Western Digital First Quarter Ended September 29, 2017 Conference Call Remarks, 10/26/17

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. Risks and uncertainties may cause actual results to differ materially from those currently expected. These potential risks and uncertainties include, among others:

  • uncertainties with respect to the company's business ventures with Toshiba;
  • volatility in global economic conditions;
  • business conditions and growth in the storage ecosystem;
  • impact of competitive products and pricing;
  • market acceptance and cost of commodity materials and specialized product components;
  • actions by competitors;
  • unexpected advances in competing technologies;
  • our development and introduction of products based on new technologies and expansion into new data storage markets;
  • risks associated with acquisitions, mergers and joint ventures;
  • difficulties or delays in manufacturing; and
  • other factors listed in our periodic SEC filings and on this website in Risk Factors.

In addition, these posted remarks include references to non-GAAP financial measures. Reconciliations of the differences between the non-GAAP measures provided in these remarks to the comparable GAAP financial measures are included in this 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.


Steve Milligan - CEO

Good afternoon and thank you for joining us. With me today are Mike Cordano, president and chief operating officer; and Mark Long, chief financial officer. After my opening remarks, Mike will provide a summary of recent business highlights and Mark will cover the fiscal first quarter and wrap up with our guidance. We will then take your questions.

We reported continued strong financial performance in the September quarter, demonstrating the power of our platform and underscoring the differentiated value we can deliver as a comprehensive data storage solutions leader.

For the September quarter, we reported revenue of $5.2 billion, non-GAAP gross margin of 42% and non-GAAP earnings per share of $3.56. We generated strong operating cash flow, reflecting continued healthy demand in our end markets, most notably in our flash-based businesses. With unabated growth in data creation leading to new challenges and opportunities for our customers, our transformation continues to resonate in the marketplace.

I would now like to spend a few minutes reviewing where we are with Toshiba.

There has been significant media coverage around this situation, and a lot of it is speculative. So as a starting point, I want to emphasize that the JVs continue to operate efficiently and productively, which we intend to maintain. The JVs benefit from the best talent in the industry and we are deeply appreciative of the professionalism, focus and dedication exhibited by the teams from Toshiba and SanDisk.

From the beginning, our number one priority has been ensuring the longevity and continued success of the joint ventures. That is why we have invested so much time and energy into finding a resolution – one that respects our partnership, and resolves this matter so we can move forward in the spirit of collaboration and innovation that has been the hallmark of this 17-year relationship.

Throughout the course of the negotiations, we made numerous allowances to meet the needs of Toshiba and other stakeholders such as lenders, customers, suppliers and government agencies. Most notably, we withdrew from the INCJ-KKR consortium. This eliminated our participation in TMC equity ownership, thus minimizing regulatory risk and directly addressing key concerns of TMC's management. It also would have meant that TMC would remain under full control of Japanese stakeholders.

hile we believe we provided the best potential solution to Toshiba and their stakeholders, Toshiba announced a transaction with a consortium led by SK Hynix and Bain Capital. We have made our concerns regarding their consortium clear. It continues to be our position that the transaction is not permitted without our consent.

That leads to where we are today. There are two potential paths for resolution: the stakeholders will either engage in constructive dialogue in the near future, or this matter will be resolved through the objective arbitration process. With respect to arbitration, we are moving forward with strong momentum following our successful track record in the California courts.

On October 5th, the International Court of Arbitration confirmed the three-member arbitration panel. Shortly thereafter, we informed the panel of our intention to seek injunctive relief to prevent Toshiba from transferring its JV interests to the SK Hynix-Bain consortium without SanDisk's consent. The panel will set a hearing schedule soon, at which point we will officially file our motion. SanDisk's consent rights are clear and explicit, and we therefore feel confident in our request for injunctive relief. We expect a ruling in the first part of 2018, in advance of Toshiba's announced timeframe to close the proposed transaction. Just to be clear, we do not undertake litigation lightly. We are not litigious and it should only be a last resort, especially in the context of this joint venture relationship.

With respect to Fab 6, you may recall that over the summer, during negotiations for the first investment tranche, Toshiba announced that it would unilaterally invest in Fab 6. This was a surprise to us. In fact, when Toshiba made its announcement, we had more meetings scheduled to further discuss our joint investment. This was the first time that SanDisk was prevented from participating in a new fab investment. To remind you, Toshiba's actions associated with the first tranche are already the subject of arbitration.

The negotiations regarding the second investment tranche for Fab 6 are ongoing.

Just as we did during the negotiations for the first investment tranche, we intend to jointly participate in the investment and we are agreeing to all good-faith, commercially reasonable terms proposed by Toshiba. However, we will not agree to terms such as SanDisk unilaterally waiving or negating its consent rights as a condition to participate which is what Toshiba has proposed. Consequently, at this time, we are not confident that an agreement will be reached on this next investment tranche either.

As we have noted, Toshiba's planned initial investment in Fab 6 is solely for its directly owned capacity that is outside of the JVs. If Toshiba proceeds unilaterally with this second investment tranche it would also be for Toshiba's directly owned capacity, not joint venture capacity.

It is also important to remember that the JVs are obligated to provide us our entitled share of flash supply through 2029. Based on the JV agreements, we remain confident in our planned supply bit growth rate of 35-45% for calendar 2018 and calendar 2019, irrespective of these initial investments in Fab 6.

In closing, I want to emphasize the following:

First, our Board and management are focused on resolving our differences with Toshiba, whether that is through a negotiated agreement or the arbitration process.

Second, we are steadfast in our commitment to protect our interests and those of Western Digital's stakeholders. We are confident in our fact-based legal positions and our right to injunctive relief.

Third, as I mentioned earlier, there has been a great deal of mis-information provided into the marketplace through various channels. We expect this activity to persist contributing to potential confusion about this situation and our legal rights. Western Digital will continue to communicate consistently and transparently – as we did with the recently filed FAQ and through public forums like this call.

And finally, I want to reiterate that our number one priority has been to ensure the longevity and continued success of the joint ventures. From day one, we have not changed this priority or our commitment to acting in the best interests of our stakeholders. I also want to thank the outstanding Western Digital team – you have maintained your focus and continued innovating and delivering for our customers in spectacular fashion.

With that, I will ask Mike and Mark to share the highlights of our quarter.


Mike Cordano - COO

Thank you, Steve, good afternoon everyone. Our September quarter results were better than expected with demand for our products remaining strong. The joint venture fab operations at Yokkaichi continued as planned and we made further progress in the ongoing conversion to 3D NAND technology.

In Client Devices, revenue grew nicely from the year-ago quarter driven by increased demand for our embedded flash products and client SSDs. Our embedded flash products, such as iNAND, gained further adoption within the mobile OEM ecosytem and our design win pipeline for these solutions deepened further for both current and emerging growth applications. Demand for our client SSDs grew due to increased adoption within our OEM's product portfolios, coinciding with the expansion of our product offering. We began ramping our 64 layer based client SSDs for OEMs in the September quarter and in the December quarter, we expect to launch our 64 layer eMMC solutions for the mobile and compute markets.

Our Client Solutions revenue grew strongly from the prior year driven by the diversity of our portfolio of HDD and flash based products. During the quarter, we launched two new mobile lifestyle products, iXpand Base and My Cloud Home, as well as the world's highest capacity microSD card at 400 gigabytes. The strength and appeal of our retail brands along with a broadening product portfolio, is enabling us to continue to deliver differentiated value to the global consumer marketplace.

In data center devices and solutions, our September quarter revenue was similar to the year-ago quarter as combined revenue growth in enterprise SSDs and capacity enterprise hard drives was offset by the expected secular decline in performance enterprise hard drives. In capacity enterprise, as we've previously commented demand continues to be muted due to the ongoing industry-wide shortage of key components, principally DRAM, resulting in slower industry petabyte growth in calendar 2017. As we look into calendar 2018, which is increasingly informed by our joint planning with hyperscale customers, we expect that petabyte growth will re-accelerate to the 40% annual rate. This will be driven by planned market migration to higher capacities such as our 12 terabyte (TB) offering to handle the growth of varied workloads and as the component shortages ease.

In the September quarter, we saw a continued shift in capacity enterprise to 10TB drives, gaining further traction with our third generation helium offering. Customer qualification activities on our fourth generation Helium offering, our 12TB drive, remained on track and we expect its commercial ramp will accelerate in the December quarter. We are pleased to note that we have shipped more than 20 million helium drives since our introduction of this platform in 2012.

Just over two weeks ago, we hosted a very successful technology event to formally announce important breakthroughs we have achieved to make microwave assisted magnetic recording, also known as MAMR, a commercial reality. We have been the leader in capacity enterprise with innovative solutions, the most recent being the HelioSeal technology. The commercial availability of MAMR technology is a significant next step in maintaining this leadership. MAMR substantially leverages past investments in perpendicular magnetic recording technology, making the justification for choosing this next-generation drive technology even more compelling. Further, an additional advantage of MAMR is that it requires almost no ecosystem changes in both our internal manufacturing processes or in customer infrastructure. As we have previously stated, we are planning to take MAMR into production in calendar 2019. We believe the areal density advantages that MAMR can deliver will enable us to provide helium drives at 40TB and higher capacities for this growing market in the years ahead.

In the September quarter, we completed the acquisition of Tegile Systems, a leading provider of flash storage systems for enterprise data center applications. With Tegile's IntelliFlash products focusing on fast data, and our ActiveScale products addressing big data, the combined company is in a stronger position to fully address diverse customer workloads. The Tegile acquisition will also enable us to accelerate our efforts to move up-the-stack to provide increasingly differentiated value for our customers.

In our flash joint ventures during the September quarter, we achieved bit output crossover for our 3D NAND versus 2D NAND. Manufacturing yields of BiCS3, our 64 layer 3D NAND, continued to improve and we met our ramp objectives of this industry-leading technology. We are also pleased to report that our entire retail portfolio has been enabled on BiCS3 already and we are well underway in expanding the use of this technology into our OEM offerings, positioning us to deliver the industry's richest mix of 64 layer based products in calendar 2017.

From a flash industry standpoint, our estimate for bit growth for calendar 2017 remains at the low end of our long-term industry outlook of 35% to 45%. For calendar 2018 we expect overall industry bit growth to continue to be in that long-term range. Given that the secular growth drivers for flash remain strong, we continue to believe that the favorable industry conditions will persist through the first-half of calendar 2018.  

Furthermore, as we have previously indicated, our bit supply requirements for calendar 2018 are secure and we are confident, based on the JV agreements, in our ability to achieve bit growth in calendar 2019 within our long term range.

In closing, our strong September quarter results continue to demonstrate the power of our platform. The various ingredients that make up this platform, including technologies, products, go to market capabilities, and our team, are helping us better serve our diversified customer base and manage our business to the best strategic and financial outcomes. The combination of our strong competitive position with our capacity enterprise Helium drives and the continued ramp of our BiCS3 products should provide a solid base to drive year-over-year revenue growth in our current fiscal year.

I will now turn the call over to Mark for the financial discussion.


Mark Long - CFO

Thank you, Mike and good afternoon everyone.

I am very pleased with our financial performance in the September quarter. Our team executed well across our broad array of markets as we capitalized on our diversified product portfolio, increased gross margins and achieved cost and expense targets. All of which resulted in significant earnings growth. We also finished the September quarter with an improved liquidity position as a result of our continued robust cash flow generation.

It is important to note that our fiscal 2017 financial performance included SanDisk's operating results for the full fiscal year so any year-over-year comparisons I reference today will be a direct comparison. Our revenue for the September quarter was $5.2 billion dollars, an increase of 10% year-over-year, driven by strong performance in each of our end markets. Revenue in Data Center Devices and Solutions was $1.4 billion dollars, Client Devices was $2.7 billion dollars and Client Solutions was $1.1 billion dollars.

Our Data Center business continues to be fueled largely by Cloud-related storage demand. Our September quarter revenue for Data Center Devices and Solutions was flat year-over-year. We saw sustained strength from capacity enterprise hard drives and enterprise SSDs, offset by an expected decline in performance enterprise hard drives. Client Devices revenue for the September quarter increased 13% year-over-year, primarily driven by significant growth in mobility and client SSDs. Client Solutions revenue for the September quarter, increased 16% year-over-year mostly as a result of the strength of our valuable global retail brands in removable and other Flash-based products.

Our non-GAAP gross margin was 42.3%, up 840 basis points year-over-year. This gross margin expansion resulted from a favorable supply/demand environment for flash based products, product cost improvements, a higher mix of flash based revenue and the strength of our capacity enterprise HDD lineup.

Turning to operating expenses, our non-GAAP OPEX totaled $819 million dollars. This included on-going investments in product development, go-to-market capabilities, IT transformation projects and operating expenses related to our recently acquired companies. We continue to make progress toward our integration synergy targets while also making investments in our future capabilities.

Our non-GAAP interest and other expense for the September quarter was $200 million dollars, inclusive of $205 million dollars of interest expense. Our interest expense decreased $31 million dollars year-over-year primarily from the repricings savings which were partially offset by Libor increases.

Our non-GAAP effective tax rate for the September quarter was approximately 7%.

On a non-GAAP basis, net income in the September quarter was $1.1 billion dollars, or $3.56 per share. On a GAAP basis we had net income of $681 million dollars, or $2.23 per share. The GAAP income for the period includes intangible amortization, charges related to integration activities and stock based compensation. Therefore, the net difference between our GAAP and non-GAAP net income is primarily a result of non-cash charges.

In the September quarter we generated $1.1 billion dollars in operating cash flow, an increase of 158% year-over-year. We continued to reinvest in our businesses with $286 million dollars spent on capital investments, resulting in free cash flow of $847 million dollars. We also had good working capital performance contributing to our significant operating cash flows in the quarter.

We paid the previously declared cash dividend totaling $147 million dollars during the quarter and also declared a dividend in the amount of $0.50 cents per share.

We closed the quarter with cash, cash equivalents and available for sale securities totaling $7.0 billion dollars, resulting in approximately $8.0 billion dollars of liquidity available to us, including our $1.0 billion dollars of undrawn revolver capacity. Since the beginning of the fiscal year, our net debt has decreased approximately $600 million dollars to $6.3 billion dollars at the end of the September quarter, mostly driven by cash flow generated by the business. We remain committed to our deleveraging plans and will continue to optimize our cost of capital and capital structure while retaining sufficient liquidity and flexibility.

We remain on track to achieve our planned synergy targets from both the HGST and SanDisk integrations in the time commitments we previously established. The combined savings of the programs have contributed to our strong financial results and validated our strategy for the acquisitions.

I will now provide our guidance for the second quarter of fiscal 2018 on a non-GAAP basis.

  • We expect revenue to be between $5.2 billion and $5.3 billion dollars
  • We expect gross margin to be slightly higher than the prior quarter
  • Turning to operating expenses, we expect those to be approximately $830 million dollars
  • Interest and other expense is expected to be approximately $205 million dollars.
  • We expect an effective tax rate in the 6-8% range.
  • Our diluted shares are expected to be approximately 309 million
  • As a result, we expect non-gaap earnings per share between $3.60 and $3.70, resulting in EPS for calendar year 2017 of approximately $12.50.

We believe our integrated product and technology platform is a key differentiator that will enable strong long-term growth and profitability. While we expect to see our normal seasonal decline in the second half of fiscal 2018, we see the opportunity to achieve revenue growth at the high end of our long-term model of 4% to 8% for fiscal 2018. Also, based on our current business outlook and capital structure we expect our non-GAAP earnings per share will be approximately $13 for fiscal 2018.

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

Closing Remarks:

I want to thank everybody for joining us today. And we look forward to speaking with you going forward. Have a great rest of the day.