WESTERN DIGITAL FOURTH QUARTER ENDED JULY 1, 2011 CONFERENCE CALL REMARKS, 07/21/11

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 continued 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 that we will be making forward-looking statements in our comments and in response to your questions concerning: industry conditions in the September quarter, including the total available market for hard drives, customer demand, supply constraints, capacity mix, average selling price and cost of components; expected benefits from, and the timing of completion of, our planned acquisition of Hitachi GST; growth in the near-line enterprise market; our product offerings in the traditional enterprise market; our position in the branded products market; our expected capital expenditures and depreciation and amortization for fiscal 2012; our investments in new products and markets; 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 May 2, 2011. 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.

In addition, references will be made during this call to historical non-GAAP financial measures, as well as forward-looking estimates of non-GAAP financial measures that give effect to our planned acquisition of Hitachi GST. Investors are encouraged to consider the reconciliations of the differences between the historical non-GAAP measures to the comparable GAAP financial measures we provide during this call and those that are included in the investor information summary posted in the Investor Relations section of our Web site at www.westerndigital.com. The forward-looking estimates of non-GAAP financial measures that give effect to our planned acquisition of Hitachi GST exclude acquisition-related expenses that we expect to incur in connection with the transaction and following the closing of the transaction. Because these acquisition-related items will not be known to us until on or after the closing of the transaction, we are unable to provide information about, or a reconciliation to, the most directly comparable GAAP financial measures. The impact of these excluded items may cause the estimated non-GAAP financial measures to differ materially from the comparable GAAP financial measures. 

As a reminder, until our acquisition of Hitachi GST closes, WD and HGST remain independent companies, so we will not be taking any questions about HGST’s business or financial performance. 

 

John Coyne - President & Chief Executive Officer

Good afternoon and thank you for joining us today. With me are Tim Leyden our chief operating officer and Wolfgang Nickl our chief financial officer.

In the June quarter, we saw stronger than anticipated demand, with the hard drive industry shipping over 165 million units. This 4 percent quarter-on-quarter increase contrasts with historical seasonal patterns of 1 to 2 percent sequential contraction. We believe that the stronger demand was driven by increased adoption of sea freight in the PC supply chain, which creates a long term leveling of seasonal demand patterns, as well as supply continuity concerns in the aftermath of the Japan earthquake.  The industry grew fiscal year volumes 4 percent to 657 million units, while WD again grew faster than the market at 6 percent shipping 207 million hard drives for the year¾a 1 percent share gain reaffirming customer preference for WD's value proposition.  This was a tough comparison year for the PC and HDD industries coming off the recession snap-back year of 2010, combined with the slowdown in consumer spending and increased competition for share of consumer spend from devices like smart-phones and tablets.

We believe that 2012 could be a stronger period for the industry and for WD for several reasons:  an acceleration of the commercial PC refresh as part of an overall macro reinvestment cycle; the potential for better consumer confidence translating into stronger discretionary spending; the planned launch of redesigned, feature-rich PCs enabled by Windows 8; and our continued favorable standing with customers as one of the preferred suppliers of the world’s most cost effective storage solutions for the massive amounts of content being generated on the client and in the cloud.

In this context, it's important to consider some history: Throughout fiscal '11, we operated close to the bottom of our business model range.  Others in the industry struggled even more, reporting results below their published models. Historical cycles show that prolonged periods of below model performance are typically followed by a return to business model parameters as suppliers and customers alike recognize the need for industry profitability to drive needed investments in both technology and capacity. WD has repeatedly outperformed as these cyclical corrections occur.

Furthermore, upon completion of our acquisition of HGST, we will have a stronger position in the traditional enterprise market, an improved solid state drive lineup, and further cost advantage.  

Thus far, in the regulatory review process to complete this transaction, we have received clearance from Brazil, Taiwan and Turkey, and we continue to work closely with the remaining agencies.  As previously announced, we currently expect that the transaction will close in the fourth quarter of calendar year 2011, and our integration planning activities continue on schedule.

I will now turn the call over to COO Tim Leyden who will describe the operational highlights for the June quarter.


Closing Remarks
In closing, I’d just like to thank you all of you for joining us today. We appreciate your questions and your interest in the company and in the industry. We look forward to seeing you again next quarter. Thank you.

 

Tim Leyden - Chief Operating Officer

As John indicated, demand in the June quarter was stronger than we originally anticipated, with industry unit volume exceeding 165 million hard drives, generating 4 percent quarter-on-quarter and 6 percent year-on-year growth, primarily driven by strength in OEM demand.  We believe there were two main factors behind this:

  • Margin focus across the PC market where lower financing and inventory carrying costs  encouraged increased use of ocean freight, leading to pull-ins of build schedules versus historical seasonal patterns, and
  • Fear of supply disruption from the Japan aftermath led to pull-forwards by OEM customers to create inventory buffer – on the basis that it is "better to be looking at it than looking for it."

We now see an industry TAM for calendar 2011 of roughly 670 million units, with a September quarter in the range of 170 to 175 million.

Now turning to WD’s performance, we shipped53.8 million units in the June quarter, up 8.0 percent sequentially and 8.2 percent from the year-ago period, as we worked successfully with our supply partners to overcome post-earthquake challenges, again providing superior availability and value to our customer base. Moderation in ASP declines delivered revenue growth of 7 percent quarter-on-quarter and 1 percent year-on-year for the June quarter.  Gross margins improved by 130 basis points to 19.5 percent. However we need to make further progress on profitability as this margin level continues to be below our business model midpoint and is some 300 basis points below the same period last year. Price declines for the quarter were broadly as we had expected and were less than the seasonal norm, average product capacity  was up only moderately, but higher volumes, tight cost management and improved utilization enabled us to come in above the upper end of our implied gross margin guidance.

Revenues totaled $2.4 billion, net income was $158 million and cash flow from operations improved sequentially from $313 million to $447 million.

Now, turning to  market segment performance, in the compute space units increased  to 117 million from  113 million in the March quarter and were up from 111 million in the year-ago quarter.  WD shipped 39.2 million units into the compute space in the June quarter compared to 36.3 million units in the March quarter and 37.1 million units in the year-ago quarter, and we grew market share by approximately 1 percent both sequentially and year-on-year.

The near-line enterprise market was up sequentially from 5.6 to 6.4 million units, and up from 5.1 million units year-on-year. Cloud computing continues to spur growth in this market. The traditional enterprise market – at 8.3 million units – remained flat with the March quarter and was up year-on-year from 7.1 million units as demand in the commercial market remained robust.  WD shipped 2.5 million units into the combined Enterprise markets in the June quarter, up from approximately 2.3 million in both the March and year-ago quarters. In the traditional enterprise space we are servicing a limited customer set with our first and second generation SAS products, and we are on plan to bring our third generation product to market within the calendar year.

The HDD manufacturers’ TAM in the branded product segment came in at 12.0 million units, down from 13 million units in the March quarter and up from 9.8 million units in the year-ago quarter, as the sequential TAM reduction followed typical seasonal patterns. Year-on-year TAM unit growth in this segment was strong. WD shipped 5.7 million units into this market in the June quarter down from 6.4 million units in the March quarter and up from 5.0 million units in the year-ago quarter. Competition remains particularly intense in the branded segment, as competitors seek to improve their share positions, but we continue to compete strongly through differentiating product features and strong brand equity.

In the DVR market segment, the TAM was an estimated 14.4 million units, up sequentially from 12.9 million in the March quarter and up from 13.2 million in the year-ago quarter.  WD shipped 6.5 million units into this market in the June quarter, up from 4.8 million in the March quarter and up from 5.3 million in the year-ago quarter. WD’s product capabilities and ability to respond quickly to customer needs helped us grow in this segment where HDDs offer an efficient and cost-effective solution for storing and retrieving video content.

The remaining balance of the TAM is represented by gaming, automotive and 1.8-inch drives.

Inventories in the HDD supply chain exiting the quarter were below historical run-rate levels in each segment.

Now, turning to the September quarter,

  • The market visibility is cloudy both from a demand and supply viewpoint, due to the supply uncertainty and the pull forward of demand that I mentioned earlier.
  • In contrast to the HDD supply chain inventory status, we believe that inventory levels continued to build in the PC OEM supply chain as the switch from air-freight to sea-freight continued, in an effort to save transportation costs.
  • OEMs continue to pull product on the basis of concerns about supply and their historical extrapolation of demand expectations for “back to school” and the holiday season.

In our other served markets in the September quarter, we expect typical seasonal patterns which are, a Branded Products volume increase, a DVR volume reduction, and flattish volume in the Enterprise segment.

Now, turning to our product lineup:

  • We are now shipping the WD Scorpio® 1TB — a two-disk 2.5-inch drive — the first in a range of products that utilize our 500 GB per platter technology
  • In our Branded Products segment we continue to lead the industry in volume shipments of USB 3
  • In our Consumer electronics segment, we released WD AV versions of our 2.5 TB and 3.0 TB SATA hard drives.   

I will now turn the call over to Wolfgang Nickl for a review of our Q4 financial performance and our outlook for the first quarter of fiscal 2012.

 

Wolfgang Nickl - Senior VP Finance & Chief Financial Officer

A summary of financial information has been posted to the Investor Relations section of our website, which we will be updating with our Q1 guidance after this call.  

For the June quarter, revenue was $2.4 billion, up 1 percent from the prior year and up 7 percent sequentially. Hard drive shipments totaled 53.8 million units, up 8 percent from both the prior-year period and the March quarter. Revenue from sales of WD TV® Media Players, WD Livewire™ Network Kits and solid-state drives totaled approximately $33 million, up 23 percent from the prior year and seasonally down 34 percent from the March quarter.

These results were above the upper end of the guidance we provided during our April investor call, due primarily to our ability to meet unexpected customer demand during a period of uncertain industry supply capabilities.

Hard drive average selling price was approximately $44 per unit, down $3 from the year-ago quarter and $1 from the March quarter.

Revenue from sales of our branded products, including WD TV® and WD Livewire™ products, was $382 million, down 4 percent from the year-ago quarter due to an aggressive pricing environment as well as a continued shift from 3.5 to 2.5-inch products. Revenue was down seasonally by 13 percent from the March quarter.

There was one customer, Dell, that comprised 10 percent or more of our total revenue.

Geographically, demand in Asia was particularly strong this quarter as it grew to 60 percent of revenue from 54 percent in the March quarter, while Americas and Europe each declined.

Our decision to strongly support OEM customers in the aftermath of the Japan earthquake, resulted in OEM sales representing 55 percent of revenue, up from 47 percent in the March quarter, while the distribution and retail channels each contributed lower percentages of revenue.

Our gross margin for the quarter was 19.5 percent, down from 22.5 percent in the year-ago quarter and up from 18.2 percent in the March quarter.  The quarter-over-quarter increase in gross margin by 130 basis points is a function of firmer pricing in the client compute market coupled with increased utilization of manufacturing assets due to higher volume.  Like-for-like price decline was approximately 2 percent for the June quarter.

R&D and SG&A spending totaled $297 million in the June quarter as compared to $242 million and $252 million in the year-ago and March quarters, respectively.  The June quarter included $32 million for acquisition-related expenses and unrelated litigation accruals, whereas the prior-year quarter included $27 million of litigation accruals and the March quarter included $10 million of acquisition-related expenses.  Excluding these items, R&D and SG&A would have totaled $265 million, or 11.0 percent of revenue in the June quarter, versus $215 million, or 9.0 percent of revenue, in the year-ago quarter and $242 million, or 10.7 percent of revenue, in the March quarter.  The quarter-over-quarter increase is primarily a function of increased investments in new product and technology development and higher incentive compensation expenses.

Net interest and other non-operating expense was $2 million, including $2 million of acquisition-related debt commitment fees.  Excluding these fees, net interest and other non-operating expense would have been zero.

Tax expense for the June quarter was $12 million, or 7.1 percent of pre-tax income. 

Our net income for the June quarter totaled $158 million, or $0.67 per share, as compared to $265 million, or $1.13 per share, for the year-ago quarter and $146 million, or $0.62 per share, in the March quarter.  The June quarter included a combined $35 million for acquisition-related expenses and litigation accruals, whereas the prior-year quarter included $27 million of litigation accruals and the March quarter included $10 million of acquisition-related expenses.  Excluding these items, non-GAAP net income for the June quarter totaled $193 million, or $0.81 per share, as compared to $292 million, or $1.24 per share, in the year-ago quarter and $156 million, or $0.66 per share, in the March quarter. 

Turning to the balance sheet, our cash conversion cycle for the June quarter was zero days. This consisted of 46 days of receivables, 27 days of inventory or 13 turns, and 73 days of payables.  We generated $447 million in cash flow from operations during the June quarter, and our free cash totaled $294 million, reflecting strong sales linearity and tight asset management.

Capital expenditures for the June quarter totaled $153 million. Depreciation and amortization expense for the fourth quarter totaled $150 million.

Capital expenditures for fiscal ‘11 totaled $778 million.  Depreciation and amortization expense for fiscal ‘11 totaled $602 million.

For fiscal ‘12, we expect capital expenditures will be at the upper end of our business model range of between 7 and 8 percent of revenue as we complete the 6 to 8-inch conversion of our wafer fab facility.  We expect depreciation and amortization to be approximately $650 million for fiscal ‘12. 

We made a $31 million debt repayment during the June quarter, and thereby reduced our debt balance to $294 million.

We exited fiscal Q4 with cash and cash equivalents of $3.5 billion, an increase of $260 million from the March quarter. 

Let me now turn to our expectations for the September quarter.

  • As Tim mentioned, we forecast a total available market (TAM) of between 170 and 175 million units which is below historical seasonality as OEMs have built some extra inventory in Q4 FY ‘11 to ensure security of supply and optimize transportation costs.
  • The actual TAM will depend on the level of back-to-school sales and the expectation for PC demand for the Holiday season, and the consequent decisions of PC OEM’s on optimizing their ocean-to-air freight mix and build plans.
  • Market segment mix will reflect typical seasonal patterns, which will mean an increase in Branded product shipments, a decrease in DVR product shipments and flat enterprise volume.
  • Price declines are expected to be moderate, while cost pressures will continue, driven by rare-earth materials, logistics costs and foreign currency exposures.  We will continue to work internally and with our supply partners to find ways to offset these cost challenges.  
  • We continue investing in innovation to support growth in new products and markets.
  • Our guidance does not include acquisition related expenses.

Based on these assumptions, our guidance for fiscal Q1 is as follows:

We expect revenue to be in the range from $2.425 billion to $2.525 billion. 

R&D and SG&A spending of approximately $250 million, excluding acquisition-related expenses. 

We expect our tax rate to be in the middle of our business model range of 6 to 9 percent.

We anticipate our share count to be approximately 238 million.

Accordingly, we estimate non-GAAP earnings per share of between $0.90 and $1.00 for the September quarter, which excludes acquisition-related expenses.

Operator, we are now ready to open the call for questions.