Western Digital Corporation Fourth Quarter and Fiscal 2016 Conference Call Remarks - July 28, 2016

Updated to the extent the Quarterly Fact Sheet and Financial Statements were updated on 8/26/2016

Robert Blair - Investor Relations

Good afternoon everyone. 

This conference call will contain forward-looking statements within the meaning of the federal securities laws, including statements concerning: our expected financial performance for our first fiscal quarter ending September 30, 2016; our market positioning; expectations regarding our transformation, growth opportunities, near-term priorities, long-term business model and strategy execution; integration activities and achievement of synergy goals; demand and market trends; our product portfolio, product development efforts and customer acceptance of our products; data growth and its drivers; and our wafer capacity. 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 quarterly report on Form 10-Q filed with the SEC on May 9, 2016. We undertake no obligation to update our 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 historical non-GAAP measures we provide during this call to the comparable historical GAAP financial measures are included in the quarterly fact sheet posted in the Investor Relations section of our website. We have not reconciled our non-GAAP financial measure guidance to the most directly comparable GAAP measures because material items that impact these measures are out of our control and/or cannot be reasonably predicted. Accordingly, a reconciliation of the non-GAAP financial measure guidance to the corresponding GAAP measures is not available without unreasonable effort.

The quarterly fact sheet posted in the Investor Relations section of our website has also been updated to reflect enhancements to our reporting, including the break out of revenues and exabytes shipped to three end-markets: datacenter devices and solutions, client devices and client solutions.  The definitions of these end-market categories can be found in the quarterly fact sheet.

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 - President & Chief Executive Officer

Good afternoon and thank you for joining us. With me are Mike Cordano, president and chief operating officer; Olivier Leonetti, chief financial officer; and Mark Long, executive vice president, finance and chief strategy officer.  After my opening remarks, Mike will provide a summary of recent business highlights, Olivier will cover the fiscal fourth quarter financials, and Mark will wrap up with our guidance for the first fiscal quarter. 

Earlier this afternoon, we reported revenue and non-GAAP EPS for our fiscal fourth quarter that were better than the preliminary results announced earlier this month. We are reporting revenue of $3.5 billion, non-GAAP gross margin of 31% and non-GAAP earnings per share of $0.79.

Fiscal 2016 was a transformative year for our company.  We took significant steps to continue our evolution into the leading storage solutions company and to return to growth with global scale and extensive product and technology assets.

Given unabated growth in data and the increasing role technology plays in the lives of individuals and organizations large and small, we believe Western Digital is uniquely positioned to address the broadest range of storage opportunities in the marketplace.  We embarked on a journey several years ago with a vision to provide a full spectrum of storage solutions.  With the various acquisitions we have made so far, along with organically growing our capabilities, we are much further along today on that mission to help the market determine which solutions work best for a given application. We are a market and customer driven organization and we believe this strategy will deliver long-term value for our customers, shareholders, and employees.

With our long-term strategy clear, we are focused on execution. I am pleased to report that our integration activities associated with our acquisitions are going well. We are on target to achieve our synergy goals as a unified entity focused on addressing the tremendous growth of data and the evolving needs of our customers.

Additionally, our near term priorities include our transition to 3D NAND and the deleveraging of our balance sheet. We have achieved several recent milestones associated with these initiatives:  

  • We have completed the rationalization and alignment of our product and technology roadmaps involving legacy WD, HGST and SanDisk products and we have shared this with our customers.
  • We celebrated the opening of the New Fab 2 wafer manufacturing facility in  Japan with Toshiba, underscoring the continued strength of our 16-year partnership. 
  • We announced our next generation 3D NAND technology, BiCS3, with an industry-leading 64 layers of vertical storage capability. Pilot production of BiCS3 has commenced and we expect meaningful commercial volumes in the first half of calendar 2017, and  
  • We repaid in full, the $3 billion bridge loan associated with the financing of the SanDisk acquisition.

We also remain focused on innovating and investing in our business to ensure that we continue to remain agile in addressing changing market needs.  At this important time in our company’s history, I am inspired by the enthusiasm and positive spirit of our employees and the favorable response to our enhanced value proposition by our customers.

I will now ask Mike Cordano to provide his comments on the business operations….

Mike Cordano - President & Chief Operations Officer

Thank you, Steve.  Good afternoon everyone.

I would like to echo Steve's excitement on what we have seen in the company in the last 77 days since the close of the SanDisk acquisition.  We are excited about the possibilities created by the combination for our customers, employees and shareholders.  Western Digital now has a broadened portfolio of solutions for the data center, client device and client solution markets. 

We have been combining our HGST and WD subsidiaries since last October in compliance with the Chinese Ministry of Commerce’s decision.  Following the close of the SanDisk acquisition on May 12, we have made substantial progress in integrating all of our assets into the new Western Digital.  The team has done a phenomenal job in reconciling and aligning the various product roadmaps, a complicated task executed well on a compressed timeline.  We have identified key leaders for our various functions and we are rapidly aligning the capabilities and talents of our employees.  Coupled with a series of restructuring actions we have taken over the last two years against the backdrop of a declining HDD TAM, we have further streamlined our manufacturing footprint in recent months with the closure of two facilities in Japan and Malaysia and the announced closure of a facility in Singapore. Relative to our legacy Western Digital business, we have reduced our overall facilities footprint by almost one fifth and our headcount by almost one quarter, over the last two fiscal years.

Turning to the specifics of our fourth quarter results, in HDDs, we achieved overall exabyte growth of 12% on a year-over-year basis, primarily driven by shipments of our capacity enterprise HDDs to datacenter customers.  Exabyte growth within our capacity enterprise product line was 47% on a year-over-year basis, faster than the market growth rate, thanks to the ongoing success of our helium platform.  We believe this trend will continue in the second half of this calendar year as we ramp our 10 terabyte product to high volume – our third generation helium drive.  This product is a key differentiator for the company as it provides us a generational advantage and has already created significant marketplace momentum.  In enterprise SSDs, we saw strength in sales to both enterprise and cloud customers.

From a client devices perspective, we are benefitting from the growing attach rate of SSDs to PCs in both the commercial and consumer categories even as client HDD unit shipments decline year-over-year.

In our other flash related businesses, we saw broad based strength across several key markets and our operational execution was strong across the board.  Our industry leading 15 nanometer technology remained the workhorse and it accounted for the vast majority of our total supply.  Manufacturing yields on 15nm technology set another record and our sustained leadership in 2D NAND has continued to position us well in the key markets we serve.

Earlier this week, we were pleased to announce our next generation 3D NAND technology, called BiCS3.  With 64 layers of vertical storage, BiCS3 will primarily feature our three bits per cell, or X3, architecture, delivering the industry's smallest 256 gigabit chip.  The combination of X3 and manufacturing innovations will allow us to extend our cost reduction capabilities beyond the 15nm node.  Consequently, we have decided to allocate a greater portion of our planned 3D NAND capacity conversion to BiCS3, instead of BiCS2, and this will allow us to rapidly convert to our next generation 3D NAND technology in 2017.  Additionally, we expect our 2D NAND technology to have a long tail as we will continue to utilize it for certain markets. 

From a wafer fab standpoint, in the June quarter, we completed the planned 5% wafer capacity expansion for 2016 and this will provide us slightly more than 3 million wafers of captive output by the end of calendar 2016.  Given the planned mix of 2D and 3D NAND technologies for the rest of the year, we expect our bit supply growth to be approximately 30% in calendar 2016, somewhat below our estimate for total industry bit supply growth as we had previously indicated.  However, as we look to 2017, the planned rate of conversion of our 2D NAND capacity to BiCS3 will enable the mix of our 3D NAND wafer capacity to approach 40% of total capacity by the end of 2017.  This will place both our mix of 3D NAND capacity and our overall bit growth rate in line with the industry.

Switching to the near-term, we believe the overall demand environment is better than it has been in recent quarters, driven by the following:

  • New product cycles in mobile devices and PCs are tailwinds for our client business, along with seasonality; additionally, SSDs are continuing to penetrate further into PCs even as PC unit volumes shrink;
  • We are seeing a tight supply of NAND as the industry transitions from 2D to 3D NAND technology, and
  • We are experiencing stronger demand in non-SSD flash markets such as mobile and there is demand pull from hyper-scale customers in our cloud-related datacenter business.

Offsetting these factors, we have seen share-driven price dynamics in certain pockets of the HDD market.  These include the low end of the 2.5-inch HDD market and the 8TB capacity point in capacity enterprise; consequently, we have moderated our participation in those areas.  Our fiscal Q4 performance and forward guidance for fiscal Q1 takes these variables into account. 

To wrap up my comments, Western Digital is very unique in our industry.  The combination of WD, HGST and SanDisk has allowed us to methodically augment our capabilities to become a truly broad based storage solutions provider.  We look forward to giving you ongoing updates on our business.

With that, I will turn the call over to Olivier to review our Q4 financial results.

Olivier Leonetti - Executive VP Finance & Chief Financial Officer

Our revenue for the June quarter was $3.5 billion dollars.

Including the partial period of SanDisk ownership:

Our non-GAAP gross margin was 31% percent and operating expenses totaled $691 million dollars. 

Interest and other expense for the quarter included $181 million dollars of interest expense related to the debt for the SanDisk acquisition.

Non-GAAP tax benefit for the June quarter was $24 million dollars, due to the impact of interest expense related to the SanDisk acquisition.

On a non GAAP basis, net income was $208 million dollars, or $0.79 cents per share.

In the June quarter we generated $355 million dollars in cash from operations and our free cash flow totaled $114 million dollars.

Our net CAPEX totaled $241 million dollars.

We also declared a dividend in the amount of $0.50 cents per share.

We closed the quarter with total cash and cash equivalents of $8.2 billion dollars, of which approximately $1.3 billion dollars was held in the U.S.

After the close of the June quarter and as Steve mentioned earlier, we utilized $3 billion to pay off the bridge loan. 

Finally, I would like to thank Steve and the rest of the leadership team at Western Digital, our employees and the investment community for your partnership and support over the last two years during my tenure as CFO. As I leave Western Digital to pursue other opportunities, I am confident in Mark’s leadership to guide the finance and strategy organization and the company through the transformation that we have undertaken.

Mark…

Mark Long - Executive VP & Chief Strategy Officer

Thank you, Olivier.

It is an exciting time for me to be leading the company in this new role and I look forward to meeting you in the weeks and months ahead.  While I will be new to the CFO role at Western Digital, I have been with the company and in the industry for many years. Before providing our September quarter guidance, let me say a few words about how we are evolving our reporting of the company moving forward.

With the close of the SanDisk acquisition, we are moving further into the execution phase of our value creation strategy, extending our platform across all segments of the storage landscape. We believe that we have a compelling long-term business model due to our comprehensive product offering and significant exposure to key growth sectors. As a result, we have an industry-leading business with above industry average margins and a balanced cash flow risk profile that leverages our diversified portfolio of storage technologies.

Today, we have begun to evolve our reporting and disclosures in our commentaries and quarterly fact sheet consistent with our value creation strategy.  We will report our business in terms of three primary end-markets:  (1) datacenter devices and solutions, (2) client devices, and (3) client solutions.  Our quarterly fact sheet describes which specific product and solution types are included in each of these three end-markets.

Within these categories, our reporting will focus on the drivers of value including revenue and exabytes shipped.  We will also be providing qualitative gross margin commentary associated with our bit allocation and mix up strategies for our NAND and HDD products, respectively.  We have discontinued providing the following information in the quarterly fact sheet: revenue from top 10 customers, enterprise SSDs and non-PC applications.  We believe these metrics are less relevant today given the diversification of our business. As we continue to evaluate the best way for us to disclose the drivers of our business, we will evolve our reporting in the coming quarters. This may result in the addition or deletion of some of the information provided today.

In the coming quarters, we will also provide additional commentary on key operating activities including achievement of our synergy and cost reduction objectives and key technology milestones. We believe these reporting modifications provide the best balance considering an evolving market, our value creation drivers and our historical reporting practices. Over the near term, we will continue to make certain legacy disclosures available to allow for a transition between our historical and new reporting.  We expect to make a full transition by the end of this fiscal year.

At our Investor Day on December 6, we will provide a deeper dive into our overall strategy.  At that time, we will discuss our long term strategy and target financial and business model which should provide further clarity on what we expect to deliver across key financial metrics, including gross margin, opex, operating margin, capex, tax and cash flow for the new Western Digital. Our overall objective as it relates to our disclosures and communication is to provide an appropriate level of transparency while balancing competitive considerations and still allowing for a deep understanding and discussion of our business.

I would like to comment on a couple of items relating to the acquisition of SanDisk and the related financing that will impact our future non-GAAP and GAAP results.  First, relating to debt financing of the SanDisk acquisition, we will be amortizing the debt discount and issuance costs over the term of the debt, and this will result in charges that we will include in interest expense of $23 million in fiscal Q1 and approximately $18 million each quarter thereafter over the next 5 years.  These debt discount and issuance costs are incremental to the cash interest payments we will make.  Second, due to purchase accounting rules, we had to reset the SanDisk Japanese yen hedges for inventory purchases eliminating approximately $51 million in unrealized gains that would have reduced cost of sales by approximately $26 million in fiscal Q1 and $17 million in fiscal Q2. We will still receive the cash related to these yen hedges. 

With that, I will now provide our guidance for the September quarter:

We expect:

  • Revenue to be in the range of $4.4 billion to $4.5 billion.

  On a non-GAAP basis, we expect:

  • Gross margin of approximately 32%
  • Operating expenses of approximately $875 million
  • Interest and other expense of approximately $245 million
  • Tax expense of approximately $50 million
  • Share count of approximately 290 million, and
  • We estimate non-GAAP earnings per share between $0.85 and $0.90.

I will now turn the call over to the operator to begin the Q&A session.  Operator?

CLOSING REMARKS:

I want to thank you for joining us today. In closing, I want to thank Olivier Leonetti for his contributions as our chief financial officer over the last two years. We greatly appreciate Olivier’s dedication during this transformative time and wish him the best in the future. We look forward to staying in touch with our investors and the analyst community in the weeks and months ahead. Thank you.