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Has Maxtor's bubble burst?

Low-end Serial ATA manufacturer Maxtor announced a massive layoff and pre-announced disappointing Q2 results. Reading between the lines, a shakeout is looming, which could portend rising prices for end users.

Maxtor Corp. said late Thursday that it will lay off 400 to 500 staff by year's end and pre-announced disappointing results for its June quarter. The news highlights the continuing pricing pressure and struggle for profits in the disk-drive sector and suggests consolidation is on the way.

Maxtor set new revenue guidance of $820 million to $825 million versus previous guidance of between $955 million and $980 million for its second quarter results. The company expects to report a net loss on a GAAP (generally accepted accounting principals) basis of between $20 million and $30 million. It will report final results for the second quarter in mid-July, 2004.

"We are extremely disappointed in our second quarter performance, which was the result of a very aggressive pricing environment in both the OEM and distribution channels and lower than expected unit shipments, primarily to distributors," said Paul Tufano, president and chief executive officer.

Maxtor expects that shipments in the second quarter will total approximately 11.6 million units, which is roughly 10% below its initial guidance. The company blamed white-box manufacturers and system integrators delaying purchases in anticipation of declining prices.

In the past quarter, the retail price for Maxtor 250 GB ATA drives dropped from an average of $238 to $213, or -10.5%. Its Serial ATA equivalent dropped even more dramatically, from $255 to $214, or -16.07%. That's a significantly higher drop than what Maxtor purported its average selling price dropped by (from $75 to $71 in the past quarter, or -5.3%). That discrepancy can in part be explained by the fact that Maxtor also sells enterprise SCSI drives, which, at least in Seagate's case, have shown much more pricing stability: In the past quarter, Seagate's 15K 36 GB SCSI drive has only moved from $313 retail to $311, or 0.6%.

A former senior executive with Maxtor, who declined to be named, concurred with the company's account of the quarter but believes it is probably hurting more than its competitors. "They are still cutting redundant areas following the Quantum acquisition…and had more product lines in development than they needed," he said. Maxtor acquired Quantum's hard-disk drive business in April2001.

Wall Street analyst Dan Renouard with Robert W Baird & Co. added that there are too many companies competing in the field and consolidation has to happen before the pricing problem will settle down. "Four to five companies in this market is too many; there is too much pricing pressure for a market growing so rapidly," he said. Roughly in order of market share in the enterprise sector there is Seagate Corp., Hitachi Ltd., Fujitsu Ltd. and Maxtor. Western Digital plays at the desktop-drive level only.

Renouard notes that Maxtor has the lion's share of the low-cost disk drive business but this means it has low margins and is getting squeezed on every deal. "Once consolidation happens, pricing will settle down and eventually could begin to rise," he said.

As to Maxtor's future, the company appears to have ridden the wave of hype around SATA, but hasn't apparently turned this into significant profits yet. The projections for low-cost storage adoption in online backup environments is high but it remains to be seen if it is high enough to turn around Maxtor's business or tempt anyone to acquire this struggling company.

The headcount eliminations will result in a reduction of costs and associated expenses estimated at approximately $60 million to $80 million annually. These actions will begin in the third quarter, the company said.

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