Western Digital Fourth Quarter Ended July 26, 2018 Conference Call Remarks, 7/26/2018


Peter Andrew - Vice President Investor Relations

Thank you Sheree and good afternoon everyone.

This conference call will contain forward-looking statements within the meaning of the federal securities laws, including statements concerning: our product and technology platform; market positioning; business strategies and growth opportunities; market and flash industry trends; our joint ventures with Toshiba Memory Corporation; and our expected future financial performance, capital allocation plans and potential share repurchases. 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 financial report on Form 10-Q filed with the SEC on May 8, 2018. 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 non-GAAP measures we provide during this call to the comparable GAAP financial measures will be posted in the 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.

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

As a reminder, we are also providing a concurrent presentation on this webcast and a PDF of the slides and our remarks will be available later today in the Investor Relations section of our website, along with our Quarterly Fact Sheet.

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


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 fourth quarter and full year financials and wrap up with our first quarter guidance. We will then take your questions.

Our strong financial results for fiscal 2018 demonstrate the power of the Western Digital Platform. For fiscal 2018, we grew revenue at the high end of our long-term range of 4% to 8% as demand for our hard drive and flash based offerings remained strong. Non-GAAP gross margin improved nearly 5 percentage points to a record 42.5% and with non-GAAP operating expense growth of just 2%, our business model demonstrated significant earnings leverage

The long-term trends of data growth and its increasing value require a robust storage infrastructure. We have assembled a compelling portfolio of storage technologies that address these market opportunities in Big Data and Fast Data. With the continued expansion of our product lines, we believe we are well positioned to address this growing market opportunity which is expected to be $100 billion in calendar 2021.

There has been much debate among the investment community about flash industry cyclicality and its effects on our business. I would like to share my perspective on it. The tight demand-supply balance experienced by the industry for the last several quarters was driven by several factors including the complexities of technology conversions such as the move from 2D to 3D and then in 3D, to higher layer counts. As these technology conversions are maturing and manufacturing yields are improving, the rate of flash supply growth is also increasing. We estimate that in calendar 2018, industry bit growth will be at the high end of the long term range. These factors together with a softer demand environment in key sectors such as mobility, are causing flash pricing to decline at a rate faster than in past quarters.

The flash industry has been in the midst of adjusting to these normalization trends and we expect pricing pressure to continue through the remainder of calendar 2018. In this context, and in response to the changing market environment, we are reviewing our near-term capital investment plans for flash with our joint venture partner.

We are a leader in both hard drives and flash based technologies and products. We expect gross margins for our flash portfolio to remain healthy. Additionally, our broad portfolio of hard drive solutions coupled with the underlying growth in cloud infrastructure allows us to better manage dynamic market conditions. To demonstrate the confidence we have in our business model, its cash flow generation potential and long-term outlook, our Board has authorized a new $5 billion share repurchase program. We believe today's announcement is an excellent capital allocation opportunity to enhance long-term shareholder value.

We are focused on innovating and executing on our long-term value creation strategy by utilizing the power of our platform. I want to sincerely thank the Western Digital team and our partners for their ongoing support. We will be hosting our 2018 Investor Day on December 4th and we look forward to engaging in a deeper discussion about our market opportunities, and how we are continuing to build the company to deliver shareholder value.

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


Mike Cordano - COO

Thank you Steve and good afternoon everyone.

Our June quarter performance once again highlights the power of the Western Digital platform. Strong demand for our products helped deliver year-over-year revenue growth in all of the reported categories. The transition to 3D flash technologies in the flash joint venture fabs continued as planned and we made further improvements in our manufacturing efficiencies.

In Data Center Devices and Solutions, demand from our Cloud customers drove continued adoption of our high-capacity Helium drives, particularly at the 12 terabyte capacity. Strong demand for these products reflects the needs of cloud customers to upgrade their infrastructure and build new data centers to support the unabated growth in data. Our Helium drives gained further traction on a global basis in both established and emerging markets. On a cumulative basis, since the launch of our Helium platform, we have shipped more than 30 million drives, underscoring our multi-generational leadership position.

We estimate that the overall exabyte growth in capacity enterprise was more than 90% year-over-year in the first-half of calendar 2018, and we continue to estimate more than a 65% year-over-year growth rate for calendar 2018.

Switching to Client Devices, we began revenue shipments of our latest NVMe client SSDs, with additional product qualifications progressing as planned. In the June quarter, we expanded our surveillance portfolio with the introduction of the Western Digital® Purple 12 terabyte drive, which is the industry's highest capacity surveillance-class product. This latest addition to Western Digital's portfolio creates new possibilities in video surveillance by supporting the capture and access of multi high-resolution video streams for use cases such as deep learning and analytics. In embedded applications, we saw further adoption of our 3D flash based products. The design win pipeline for emerging applications in the automotive, industrial and connected home verticals remain strong.

In the Client Solutions category, the worldwide appeal of our G-Tech, SanDisk and WD brands continued to drive consumer preference for our products. In the established markets, we expanded our presence in the e-tail channel and achieved better-than-expected June quarter performance notably in APAC and China.

Last week, we announced the industry's first 96-layer four bits per cell, QLC, 3D flash technology. This new 3D flash chip delivers the industry's highest storage capacity of 1.33 terabits in a single die, reflecting the deep flash technology design and implementation expertise of our team. We have commenced sampling, and volume consumer product shipments are expected to begin later this calendar year.

Turning to our flash joint ventures, the ramp of BiCS3, our 64 layer 3D flash technology, progressed well with manufacturing yields setting new records. The transition to BiCS4, our 96 layer technology, is also underway and for the full calendar year 2018, we expect our 3D flash bit output to constitute nearly 75% of our total captive bit supply.

As Steve described, the flash market is continuing to normalize. In response to these dynamic conditions, we are in discussions with Toshiba Memory Corporation, our joint venture partner, to moderate the near-term pace of capital investments. We are working to ensure that any changes to our investment plans are done with the intent to moderate the pace of flash supply growth without compromising our technology leadership.

As we have stated previously, we are continuing to rationalize our hard drive manufacturing footprint as part of our ongoing integration activities. To this point, we recently informed employees of our plan to decommission hard drive manufacturing at our Kuala Lumpur site. Implementation of this plan has commenced, and we will be moving our operations to Thailand over the next 18 months.

In summary, with our unique portfolio, we are able to address and capture the opportunities presented by the growth in and the increasing value of data. With the continued expansion of our product portfolio in calendar 2018 and beyond, we are confident that the Western Digital platform is well positioned to deliver the best financial and strategic outcomes in a variety of market conditions.

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


Mark Long - CFO

Thank you, Mike and good afternoon everyone.

I am pleased with our financial performance in the June quarter and fiscal year 2018. We executed well across our broad array of markets with our diverse product portfolio, achieved expense targets and reduced interest expense, all of which resulted in significant earnings growth. We finished the year with a strong liquidity position as a result of improving our capital structure and continued strong cash flow generation.

Revenue for the June quarter was $5.1 billion dollars, an increase of 6% on a year-over-year basis.

The June quarter revenue for Data Center Devices and Solutions was $1.6 billion dollars, an increase of 14% year-over-year. Our Data Center revenue growth continues to be driven by Cloud-related storage.

Client Devices revenue was $2.5 billion dollars, an increase of 3% year-over-year. We had significant growth in mobile and embedded products offset by client compute devices.

Client Solutions revenue was $1 billion dollars, an increase of 2% year-over-year, driven by the strength of our global brands sold through retail.

For fiscal year 2018 year-over-year revenue growth was 8%, driven by growth in each of our end markets. This is indicative of strong operational execution and the strength of our diverse product portfolio.

Non-GAAP gross margin for the June quarter was 41.0%, down 30 basis points year-over-year. Flash average selling price per gigabyte declined in the mid-to-high single digit range on a quarter-over-quarter basis. For fiscal year 2018 our non-GAAP gross margin expanded 470 basis points, resulting from a higher mix of revenue from sales of flash products and capacity enterprise drives.

Non-GAAP OPEX for the June quarter totaled $820 million dollars, below our guidance due primarily to lower variable incentive compensation.

Our non-GAAP net interest and other expenses for the June quarter was $101 million dollars, a year-over-year decrease of almost 50%. This includes $107 million dollars of non-GAAP interest expense for the June quarter, a decrease of $94 million dollars year-over-year. For fiscal year 2018 we reduced non-GAAP interest expense $180 million dollars year-over-year, primarily due to the financing transactions implemented throughout fiscal year 2018.

In the June quarter our effective non-GAAP tax rate was 6%.

On a non-GAAP basis, net income for the June quarter was $1.1 billion dollars, or $3.61 per share, an increase of 23% year-over-year. For fiscal year 2018 we increased our non-GAAP earnings per share by $5.54, an increase of 60% year-over-year.

In the June quarter, we generated $863 million dollars of operating cash flow. We continued to reinvest in our business with $225 million dollars in capital investments, resulting in free cash flow of $638 million dollars.

For fiscal year 2018, we generated $4.2 billion dollars in operating cash flow, an increase of 22% from the prior year. We deployed $1.6 billion dollars on capital investments, resulting in fiscal year 2018 free cash flow of $2.7 billion dollars.

In the June quarter we had an increase in inventory primarily driven by preparation for seasonal demand for flash in the back half of the calendar year. Additionally, hard drive buffer inventory grew to facilitate the expected closure of the Kuala Lumpur hard drive factory.

In the June quarter, we returned $586 million dollars to shareholders, of which $150 million dollars was in dividends and $436 million dollars was through share repurchases. We also declared a dividend in the amount of $0.50 cents per share.

As part of our continued balanced capital allocation strategy, our Board of Directors authorized a new $5 billion dollar share repurchase program, replacing our prior programs. We are targeting repurchasing $1.5 billion dollars of our common stock over the next twelve months, depending on market conditions. We believe this is an attractive capital allocation opportunity and demonstrates the confidence we have in our long-term outlook.

We closed the quarter with cash, cash equivalents and available for sale securities totaling approximately $5.1 billion dollars. In addition, we have $1.75 billion dollars remaining out of our $2.25 billion dollars of total revolver capacity. As a result, we ended the quarter with approximately $6.9 billion dollars of available liquidity.

We believe that our long-term gross margin model should be increased. Despite near-term volatility in the flash market, the power and resiliency of the Western Digital platform remains strong. We are increasing our long-term non-GAAP gross margin model range to 35% to 40% from 33% to 38%.

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

We expect:

  • Revenue in the range $5.1 to $5.2 billion dollars,
  • Gross margin in the range of 38% to 39%,
  • Operating expenses between $825 and $835 million dollars,
  • Interest and other expense of approximately $105 million dollars,
  • An effective tax rate of approximately 10%, also consistent with our updated longer-term outlook,
  • Diluted shares of approximately 304 million,
  • As a result, we expect non-GAAP earnings per share of $3.00 to $3.10.

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

Closing Remarks:

Thank you all for joining us. And we look forward to updating you as we move forward. And thank you for your interest in our company. Have a good day.