Western Digital Corporation Conference Call Remarks, 12/12/2017

Bob Blair - VP Investor Relations

Good afternoon, everyone. Thank you for joining us today to discuss our settlement with Toshiba and the future of our flash memory joint ventures.

This conference call will contain forward-looking statements within the meaning of the federal securities laws, including statements regarding the global settlement with Toshiba, TMC and Bain Capital, and the resolution of outstanding legal disputes; the NAND flash memory joint ventures; investments in Fab 6; our participation in TMC's new wafer fabrication facility to be constructed in Iwate, Japan; NAND flash memory and the flash memory market; our technology and market positioning; demand and market trends; our expected future financial performance; our financial and business strategies and execution; our stock repurchase and deleveraging plans; and expectations regarding growth opportunities. 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 annual report on Form 10-Q filed with the SEC on November 7, 2017. We undertake no obligation to update these forward-looking statements to reflect new information or events.

Further, references will be made during this call to non-GAAP financial measures. Reconciliations of the differences between the non-GAAP measures we provide during this call to the comparable GAAP financial measures will be posted in the Investor Relations section of our website. We have not fully reconciled our non-GAAP financial measure guidance to the most directly comparable GAAP measures because material items that impact these measures are not in our control and/or cannot be reasonably predicted. Accordingly, a full reconciliation of the non-GAAP financial measure guidance to the corresponding GAAP measures is not available without unreasonable effort.

In the question/answer part of today's call we ask that you limit yourselves to one question to allow as many callers as possible to ask their question. I thank you in advance for your cooperation.

With that, I will now turn the call over to our CEO, Steve Milligan.


Steve Milligan - CEO

Thank you, Bob, and thank you all for joining us on such short notice. With me on today's call are Mike Cordano, our President and Chief Operating Officer, and Mark Long, our Chief Financial Officer. In addition to discussing the details of today's announcement, we want to provide an update to our business and financial performance. We have some prepared remarks and then we will take your questions.

We are very pleased with today's news, and as we prepare to enter the new year, we are doing so on a strong footing.

Today we announced that Western Digital, Toshiba, TMC and Bain Capital have entered into a global settlement that strengthens, extends and enhances our mutual commitment to the flash memory JVs.

For the past 17 years, our NAND flash memory JVs have set the industry standard for innovation, quality and collaboration in technology.

This is widely considered to be one of the most successful joint ventures in the history of the technology industry. Since 1999, our partnership with Toshiba has achieved unprecedented success, growing into a global technology leader with 13 generations of jointly developed and manufactured NAND flash memory.

This announcement affirms the partners' commitment to the strong future of our world-class JVs and guarantees our long-term access to NAND supply.

This agreement is a win-win for all parties.

Western Digital and TMC have agreed to the following:

  • Flash Alliance will be extended to December 31, 2029 and Flash Forward to December 31, 2027.
  • With regard to Fab 6, Western Digital will participate in all future investments including the second investment tranche.
  • Western Digital and TMC intend to enter into definitive agreements regarding our participation in the new wafer fab facility in the Iwate prefecture, on terms substantially similar to those that apply to the fabs in Yokkaichi.
  • We have also renewed our commitments to R&D collaboration to enable long-term technology leadership.

The two companies have established appropriate protections for intellectual property to adapt to changing corporate ownership structures. In addition, we have put in place equity transfer restrictions to enable the successful continuity of the JVs.

Western Digital will consent to the transfer of Toshiba's equity interests in the flash memory JVs to TMC and to the sale of TMC to the Bain-led consortium.

This sets the stage for TMC's eventual initial public offering.

As a result, Western Digital, Toshiba and TMC will withdraw all pending litigation and arbitration actions.

Western Digital continues to focus on its long-term growth strategy and strong business fundamentals.

Our strategy has been to establish a comprehensive platform that extends across technologies, products, and markets.   

The power of this diversified platform has allowed us to lead the global evolution of the data storage industry, uniquely positioning us to address the rapid growth in Big Data and Fast Data applications. The Western Digital platform is a critical enabler of next generation technologies such as artificial intelligence and virtual reality that power applications including self-driving cars and fully automated factories.

With that, let me turn it over to Mike.


Mike Cordano - COO

Thank you Steve, good afternoon everyone.

I would like to provide our perspectives on the flash memory industry.  What I am showing here is the industry's investments in flash as a percent of total industry revenue.  The trend here is that in the early years of the industry the ratio of capex to revenue was significant, nearly 55% in 2008 vs approximately 40% expected in 2017. 

Over time, as the industry has become larger the overall capex/revenue ratio has declined.  Additionally, the rate of growth of industry revenue has been higher than that of capital investments. This growth in the industry revenue has been supported by the increasing diversity of applications that require flash.

The flash industry is larger and more mature than before.  As the size of installed capacity has grown, new capex has a smaller incremental impact on bit output. Also, incremental capacity adds are done in a modular fashion, allowing industry capacity to grow in a measured manner.  Consequently, this allows us to better navigate different stages of industry cycles.

The flash industry's ability to deliver annual cost decline falls into two categories. The first is the inherent capability of the technology to provide cost reduction below the previous node and the second is the rate at which the industry can adopt that new technology into production.

Comparing against the baseline of the last few 2D transitions, in the 3D flash era, while we are able to get higher bit growth per wafer, the higher cost of manufacturing the 3D flash wafer, the longer timeline to develop the new nodes and the longer time to install new tools all contribute to lower annual flash cost decline rates.

An additional factor you see in the industry today is that several of the flash suppliers also make DRAM. Given the tightness in DRAM supply, some of these companies are shifting their 2D flash capacity to DRAM and that is moderating the overall rate of bit supply growth for flash. Consequently, we expect the flash industry bit growth in calendar 2017 to be at the low end of our long-term range of 35% to 45% and for calendar 2018 within that long-term range.

Through strong execution, we will exit  calendar 2017 with more than 65% of our bit output on 3D flash.

In the near-term, overall spot market pricing trends have been consistent with our expectations.  We see the market stable and normalizing where modest price declines in flash are largely offset by underlying flash cost reductions.

Also note that Western Digital is a product company, so the vast majority of our flash sales are based on our products, not just components.  You should keep that in perspective as you think about how open market pricing trends influence our business, as our portfolio of products and end markets we participate in, lessen our pricing volatility.

We are also updating our expectation that the flash supply-demand environment will remain healthy throughout the 2018 calendar year.  

I would like to also emphasize Western Digital's leadership in flash in general.  We have been the leaders in 2D flash and we ended our 2D flash scaling roadmap with our 15 nanometer node, the most successful in the industry.  Over the 11 generations of 2D flash, we have learned immensely about the complexities of this technology and how to make it work for the broadest use cases.

We are applying all our learnings to 3D flash and we are very pleased with where we stand today. Our BiCS3, which is the 64 layer technology, is ramping well and is being implemented across our portfolio. In fact, we will exit calendar 2017 with more than 90% of our 3D flash bit output on 64 layer technology.

We are also on track to begin product shipments of our BiCS4, 96 layer technology, to retailers this week.

As we have stated previously, throughout calendar 2017, we have accelerated our R&D investments and efforts to broaden and deepen our portfolio.  This was intended to deliver two primary benefits: greater revenue diversification and expanded customer breadth.  Keep in mind none of our customers account for more than 10% of our revenue.  We have expanded our product line with capabilities to control the technology stack from its underlying form to a value-added product containing our systems technologies.  This will allow us to continue excuting and delivering strong financial results in a variety of market conditions.

I will now turn the call over to Mark.


Mark Long - CFO

Thank you, Mike and good afternoon everyone.

I'd like to update you on our expected financial performance for our fiscal second quarter of 2018.

On a non-GAAP basis, we now expect:

  • Revenue to be approximately $5.3 billion dollars;
  •  Gross margin to be between 43% and 44%.
  • Operating expenses to be between $850 and $860 million dollars, versus our prior guidance of approximately $830 million dollars.
  • This increase is entirely driven by over-achievement on our 6 month variable compensation plan.
  • Interest and other expense is expected to be between $190 to $195 million dollars.
  • Further, we expect an effective tax rate in the 5-7% range.
  • Our diluted shares are expected to be approximately 309 million.
  • As a result, we now expect non-GAAP earnings per share of approximately $3.80.

I'd also like to provide our current view of fiscal 2018 and some of the gross margin dynamics we expect in calendar 2018. 

  • We expect to see the opportunity to achieve annual revenue growth at the high end of our long-term model of 4 to 8% for fiscal 2018. In addition, for all of calendar 2018, we now expect our annual revenue growth to also be at the high end of our long-term model.
  • We expect gross margins to be healthy, as Mike alluded to, and above our long term model throughout calendar 2018.
  • Also, based on our existing capital structure, we now expect our non-GAAP earnings per share to exceed $13 for fiscal 2018.

Beyond the income statement, let me give you some perspective regarding our balance sheet and cash flow expectations as well…

First, turning to our capital structure and debt capacity. We recently refinanced some of our loans on more favorable terms and prepaid our Euro loan in full to achieve greater interest savings and eliminate expensive hedging costs. 

We increased our existing revolving credit facility by approximately $500 million to $1.5 billion to give us added flexibility.

We also announced last month that we will resume potential stock repurchases under our previously approved $5 billion program of which $2.1 billion is remaining, subject to market conditions and compliance with our debt instruments.

Additionally, we generated $3.4 billion of operating cash flow in fiscal 2017 and approximately $1.1 billion in the first quarter of fiscal 2018.  For the December quarter, we expect a similar level of operating cash flow as last quarter. 

Due to the ongoing 3D flash conversion, as we have previously indicated, in fiscal 2018 we will likely be slightly above our long-term cash capex investment range of 6 to 8% of revenue for both flash and HDD combined.  Following the initial conversion to 3D NAND, we anticipate that our long-term total cash capex investments will remain in the 6 to 8% of revenue range.

Given our focus on reaching a solution with Toshiba and running our business, we haven't had the opportunity to communicate with the investment community as much as we would like since our Investor Day a year ago.  But we look forward to engaging with you on a more robust basis in the year ahead, beginning with today's call.

We are now ready to take your questions… Operator.

Closing Remarks:

Again, we thank you all for joining us today. We look forward to staying in touch with you in the months and year ahead as we continue to execute to our strategy. I also want to extend my heartfelt thanks to all Western Digital employees for their hard work and dedication during the past year. I greatly appreciate that effort. Have a great day