commensurate with the value we are delivering.   

I want to once again remind you that WD will have a 14-week quarter in this fiscal year and we will include that extra week in our fourth fiscal quarter that will end on July 3, 2009. 

Now I will discuss our expectations for the third quarter of our fiscal year 2009.  First, let me outline the market situation as we see it.

Taking these factors into account, we expect current quarter revenue for WD to be in a range from $1.35 billion to $1.50 billion.  For comparative purposes, you should note that our fiscal Q3 revenue numbers last year included $89 million of revenue for external media sales as we fulfilled Komag’s pre-acquisition contractual obligations.

We are modeling gross margin in a range from 14.0% to 14.5%.

R&D and SG&A are expected to total approximately $175 million. 

Our net interest expense is projected to be about $4 million.
 
We anticipate tax expense of between $5 million and $10 million for the March quarter.      

We anticipate our share count to be approximately flat with the December quarter.

These amounts exclude remaining restructuring charges, which we estimate to be about $27 million.  This estimate may change up until the date of actual disposal or completion of the restructuring plan.  

GAAP EPS, including the restructuring charges, is therefore expected to be between a loss of $0.11 and a profit of $0.02 for the March quarter. Excluding the restructuring charges, we estimate non-GAAP earnings per share of between $0.01 and $0.14.  The non-GAAP earnings per share are calculated using the same share count as the GAAP earnings per share.

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