WESTERN DIGITAL FOURTH QUARTER ENDED JULY 2, 2010 CONFERENCE CALL REMARKS, 07/21/10

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 recent uncertainty and volatility in 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 data storage 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

I want to mention as we begin that we will be making forward-looking statements in our comments and in response to your questions concerning: industry inventory, pricing and demand; our position in the industry; our growth and profitability; the impact of our entry into, and our position in, the traditional enterprise market; the impact of our acquisition of Hoya’s magnetic media operations; the sufficiency of our cash to meet operating needs; our investments in technology and capacity; our expected capital expenditures, depreciation and amortization and tax rate for fiscal 2011; our share repurchase plans; our long-term business model; and our financial results expectations for the September quarter, including revenue, gross margin, expenses, tax rate, share count, 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 April 30, 2010. 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.

I also want to note that copies of todays remarks from today's call will be available on the Investor section of Western Digital's website immediately following the conclusion of this call.

 

John Coyne - President & Chief Executive Officer

Good afternoon and thank you for joining us today.

Fiscal 2010 was another highly profitable, growth year for WD. Ever increasing demand for cost effective, high capacity storage continues to provide opportunity for substantial growth and consistent value creation over an extended term, when addressed with an effective business model.

With a relentless focus on customer needs, quality, low-cost and high asset efficiency, WD has become solidly and increasingly profitable throughout the last decade.

Over the last five years, WD has profitably grown revenue at a compound annual rate of 22%. In this same period we have grown operating income at a compound rate of 50% per annum.

For fiscal year 2010, we grew revenue 32 percent to $9.8 billion. We increased operating income by 194% year-on-year. 

The hard drive demand growth story continues to be driven by the proliferation of multiple devices and applications that are resulting in the generation, utilization and storage—either locally or in the cloud—of massive amounts of digital content on low cost, high-capacity hard drives. We believe that the industry’s growth trajectory will continue over the foreseeable future, creating significant additional opportunity for WD with its well-honed business model and expanding product set, to continue to generate growth on a sustained and profitable basis. 

This growth opportunity has been created in large part by our ability to continually drive down average cost per gigabyte, leading to attractive price points that have driven mass market adoption of devices incorporating hard drives.  At the same time, we have gradually expanded gross margins while growing revenues by continuously increasing efficiencies and reducing costs.

Our assessment in late April of a June quarter TAM in the range of 157 million to 162 million units proved overly optimistic. Actual demand for hard drives in the quarter was about 156 million units, down 4% sequentially but up 16% from the year-ago period. The major factors leading to the lower TAM were weakness in Europe, destocking by OEM customers and a shift in OEM ordering patterns to take advantage of lower-cost sea versus air freight. In hindsight, this expanded the March quarter at the expense of the June quarter.  Given the change in the demand during the June quarter, WD and others in the industry responded quickly to adjust build plans, resulting in quarter ending inventory modestly increased but at manageable levels.

JIT inventory increased from 7 to 10 days while component distribution inventories increased slightly but remained at the midpoint of the normal 4 to 6 week range, including in-transit.

Taking these market dynamics into account, we were pleased to deliver one of the strongest fiscal fourth quarter performances in company history.

While market dynamics in the June quarter will temper short term growth rates and affect price levels in the September quarter, we believe that the second half of the calendar year and calendar year 2011 will continue to present substantial growth opportunities and rewards for hard drive industry participants with effective business models and compelling product offerings.

WD continues to generate substantial free cash flow while continuing to reinvest significantly in our business, both in expanding and enhancing our product offerings and in improving our operations.

Over the course of fiscal 2010:

  • We continued to lead the industry's fastest growing segment—2.5-inch drives—deploying industry-leading areal density products at the 640GB, 750GB and 1TB capacity points.
  • We made our entry into the traditional enterprise market with the introduction of our first 2.5-inch SAS hard drives for server applications—part of our multi-year commitment to serve this important and heretofore unserved market for WD.
  • We brought to market our first client-oriented solid state drive to complement our existing portfolio of high reliability embedded SSDs, and we are in development of our first solid state drive for high-end enterprise applications.
  • In our Branded products business, we broadened our portfolio of WD storage devices, with the introduction of My Book® Studio LX™ hard drives for Apple users, and the My Book AV DVR Expander hard drives which allow users to keep more of their favorite movies and TV shows. We extended our family of WD media players with WD TV® Live™ Plus featuring added services such as Netflix, YouTube, Flickr, Pandora, Live 365 as well as MediaFly that enable consumers to stream their favorite shows and personal content directly to their TVs. It is also the first network media player compatible with Windows® 7.
  • And on the manufacturing side, we improved the security of supply of glass substrates and enhanced our long-term cost structure with the acquisition of Hoya’s media operations.

Before I pass the call to Tim Leyden, I want to acknowledge our loyal customers who are the primary reason for WD's continued significant growth as a leading supplier of storage devices. We will continue to work passionately and diligently to earn their on-going business. I also want to thank the WD team and our supply partners for their exceptional contribution to WD’s revenue, profitability and cash generation in the fiscal year just ended.


Closing Remarks
Thank you again for joining us. We look forward to speaking and meeting with you in the months ahead.   

 

Tim Leyden - Executive Vice President & Chief Financial Officer

In the June quarter, demand was weaker and more back end loaded than we had anticipated. We believe that the weaker and less linear demand resulted from a number of things: OEM restocking during Q3 reduced market size in Q4, the European credit crisis led to some purchasing pause by retailers for a number of weeks due to the Euro exchange fluctuation, and there was relative weakness in the consumer space.

The combination of these factors and the pressure exerted by some competitors increasing their production in a smaller market contributed to more downward pressure on selling prices than we had expected.

Given these conditions, we acted to optimize our financial results while at the same time defending our market position. We are pleased that despite these challenging fiscal Q4 conditions, we achieved gross margins of 22.5% for the quarter—a fifteen year high for WD in a fiscal Q4 and at the high end of our long-term gross margin model range.

For our full fiscal year 2010 total revenue was $9.8 billion, hard drive shipments were 194 million units, and ASP was $50. Revenue from non-hard drive sales totaled approximately $154 million.

The corresponding numbers for fiscal 2009 were total revenue of $7.5 billion, shipments of 146 million units and ASP was $51. Revenue from non-hard drive sales totaled approximately $62 million.

Compared with 2009, gross margin in fiscal 2010 was 24.4% versus 17.9%. Operating income was $1.525 billion versus $519 million. Net income was $1.382 billion versus $470 million, and earnings per share was $5.93 versus $2.08.

Net income in fiscal 2010 included $27 million of expense related to litigation settlements. Net income in fiscal 2009 included a $14 million in-process R&D charge related to the acquisition of SiliconSystems, $112 million of restructuring charges, offset by related tax benefits of $4 million, and an $18 million gain on the sale of the company’s substrate manufacturing facility in Sarawak, Malaysia.

Turning to the 2010 fourth quarter results, total revenue was $2.4 billion, up 24% from the prior year but down 10% sequentially. Hard drive shipments totaled 49.7 million units, up 24% from the prior-year period but down 3% sequentially. Revenue from sales of WD TV™ Media Players and solid-state drives, totaled approximately $27 million, up 20% from the prior year and down 41% vs. the March quarter.

Average hard drive selling price was approximately $47 per unit, down $1 from the year-ago quarter and down $4 from the March quarter.

We shipped 19.9 million mobile drives in the June quarter, compared to 16.9 million in the year-ago quarter and 19.8 million in the March quarter reflecting muted consumer demand in the US and EMEA, offset by commercial and emerging market growth.

During the June quarter, we shipped 5.3 million drives into the DVR market, compared to 3.7 million in the year-ago quarter, and 4.6 million in the March quarter.  The strength in this market in the June quarter was in line with historical seasonal patterns.  

Revenue from sales of our branded products, including WD TV, was $400 million, up 26% from $318 million in the year-ago quarter and down 14% sequentially from $467 million in the March quarter reflecting the typical seasonality of the retail market.  In addition to normal seasonality, the decline in the value of the Euro impacted sell-in in Europe for a number of weeks.

Enterprise SATA demand continued to grow in fiscal Q4 particularly at the higher capacity points. Our product line-up has us well positioned in this segment.  Our SAS products are making progress towards our multi-year plan to gain a representative share of the traditional enterprise market.  

Moving on to our sales channel and geographic results:

Revenue by channel was 54% OEM, 29% distribution, and 17% branded products in the June quarter, mirroring the same percentage splits as in the year-ago quarter, and 49%, 33% and 18% in the March quarter.

No single customer comprised more than 10% of total revenue.

Relative to the geographic split of our revenue, the Asian market continued to be strong at 54% of revenue in the June quarter as compared to 54% in the year-ago quarter and 52% in the March quarter.  The Americas and European regions contributed 25% and 21%, respectively, in the June quarter, compared to 24% and 22% in the year-ago quarter and 24% and 24% in the March quarter.

Our gross margin for the quarter was 22.5%, up from 19.2% in the year-ago quarter and down from 25.2% in the March quarter.  Gross margin was impacted on a sequential basis by pricing, channel mix, segment mix and volume reductions.

Total R&D and SG&A spending was $242 million, or 10.2% of revenue. This includes the $27 million of litigation settlements, and compares with $184 million, or 9.5% of revenue in the year-ago quarter, and $224 million, or 8.5% of revenue in the March quarter.  

Operating income was $293 million, or 12.3% of revenue.  This compares with $209 million, or 10.8% of revenue in the year-ago quarter, and $441 million, or 16.7% of revenue in the March quarter.

Net interest and other non-operating expenses were approximately $1 million.

Tax expense for the June quarter was $27 million, or 9.2% of pretax income.

Our net income totaled $265 million, or $1.13 per share.  This compares with $196 million, or $0.86 per share, and $400 million, or $1.71 per share in the year-ago and March quarters, respectively.

Turning to the balance sheet, we generated $1.9 billion in cash flow from operations during fiscal 2010, including $363 million during our fourth quarter. 

Our cash conversion cycle for the fourth quarter was a positive 2 days. This consisted of 48 days of receivables outstanding, 28 days of inventory or 13 turns, and 74 days of payables.  Our inventory turns were reduced by approximately 1 turn as a result of including the Hoya inventory that we acquired on June 30th.

Excluding acquisitions, capital expenditures for the June quarter, were $185 million. Our non-cash charges for depreciation and amortization expense totaled $134 million.

Capital additions for fiscal 2010 totaled $737 million, lower than our April projection of $750 million, as we scaled back in line with lower demand.  Depreciation and amortization expense for fiscal '10 totaled $510 million.

During the fourth quarter, we acquired the magnetic media sputtering operations of Hoya Corporation for $233 million in cash. We expect that the Hoya facility will be mildly accretive to WD’s long-term gross margin model by the end of the calendar year, but prior to that it will have about a 50 basis point negative impact on the gross margin as we get it tuned to WD’s production standards.

We made $82 million of debt repayment installments during fiscal 2010, including $25 million during our fourth quarter.  We reduced our debt balance to $400 million at the end of fiscal 2010.

We exited fiscal Q4 with cash and cash equivalents of $2.7 billion, a decrease of $92 million from the March quarter.  We continue to hold a cash balance in excess of our anticipated operating needs, with the strategy to maintain operational flexibility, increase our investments in advanced technology, expand our product breadth through the pursuit of internal and external opportunities and to protect against macro economic weakness.

The balance remaining on our stock repurchase authorization is $466 million.
 
Now I will discuss our expectations for capital, depreciation and tax for fiscal 2011.

We expect our capital expenditures for fiscal 2011 to be between 7% and 8% of revenue, with an additional $200 million related to our 6-inch to 8-inch wafer conversion and some expenditure to optimize the output from our recently acquired Hoya production facility.  We expect total CAPEX in Q1 to come in around $275 million. We expect depreciation and amortization to be about $650 million for the fiscal year.

We expect our book effective tax rate to range between 6% and 9% and our cash tax rate to be between 1% and 2%.

Now I will move on to our long-term business model.

We believe that annual growth of unit shipments for the hard drive market will continue in the 10-15% range into the foreseeable future, which should generate industry revenue growth of between 5 and 7.5%. Given this industry growth rate, we expect to operate within our long-term gross margin model range of 18 to 23%, with some longer-term upward momentum from increasing our percentage of internal media as well as advancing our presence in the traditional enterprise market. Our Opex model is targeted to continue in the 9 to10% range and our resulting operating income will range from 8 to 14%. Tax expense is estimated to be in the range of 6 to 9% of income before taxes.  These parameters would yield net income in the 7 to 12.5% range.

Now, turning to our guidance for fiscal Q1.

Historically, September quarter demand has been up by 10 to 13% when compared to June volumes. However, a number of factors are leading us to forecast lower growth this quarter.  We believe that some of July’s natural OEM demand was fulfilled at the end of June and that OEM’s are less concerned about shortages than they were a few months ago.  U.S. retail sales statistics also suggest that there has been some emerging consumer demand weakness. Additionally, we believe that OEM’s have planned for a regular back-to-school season and that components to satisfy those demand expectations are either in their manufacturing pipelines or in transit at this point in time.  As we enter the quarter, demand has started out slowly as some customers deplete on-hand component inventory and await confirmation of the extent of back-to-school demand.  These factors will dampen the typical seasonal uplift to an expected range of between 2% and 6%, which translates into a TAM range of between 160 to 165 million units.  Taking these factors into account, we anticipate that pricing will be competitive and further dependent on emerging demand level dynamics as back to school season gets underway.  Should demand turn out to be stronger than we anticipate we expect to be able to respond to the upside.   

Accordingly, we expect current quarter revenue for WD to be in a range from $2.350 billion to $2.450 billion. 

R&D and SG&A are expected to total approximately $235 million. 

Our net interest expense is projected to be about $1 million.

We expect our tax rate to be about 7.5%.

We anticipate our share count to be approximately 236 million.

We estimate earnings per share of between $.80 and $.90 for the September quarter.