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 that we will be making forward-looking statements in our comments and in response to your questions concerning: benefits expected from our planned acquisition of Hitachi GST; industry conditions in the June quarter, including the total available market for hard drives, customer demand, supply constraints, capacity mix, average selling price and cost of components; our presence in the traditional enterprise market; our expected capital expenditures and depreciation and amortization for fiscal 2011; the terms of, and our ability to syndicate, our new credit facility to be entered into in connection with our planned acquisition of Hitachi GST; and our financial results expectations for the June 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 January 28, 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 review the reconciliation of the differences between the historical non-GAAP measures to the comparable GAAP financial measures in our press release and investor information summary included as Exhibits 99.1 and 99.2, respectively, to the Form 8-K we furnished to the SEC today, copies of which can be found under the “SEC Filings” link 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. With me on our Q3 call are Tim Leyden our chief operating officer and Wolfgang Nickl our chief financial officer.
First and foremost, we were pleased to determine in early March that Western Digital employees in Japan as well as those of Hitachi GST were all safe after the tragic events of last month. Those personally affected by these events continue to be in our thoughts.
Like many technology companies, we have been busy dealing with the disruptions resulting from the events in Japan. We are also proceeding on plan with our acquisition of HGST and have made significant progress on that front: we are in the approval process with all required regulatory agencies, our integration planning is well underway and we have successfully syndicated the loan financing associated with the transaction. We remain very excited about the potential of this acquisition.
Industry shipments came in at 160 million units for the March quarter, slightly above our original expectation of 155 million units as customers accelerated product purchases in the last three weeks of the quarter due to supply concerns as a result of the Japanese earthquake.
Analyzing the effects of the events in Japan on the technology industry generally, there were and remain a number of supply chain challenges which are impacting both demand and supply visibility in the June quarter and beyond. Tim will describe these in more detail but I am pleased that the WD team, with strong support from our suppliers, has mitigated the initial impact on our ability to support pre-earthquake customer share awards for the June quarter. We have now turned our attention to responding to customer upside requests for this quarter, which we believe are driven by unresolved supply chain issues at competitors and to fully supporting customers’ needs in the September quarter.
We believe end customer demand for the June quarter in all markets for HDDs is tracking to seasonally normal patterns. However there is uncertainty around the ability of our customers and the HDD industry to fully satisfy this demand due to supply chain challenges. In uncertain times like these, we believe the highly flexible and responsive WD business model is especially well equipped to perform and deliver value to our customers and shareholders.
I will now turn the call over to COO Tim Leyden who will describe the operational challenges and highlights in the March quarter in greater detail.
In closing, I’d like to thank you all of you for joining us today. We appreciate your questions and interest in the company and the industry. We look forward to seeing you again in another quarter.
Tim Leyden - Chief Operating Officer
Entering the March quarter, we aligned our business with the 155 million unit TAM (total available market) that we had forecasted in the January earnings call. Responding to the unexpected increase in TAM triggered by the fears of uncertain supply in the last few weeks of the quarter, our adaptable model enabled us to react rapidly to the upturn in demand and satisfy the actual TAM of 160 million units.
Price declines for the quarter were broadly as we had expected, overall product capacity mix was relatively flat, but tight cost management enabled us to come in at the high end of our implied gross margin guidance.
We shipped 49.8 million units in the March quarter, down 4.6 percent sequentially and 2.5 percent from the year-ago period, while the overall market declined by 4.8 percent and 2.3 percent respectively. Revenues totaled $2.25 billion, gross margin was at 18.2 percent and we remained solidly profitable with net income of $146 million. We generated strong cash flow from operations of $313 million.
Now, turning to the overall market, in the compute space units decreased sequentially from 116 to 112 million and decreased year-on-year from 119 million. We believe that the softer demand in the March quarter was driven to some extent by the late supply of CPUs to PC ODMs. Commercial demand strength continued, while consumer demand remained subdued. Against this backdrop WD shipped 36.3 million units into the compute space in the March quarter compared to 37.8 million units in the December quarter and 38.5 million units in the year-ago quarter, as we maintained essentially flat market-share in all three periods.
The near-line enterprise market was up sequentially from 5.4 to 5.6 million units, and up from 5.2 million units year-on-year. Driven by the expansion of cloud computing, this market continues to offer further growth opportunity. The traditional enterprise market – at 8.3 million units – remained flat with the December quarter and was up year-on-year from 7.4 million units reflecting the continued strength of the commercial market. The shift to 2.5-inch SAS continued as the percentage of total market represented by this platform has now advanced to around 54 percent of the TAM. WD shipped 2.3 million units into the combined Enterprise markets in the March quarter, essentially flat with the December and year-ago quarters. We continue to put the building blocks in place to increase our presence in the traditional enterprise space and we are shipping our second generation SAS product to a limited customer set and we continue to work on our third generation product.
The HDD manufacturers’ TAM in the branded product segment came in at 13 million units, seasonally down from 14.7 million units in the December quarter and up from 10.7 million units in the year-ago quarter, presenting continuing evidence of strong demand for personal storage. The seasonal cadence of this market is such that sell-in exceeds sell-through during the December quarter in order to have adequate inventory in place for the holiday and post-holiday sales, whereas sell-through exceeds sell-in during the March quarter as distributors and retailers lighten up on inventory in preparation for the seasonally weaker June quarter. WD shipped 6.4 million units into this market in the March quarter down from 7.4 million units in the December quarter and up from 5.6 million units in the year-ago quarter. We continue to compete strongly in this market segment where our brand equity, product line-up and differentiating features have earned us the leading position.
In the DVR market segment, the TAM was 13.5 million units, down sequentially from 14.3 million and up from 12.1 million in the year-ago quarter. WD shipped 4.7 million units into this market in the March quarter, essentially flat with the December quarter and up slightly from 4.6 million in the year-ago quarter. WD’s product capabilities resonate with customers in this segment and we continue to see growth opportunities as HDDs offer the best value proposition to store and enjoy 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 June quarter, we believe that in an environment absent the impact of the Japanese earthquake, the true demand for HDDs in the compute space would follow seasonal demand patterns and would be flat to down from the March quarter. However, given the likely impacts, we believe that HDD TAM in the June quarter will be supply constrained. Shortages at this point appear to be more acute in 2.5-inch drives, but we expect that product will also be short in the 3.5-inch form factor – assuming that customer demand is not impacted by an inability to get other components that they need to build their systems. There are multiple levels of the supply chain at which availability problems may occur – from base chemicals up to final discrete components – and issues at each level are still being worked by us, our suppliers and our customers. In the meantime, our customers are ordering what they can in order to reduce the number of their individual supply concerns. We are planning around a normal June quarter demand and we have underpinned supply to satisfy that level of unit volume. We are now looking to support our customers with upside supply in response to their requests as they try to bridge shortages from other HDD suppliers. As John indicated, it is in uncertain times like these that WD’s flexible and responsive model and our consistency in execution enable us to serve our customers well.
In our other served markets, we expect volumes in DVR to be up seasonally, Branded Products to be down and Enterprise segments to be flat.
Now, turning to our product line–up, we introduced new capacities for users of consumer network storage and high-speed direct-attach storage. We began populating our industry-leading My Book external drives with our 3 TB hard drives:
- Creative PC professionals and Mac enthusiasts can now utilize the 6 TB My Book Studio Edition II storage systems to support their ever-increasing production of HD content. This two-drive storage system has four interfaces, including eSATA and FireWire 800 for the fastest transfer speeds, RAID capability and Apple Time Machine compatibility.
- Our fast My Book Live network drive, with a total capacity of 3 TB, now centralizes more media than ever before in consumers’ homes.
- We also added functionality to our WD TV Live media players, including CinemaNow, which provides users access to new-release movies and TV episodes; new Netflix features, including the ability to search for movies and get recommendations directly on users’ HDTV, as well as support for enhanced audio with Dolby Digital Plus.
I will now turn the call over to Wolfgang Nickl for a review of our Q3 financial performance and our outlook for the fourth quarter.
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 will be updated with our Q4 guidance after this call.
Our Q3 actual results were slightly above the upper end of the guidance range we provided during our January investor call.
Revenue for the third fiscal quarter was $2.25 billion, down 15 percent from the prior year and 9 percent sequentially. Hard drive shipments totaled 49.8 million units, down 3 percent from the prior-year period and 5 percent sequentially. Revenue from sales of WD TV Media Players, WD Livewire Network Kits and solid-state drives totaled approximately $50 million, up 8 percent from the prior year and down 12 percent from the December quarter.
Average hard drive selling price was approximately $45 per unit, down $6 from the year-ago quarter and $2 from the December quarter.
Revenue from sales of our branded products, including WD TV and WD Livewire products, was $441 million, down 6 percent from the year-ago quarter and 19 percent sequentially.
There was no single customer that comprised 10 percent or more of our total revenue.
Geographically, the regions contributed roughly the same relative percentage of revenue as in the December quarter, with Asia sales continuing to represent the majority of our revenue.
From a channel perspective, retail’s percentage of revenue declined along seasonal expectations, while our OEM percentage increased slightly.
Our gross margin for the quarter was 18.2 percent, down from 25.2 percent in the year-ago quarter and 19.2 percent in the December quarter. The quarter-over-quarter reduction of gross margin by 100 basis points is a function of a seasonal decline in our Branded Products business and some cost of under absorption of our manufacturing assets due to a reduced build plan.
Total R&D and SG&A spending of $252 million included $10 million of expenses related to the planned acquisition of HGST. Excluding these acquisition-related expenses, R&D and SG&A would have totaled $242 million, or 10.7 percent of revenue. This compares with $224 million, or 8.5 percent of revenue in the year-ago quarter, and $235 million, or 9.5 percent of revenue in the December quarter. The quarter-over-quarter increase is primarily a function of increased investments in new product development and higher incentive accruals.
Operating income was $158 million, or 7.0 percent of revenue, including $10 million of acquisition-related expenses. Non-GAAP operating income was $168 million, or 7.5 percent of revenue. This compares with $441 million, or 16.7 percent of revenue in the year-ago quarter, and $240 million, or 9.7 percent of revenue in the December quarter.
Net interest and other non-operating income was $1 million.
Tax expense for the March quarter was $13 million, or 8.2 percent of pre-tax income.
Our net income totaled $146 million, or $0.62 per share, including $10 million of acquisition-related expenses. Non-GAAP net income totaled $156 million, or $0.66 per share. This compares with $400 million, or $1.71 per share, and $225 million, or $0.96 per share in the year-ago and December quarters, respectively.
Turning to the balance sheet, our cash conversion cycle for the March quarter was a positive 2 days. This consisted of 47 days of receivables, 28 days of inventory or 13 turns, and 73 days of payables. We generated $313 million in cash flow from operations during the March quarter, and our free cash flow totaled $138 million.
Capital expenditures for the March quarter totaled $175 million. Depreciation and amortization expense for the third quarter totaled $151 million.
We have lowered our forecast for capital expenditures and depreciation. We now expect our capital spending for the current fiscal year to be between $775 million and $800 million, including approximately $100 million for our 6 to 8-inch wafer conversion and some smaller expenditure to optimize the output from our Singapore media facility we acquired last year. Depreciation and amortization is now expected to be about $610 million for the current fiscal year. For fiscal year 2012, we are planning carry-over spending of up to $100 million for 6 to 8-inch wafer conversion and Singapore media facility optimization.
We made $25 million of debt repayment installments during the third quarter, and thereby reduced our debt balance to $325 million.
We exited fiscal Q3 with cash and cash equivalents of $3.2 billion, an increase of $120 million from the December quarter.
Before I talk about our Q4 guidance, let me update you on the progress we made on the debt financing related to our planned acquisition of HGST:
The cash portion of the purchase price will come from available off-shore cash and new debt. Our existing term loan will be repaid from available cash balances. The new debt will not be rated, but will have terms similar to investment grade debt and covenants that are very similar to what we have now. The new credit facility will consist of a term loan of up to $2.5 billion and a $500 million revolving line of credit. We have fully negotiated the definitive loan documents with the syndicate members and, subject to customary closing conditions including completion of the acquisition in accordance with its terms, we fully expect all of the syndicate members to be part of the final lender group. The term loan and any amounts drawn under the line of credit will carry an interest rate of LIBOR plus a margin that is based on our leverage ratio. We currently expect that margin to be 200 basis points. Undrawn amounts on the revolver will carry a commitment fee of about 35 basis points, which will also vary according to our leverage ratio. The debt will not be funded until the acquisition closes, but we will be paying ticking fees on the $3 billion commitment at an annualized rate of 35 basis points between now and then. The loan will have a 5-year term, with half of the principal being paid quarterly over that period, and the other half being paid at maturity.
Let me now turn to our expectations for fiscal Q4.
Absent the impact from the earthquake in Japan, we believe demand would have been flat to slightly down in line with historical seasonality. However, there are several factors that could alter that pattern, including:
- Our belief that harddrive suppliers will struggle to meet customer demand.
- Customers are still in discovery mode to establish which components may limit their ability to service their system level customers.
- If hard drives prove to be the bottleneck, we will be able to ship everything we can build.
- We have made significant progress stabilizing our supply and are confident that we can supply our customers what we committed to them prior to March 11th.
- We expect better than seasonal capacity mix up, moderate price declines and some cost increases for part substitution and expedite charges.
- Despite the fact that we are currently above our OPEX model, we continue to invest in our Branded Products portfolio, solid-state initiatives and fundamental technology capabilities.
- Our guidance does not include acquisition and financing related costs.
Based on these assumptions, our guidance for fiscal Q4 is as follows:
We expect revenue to be in the range from $2.2 billion to $2.25 billion.
R&D and SG&A spending of approximately $245 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.
We estimate non-GAAP earnings per share of between $0.60 and $0.65 for the June quarter, which excludes acquisition-related expenses.
Operator, we are now ready to open the call for questions.