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FOOL PLATE SPECIAL
An Investment Opinion by Dale Wettlaufer

Unit Growth Strong, Pricing Weak at Western Digital

WESTERN DIGITAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %> shareholders are going to feel a little queasy today when they punch up the stock quote on the Southern California disk drive maker. This morning the company announced that it expects to report Q2 EPS of $0.20 to $0.30, below the mean estimate of $0.83. At midday, Western Digital is down $5 5/16 to $24 15/16. After two quarters of earnings warnings and an 85% decline in first quarter EPS (before charges) at competitor SEAGATE TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %>, Western Digital is feeling the effects of highly competitive pricing in desktop drives due to a number of factors that are familiar to investors in the PC, disk drive, and semiconductor industries. Deflationary price pressures rule in the disk drive industry. With prices falling under a dime per megabyte of storage at the high-end and under a nickel per megabyte at the low-end (or desktop end) of the market, down from about $0.25 a few short years ago, this is a unit growth game. Whenever the inventory channel gets a little clogged up, all hell breaks loose with short-term perceptions.

Western Digital is forecasting extremely robust unit demand growth, with sequential unit growth at a minimum of 15.9%. Comments the other day from upstream supplier HUTCHINSON TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HTCH)") else Response.Write("(Nasdaq: HTCH)") end if %>, which supplies 70% of the disk drive suspension assemblies for the industry, indicate that the rest of the industry has not experienced this same sort of demand growth. That leads us back to pricing pressures and what might be happening at Seagate. Though CEO Al Shugart has said on numerous occasions that Seagate would maintain prices to generate the required return on the massive capital assets of the company, there's a gulf between what Seagate would like to do and what it must do when the inventory channel becomes bloated. Companies such as Seagate and Fujitsu that don't specialize in turning inventory and managing working capital, instead concentrating on building margins through being a vertically integrated manufacturer, suffer from the double-edged sword of operating leverage. Defined as the ratio of percentage change in operating earnings to a percentage change in revenues, high operating leverage can be great when times are good and very challenging to earnings when things are slow.

One good measure of working capital management can be seen in inventory turnover. Last quarter, Seagate likely achieved an annualized inventory turnover under 8 times (extrapolating from the Q4 balance sheet -- no balance sheet is included in the Q1 press release) while Western Digital came in at 14.5 times annualized. In a period of dropping prices in digital signal processors, media, and other components (which is a constant in the industry), the company that turns inventory faster will realize cost savings faster and operate nearer its target gross margin. In addition, the company that has the higher-cost structure will not be able to adapt as quickly to changing demand in the market. As inventory backs up and production assets work under capacity, that company needs to back off and liquidate inventory to pay for the depreciation, financing, and labor clocks that are always ticking for the physical plant.

The upshot of this wafer-dry discussion? Western Digital and Seagate are experiencing different problems. Unit sales are not growing as fast at Seagate, which has lost market share at the high-end. As a consequence, though, Western Digital suffers the same price pressures that Seagate must bring upon itself to remedy the situation. In the short term, that is cold comfort for Western Digital holders. When price pressures level off, though, Western Digital will be able to profit from that condition more quickly and will be better able to get shareholder return going in the right direction.

UPS

Teleservices outsourcer SITEL CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SWW)") else Response.Write("(NYSE: SWW)") end if %> gained $7/8 to $9 13/16 this morning after reporting Q3 EPS of $0.01 last night, matching expectations of $0.01.

QUALITY FOOD CENTERS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: XQ)") else Response.Write("(NYSE: XQ)") end if %>, the second-largest supermarket chain in the Puget Sound region of Washington State, moved up $8 to $59 5/8 after announcing that it was being acquired by FRED MEYER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FMY)") else Response.Write("(NYSE: FMY)") end if %>, which rose $1 13/16 to $32 3/4. Fred Meyer is also acquiring Southern California operator Ralphs Grocery to create a massive $15 billion supermarket chain.

Contract manufacturer of custom designed fabricated products TMCI ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TMEI)") else Response.Write("(Nasdaq: TMEI)") end if %> gained $27/32 to $6 3/32 after reporting Q3 EPS of $0.14 versus $0.05 for the prior year period.

Manufacturer of cable assemblies and wire harnesses for original equipment manufacturers JPM CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: JPMX)") else Response.Write("(Nasdaq: JPMX)") end if %> gained $2 to $21 1/2 after reporting Q4 EPS of $0.25, topping estimates of $0.23.

Personal health and care management services provider ACCESS HEALTH <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ACCS)") else Response.Write("(Nasdaq: ACCS)") end if %> rose $3 3/8 to $36 5/8 on reporting Q4 EPS of $0.25, beating expectations of $0.24.

ABIOMED INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ABMD)") else Response.Write("(Nasdaq: ABMD)") end if %> said today that it will withdraw its secondary public offering of common stock in response to market volatility, which boosted shares of the cardiovascular, dental, and medical products maker $2 1/4 to $19 1/2.

DOWNS

Electronic component original equipment manufacturer NAM TAI ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NTAIF)") else Response.Write("(Nasdaq: NTAIF)") end if %> lost $3 to $21 7/8 after reporting Q3 EPS of $1.06 versus $0.40 in the prior year period.

Shoe seller NINE WEST GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NIN)") else Response.Write("(NYSE: NIN)") end if %> lost $2 7/16 to $33 1/4 over concerns about the Securities and Exchange Commission issuing a subpoena for documents on the company's products made in Brazil.

Disk drive manufacturer QUANTUM CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QNTM)") else Response.Write("(Nasdaq: QNTM)") end if %> fell $3 13/16 to $31 3/4 this morning after the announcement by WESTERN DIGITAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %> that it was experiencing earnings pressure due to pricing concerns despite continued strength in unit sales.

APPLIED MAGNETICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: APM)") else Response.Write("(NYSE: APM)") end if %> lost $1 11/16 to $21 15/16 and READ-RITE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RDRT)") else Response.Write("(Nasdaq: RDRT)") end if %> fell $1 1/8 to $20 as these companies adjust to the current inventory needs of their customers in the disk drive industry.

ATRIX LABORATORIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ATRX)") else Response.Write("(Nasdaq: ATRX)") end if %> announced the termination of the company's worldwide license agreement with GENSIA SICOR <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GNSA)") else Response.Write("(Nasdaq: GNSA)") end if %> to develop a "sustained-release version of leuprolide acetate for treating prostate cancer," which slammed Atrix $2 to $17 1/2.

CONFERENCE CALLS

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Randy Befumo (TMF Templr), Fool One
Dale Wettlaufer (TMF Ralegh), Fool Two
Alex Schay (TMF Nexus6), Fool Three
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Brian Bauer (TMF Hoops), Fool Four
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