Western Digital Q2 beats Street; sees inventory drag

The company's shares, which have been among the worst performers on the S&P 500 index .SPX in 2010, rose 5 percent after the earnings beat expectations but pared most of the gains on the weak sales outlook.

Western Digital expects third-quarter revenue of $2.20 billion to $2.25 billion compared with analysts' expectations of $2.27 billion.

"Despite a reduction of about 2-3 million hard drives in the PC supply chain, there is still an inventory in excess of 6-8 million units in the PC manufacturers pipeline," Chief Operating Officer Timothy Leyden said in a conference call.

The inventory warning indicates that Western Digital could see a return of the supply glut that hit its results in mid-2010.

For the current quarter, Western Digital said hard-drive unit shipments rose 5 percent to 52.2 million.

In October, the company had warned that tablets such as Apple's (AAPL.O) iPad -- which use flash memory rather than hard-drive storage -- would reduce growth in shipments of low-end laptops by 10-20 percent over the next few quarters.

However, analysts said pricing was better than most estimates, significantly boosting gross margins and indicating that tablet sales had not begun to hurt hard-drive makers.

"The Street estimates for gross margins were about 16.2 percent, while the company posted 19 percent," said Wedbush Securities analyst Kaushik Roy.

"It indicates that tablet cannibalization has not yet impacted them. The question is going forward what happens."

Some analysts, however, warned that increased adoption of tablets and use of flash drives in the enterprise segment may pose a risk for the hard drive industry.

"Apple is early in driving new form factors such as tablets SSDs and similar type of form factors will also be launched for the traditional Windows World that will hurt Western Digital and Seagate," Rodman & Renshaw analyst Ashok Kumar said.

However, Needham's Richard Kugele said the tablet is largely an incremental device and only encroaches on the low end of the netbook space.

Western Digital said net income for the October-December quarter fell to $225 million from $429 million in the year-ago period. Revenue fell 5.5 percent to $2.48 billion.

Analysts expect Seagate to post better-than-expected quarterly profit when it reports results on Wednesday.

(Reporting by Supantha Mukherjee in Bangalore; Editing by Prem Udayabhanu, Saumyadeb Chakrabarty and Bernard Orr)