Western Digital First Quarter Fiscal 2019 Conference Call Remarks, 10/25/2018


Peter Andrew - Vice President Investor Relations

Thank you and good afternoon everyone.

This conference call will contain forward-looking statements within the meaning of the federal securities laws, including business plans and strategies, industry trends, and business and financial outlook. These forward-looking statements are based on management's current assumptions and expectations and we assume no obligation to update them to reflect new information or events. Please refer to our most recent annual financial report on Form 10-K filed with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially.

We will also make references to non-GAAP financial measures today. Reconciliations between the non-GAAP and comparable GAAP financial measures are included in the press release and the guidance summary that are being posted in the Investor Relations section of our website.

During the Q&A, we ask that you limit yourselves to one question.

Before I pass the line to Steve, I want to alert everyone that in an effort to provide investors greater transparency into our business and make our earnings related information easier to find – we have made a number of significant changes to the information in the earnings related materials posted on our website. All of these materials can be found in the Investor Relations section of our website under quarterly results and earnings documents. Please take a few minutes to check out this new material and we look forward to your feedback.

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


Steve Milligan - CEO

Thank you, Peter, and good afternoon, everyone. 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 financials and wrap up with our second quarter guidance. We will then take your questions.

For the first quarter of fiscal 2019, we reported revenue of $5 billion and non-GAAP gross margin of 38%. Non-GAAP operating expenses were at the year-ago level, and with the help of a capital structure that has significantly reduced interest expense, we delivered $3.04 in non-GAAP earnings per share and over $700 million in operating cash flow during the quarter.

While our first quarter results were impacted by declines in flash average selling prices, we experienced strong performance in capacity enterprise, surveillance hard drives, and embedded flash solutions, with each growing revenue over 30% on a year-over-year basis.

Current geopolitical and industry dynamics are creating a more challenging global business environment. For example, trade tensions with China, changes in monetary policy, foreign exchange volatility and the corresponding economic impacts are causing our customers to be more conservative, resulting in a demand slowdown for our products.

This softening demand, in combination with increased flash supply, has led to a market imbalance resulting in a deteriorating near-term flash pricing environment.

In response to these conditions, we are making an immediate reduction to wafer starts and delaying deployment of capital equipment. These actions will reduce our wafer output beginning in fiscal Q3 2019. The goal of these actions is to better align our output with the projected global demand for flash.

The duration of the planned output reduction will depend upon market conditions and will not impact our ability to meet customer commitments, nor will it impede our ability to deliver the most innovative and cost competitive solutions to the market.

Longer term, we remain focused on technology leadership, the broadening of our product portfolio and continued operational improvements. Highlights of our recent successes in these areas include:

  • Leadership in bringing the highest capacity and lowest total cost of ownership solutions to Cloud customers with our recently introduced 15 terabyte SMR-based hard drive;

  • Successful introduction of 96-layer BiCS4 solutions including our latest SATA based client SSD and the industry's first UFS 2.1 embedded flash drive for high end smartphones;

  • Ongoing growth in Data Center Systems and industry accolades for our ActiveScale object storage systems; Gartner has recognized ActiveScale as a Challenger in the 2018 Gartner Magic Quadrant; and

  • Operational improvements that include the right-sizing our hard drive manufacturing footprint.

We remain well positioned to capitalize on the long-term opportunities associated with the rapid growth in the volume and value of data. I want to thank the Western Digital team and our partners for their ongoing support. We look forward to hosting our 2018 Investor Day on December 4th to provide further insight about our plans to deliver long-term shareholder value through ongoing growth and leadership in today's data-driven world.

With that, I will now ask Mike to share our business highlights.


Mike Cordano - COO

Thank you Steve and good afternoon everyone.

As Steve mentioned we are taking aggressive actions to align our supply of flash to current end market demand. I would like to provide some additional insight into our actions announced today.

Our immediate reduction in wafer starts and delayed deployment of capital equipment is a reflection of the adjustment to bit supply growth needed to improve the supply-demand dynamic by mid-year 2019. The magnitude of these actions is a reduction of 10% to 15% of our planned bit output in calendar year 2019.

With these adjustments to our supply, we expect our bit growth in calendar year 2019 to be in line with our view of end market demand growth of between 36% to 38%.

We will continue to monitor market conditions and make additional adjustments, either up or down, as the situation dictates.

As we enter the second fiscal quarter, we are faced with a number of market factors that will impact our near-term results. Beyond the flash supply dynamic, other challenges include:

  • We expect to be negatively impacted by the widely publicized CPU shortage. Industry analysts have estimated that PC unit growth will be constrained between 5% to 10% for the current quarter, with the situation potentially lingering into early calendar year 2019.

  • We are experiencing a temporary slowdown in data center capital spending particularly by large Cloud service providers. After several quarters of growth above the expected long-term exabyte growth rate of 40% for capacity enterprise, we are in the midst of adjusting to a more normal growth rate. For the calendar year 2018 we now project capacity enterprise exabyte growth of approximately 55%. Based on discussions with our customers, we expect stronger growth to resume in the second half of calendar year 2019.

  • Steve has already talked about how the global business environment is contributing to a risk-averse orientation within our end markets. These dynamics are having a disproportionate impact on certain end markets outside the U.S., particularly China.

As a management team we are well aware of the current macroeconomic and industry conditions, and are taking appropriate actions to respond, while ensuring we invest for future growth and leadership across the markets we serve.

Examples of our progress in the first quarter were:

  • We maintained our leading position across all of the brands in our Client Solutions portfolio, including G-Tech, SanDisk and WD.

  • Client Devices experienced healthy demand in both surveillance hard drives and in embedded mobile flash solutions versus a year ago. Leading smartphone providers continue to increase the average capacity per device, which is driving ongoing growth for our mobile products.

  • Data Center Devices and Solutions revenue grew year-over-year driven primarily by continued demand for our capacity enterprise hard drives. In addition, we experienced record revenue in our emerging Data Center Systems products – a strategic growth area we will discuss in more detail at our upcoming Investor Day in December.

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


Mark Long - CFO

Thank you, Mike and good afternoon everyone.

As Peter mentioned earlier, we have updated our disclosures to provide investors with additional transparency into our business. In particular, we are providing a break down of our total revenue and non-GAAP gross margins for flash products and hard drives. These disclosures are included within the earnings presentation available on our IR website.

I will now review the financial performance for the September quarter.

Revenue for the September quarter was $5.0 billion dollars, a decrease of 3% on a year-over-year basis and below our original outlook for the quarter. The shortfall was primarily driven by weaker than expected flash pricing. Specifically, our flash based products had revenue bit growth of 28% sequentially while the average selling price was down 16%.

The September quarter revenue for Data Center Devices and Solutions was $1.4 billion dollars, an increase of 6% year-over-year. Our Data Center revenue growth continues to be driven by Cloud-related storage.

Client Devices revenue was $2.7 billion dollars, which was essentially flat year-over-year. We had significant growth in embedded flash and surveillance products, offset by client compute hard drives.

Client Solutions revenue was $932 million dollars, a decrease of 18% year-over-year driven by the normalization trends in flash market pricing.

Non-GAAP gross margin for the September quarter was 38.0%, down 430 basis points year-over-year. Gross margin declined primarily due to a reduction in flash ASPs.

Non-GAAP OPEX for the September quarter totaled $820 million dollars, consistent with the prior quarter. Given the current environment we continue to align our spending with our top priorities.

On a non-GAAP basis, net income for the September quarter was $906 million dollars, or $3.04 per share.

In the September quarter, we generated $705 million dollars of operating cash flow. We continued to reinvest in our business with $248 million dollars in capital investments, resulting in free cash flow of $457 million dollars.

In the September quarter, we had a sequential increase in inventory primarily driven by a return to normal operating levels for capacity enterprise products. Flash inventory grew slightly, contrary to normal seasonal trends, as a result of the market factors that Mike identified.

In the September quarter, we returned $711 million dollars to shareholders, of which $148 million dollars was in dividends and $563 million was through share repurchases. These share repurchases put us on target of our goal to repurchase $1.5 billion dollars of our common stock during fiscal year 2019, depending on market conditions. We continue to believe this is an attractive capital allocation opportunity and demonstrates the confidence we have in our long-term outlook.

We 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 approximately $4.8 billion dollars.

Before I provide our guidance, I would like to describe the financial impact of our decision to reduce our flash output through reduced wafer starts and delayed deployment of capital equipment. We expect to reduce our planned flash output by approximately 10% to 15% for calendar year 2019. The goal of these actions is to bring our supply more in line with the demand environment, with the majority of the supply reduction occurring by the middle of calendar year 2019.

Based on our current plan to temporarily reduce our flash output, we expect to take a GAAP only charge in the range of $250 million to $300 million dollars spread over the remaining quarters of fiscal year 2019. This charge is driven by our fab capacity decisions and does not reflect an incremental cash payment. As Mike indicated we may adjust our plans based on market conditions and this could impact the extent of any charges.

I will now provide our guidance for the second fiscal quarter of 2019 on a non-GAAP basis.

We expect:

  • Revenue in the range $4.2 to $4.4 billion dollars,

  • Gross margin in the range of 32% to 33%,

  • Operating expenses between $760 and $780 million dollars,

  • Interest and other expense of approximately $105 million dollars,

  • An effective tax rate of 10% to 12%,

  • Diluted shares of approximately 295 million,

  • As a result, we expect non-GAAP earnings per share of $1.45 to $1.65.

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

Closing Remarks:

Thank you for joining us and we look forward to seeing many of you on December 4 at our Investor Day. Have a good rest of the day.