Western Digital Corporation
Q4 2015 Earnings Call Transcript

Published: 30 Jul 2015

[Operator:]

Good afternoon and thank you for standing by. Welcome to Western Digital’s fourth quarter financial results for fiscal year 2015. Presently all participants are in a listen-only mode. Later we will conduct a question and answer session [Operator Instructions]. As a reminder, this call is being recorded. Now I will turn the call over to Mr. Bob Blair. Sir, you may begin.

[Robert Blair:]

Thank you, as we being I would like to mention that we’ll be making forward-looking statements in our comments in response to your questions concerning, among others, our product and technology positioning. Customer acceptance of our SaaS SSD products our outlook for enterprise and SSD businesses, data growth and its drivers enterprise storage and our ability to address this space. Our non-PC business in the PC market demand and our ability to respond the demand changes. China's Ministry of Commerce matters, optimizing our business, anticipating contribution from our new businesses than our financial performance including our financial results, expectations for the September quarter and earnings expectations for the second half of fiscal 2016. 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 12th, 2015. We undertake no obligation to update our forward-looking statements to reflect new information or events. In addition, 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 the comparable GAAP financial measures are included in the quarterly fact sheet that we have posted on our Investor Relations section of our website. We ask that participants limit their comments to a single question and one follow-up question. I also want to note that copies of remarks of today’s commentary by our Chief Executive Officer and CFO will be available on the investor section of our website immediately following the conclusion of this call. I’ll now turn the call over to President and Chief Executive Officer, Steve Milligan.

[Steve Milligan:]

Good afternoon and thank you for joining us. After my opening remarks, Olivier Leonetti will provide additional commentary on our June quarter performance and our outlook for the September quarter. Demand for our fourth fiscal quarter was lower than expected given a week PC market. In that context I am satisfied with our performance. We reported revenues of $3.2 billion non-GAAP gross margin of 29.8% and diluted earnings per share of $1.51. Our storage shipments for the June quarter were 56 exabytes up 2% year-over-year. Our results reflect strong product and technology positioning coupled with solid execution. Our enterprise SSD revenue more than doubled year-over-year to $244 million demonstrating the continued success and broadening customer acceptance of our leading SaaS SSD products. We expanded our footprint in the enterprise SSD space with the initial ramp of our new UltraStar PCIe NVMe offering. It is been qualified with several leading customers and we expect revenue from this product to increase throughout fiscal 2016. We saw strong demand for our high-capacity helium and 15K RPM 2.5 inch performance hard drives. Revenue from our video surveillance hard drives continued its rapid growth as we expanded our lineup of these purpose filed solutions. And we continue to see positive market reaction to the value proposition of our new active archive system. Our view of persistent data growth remains intact driven by mobility and the cloud. The outlook for enterprise storage business remains healthy and we believe we are well position to address this growing market space. Regarding PC market demand we believe it is prudent to remain cautious in the near term given the timing of the Windows 10 and Skylake launches. That being said we are seeing early signs of market stabilization. Leading us to believe that PC market demand could pick up towards the end of this calendar year. On more stable PC market demand environment coupled with continued strength in our enterprise business provides the opportunity for improving financial performance as we move through the fiscal year. In the mean time we will continue to be discipline to the management of our business while being ready to address unanticipated upside if it materializes. I would like to comment on the status of our discussions with China's Ministry of Commerce. Since our last earnings we believe we have made meaningful progress. We have met with MOFCOM several times to discuss their review process and a potential time table for them to complete their work. We have submitted a comprehensive report on the current market which we believe shows that the storage eco-system has evolved significantly in the last three years and that lifting the hold separate restriction will enhance competition, increase innovation and benefit customers. We have also met with several other stakeholders in China and shared our view on the benefits of lifting the hold separate. Based on our conversations with MOFCOM we believe that they are working steadily on several fronts and we are hopeful that they can conclude their evaluation of our application to lift the hol separate in the near future. Olivier will now provide a summary of our June quarter performance and our outlook.

[Olivier Leonetti:]

Thank you Steve. Our revenue for the June quarter was $3.2 billion. We shipped a total of 48.5 million hard drives at an average selling price of $60. Our non-GAAP gross margin was 29.8% and operating expenses totaled $560 million. Tax expense for the June quarter was $27 million or 7% of non-GAAP pre-tax income. On a non-GAAP basis net income of $356 million or $1.51 per share. In the June quarter we generated $488 million in cash from operation and our free cash flow totaled $332 million. Our CapEx totaled $156 million of 5% of revenue we repurchased 2 million shares for $198 million. We also declared a dividend in the amount of $0.50 per share. We closed year end with total cash and cash equivalent of $5 billion of which approximately $700 million was held in the U.S. I will now provide our guidance for the September quarter. We expect revenue to be in the range of $3.2 billion to $3.3 billion, excluding the amortization of intangibles we expect gross margin percentage to be roughly flat with our June quarter. Operating expenses of approximately $575 million and accordingly we estimate non-GAAP earnings per share between $1.50 and $1.60. Operator we are now ready attend the call for questions.

[Operator:]

And our first question is from Kathryn Huberty with Morgan Stanley. Kathryn Huberty Yes, thanks. I believe coming into the June quarter, you had expected a fixed cost absorption hit on gross margins. It doesn't look like inventory on the balance sheet came down in June. So just curious if you could walk through the gross margin drivers in September, and particularly, given the high inventory, why don't we see a hit on gross margin as you go into the next quarter? Olivier Leonetti So we had to manage in the June quarter various variables. First of all to your point fixed cost absorption was an issue because of the lower TAM and we were able to mitigate -- more than mitigate this negative effect through two factors. First of all mix up improvement and also management of our cost based. Kathryn Huberty Yes just a quick follow up on OpEx, which was down $30 million again in the June quarter. Where are those cost savings coming from, in light of the restrictions around MOFCOM, and do you still see the same net savings, to the extent that you get that MOFCOM approval, over the next couple of quarters? Thanks. Olivier Leonetti So two parts in your question, on part number one, most of the saving in the quarter is due to lower executive compensation or lower executive compensation in total due to obviously the performance of the company. These are the MOFCOM, the synergies we have announced are still intact, as a reminder we have indicated that synergy in OpEx would be in the range of 400 million a year and that COGS synergies would be material and on top of that number.

[Operator:]

And the next question is from Aaron Rakers with Stifel. Your line is open. Aaron Rakers Yes, thanks. One question, one follow-up, as well. Going back to Katy's question, when you look at the gross margin this quarter, which was quite impressive, considering a 120 down to a 111 million unit number for the industry, what is the impact to gross margin that you've seen, given the inability or given the deleverage from a fixed cost absorption perspective? If it weren't for the lower TAM, I'm asking what kind of gross margin could you have attained in this last quarter. Olivier Leonetti So the impact of lack of absorption is material right. We are not going to give any details of how much it was. But indeed it would have been a material increase in the margin rate. Steve Milligan The other thing Aaron to keep in mind which is that, obviously the part of the business that was weaker which is PC related, so our client business carries a lower margin. Yes there is absorption impact in terms of having less units. But the effect of having a lower amount of lower margin business naturally provides -- if you want to call it, accretion from a gross margin perspective. Because our software business whether it be from revenue or a unit or for that matter from an earnings perspective was entirely driven by a slower PC market. Aaron Rakers Okay. And as a follow-up, when we look into the back half of the year, I think last quarter we talked about a 40-60 split in terms of enterprise demand, particularly from the hyperscale and cloud guys. What's your current outlook relative to that for the second half on the enterprise side, and is that not a positive factor to consider from a mix perspective on gross margin going forward? Steve Milligan So the 40-60 split that I believe was talked about last quarter I think was on the CA call that is consistently what it's run over the last several years. We would expect generally speaking for that pattern to hold plus or minus few percentage points for this calendar as well. And then I’ll ask Olivier to comment on the puts and takes in terms of gross margin for our September quarter. Olivier Leonetti So the statement about 40-60 is mainly exabyte statement. So relative to our guidance we are guiding to roughly flat, meaning it could be slightly up or slightly down. Obviously, we have many puts and takes which could unfold during the quarter. Enterprise could be stronger, PC demand could be stronger, that could be negative to the margin rate and we think that’s roughly flat is as good as we can guide at the stage.

[Operator:]

And the next question is from Joseph Wittine with Longbow Research. Your line is open. Joseph Wittine I understand the PC market is rough, but your shipments are eroding faster than the industry. You're down about 30% year-over-year. PC units down about low double digits. So curious why you're decelerating so much faster. What chunk of it is inventories, is been taken down, therefore you get some sort of snapback, versus how much is just the ongoing secular decline in hard drive attach rates within PCs? Any color would be helpful. Steve Milligan Yes so two comments on that and you’ve hit on them. We don’t have entire visibility to this all by the way. But we believe that there has been a meaningful inventory draw down both on -- throughout the supply chain from a PC perspective. So and we certainly from our own company perspective have been very careful to not over drive the market in terms of shipping too much inventory into our customers. And so we've seen a sharper decline in our client business than what we've seen from a broader PC perspective because of what we believe to be a meaningful thinning of the overall inventory supply, that’s one factor. To what extent that’s happen, that’s difficult to determine. But clearly our customers do not want to have or do not want to run the risk of having, “obsolete inventory” in front of the Intel and the Microsoft transition. So that’s clearly caused them to draw their inventory levels down. The second thing is that we naturally are going to decline faster than the broader PC market because of the increasing attach rate of solid state devices replacing hard drives, which is consistent of by the way with our expectations. So that helps explain at least some of the disconnect on our numbers versus the broader PC industry. Joseph Wittine That's helpful, Stephen. And I guess a follow-on would be what does guidance assume as far as PC inventories in the third quarter and what’s the TAM baked in that as well? Steve Milligan If you look at -- let me give you some data points to contemplate. Obviously we have not seen Seagate’s -- Toshiba's numbers published yet, so we don't know where they ended up. But we would expect that the TAM for last quarter to be somewhere between on 110 and 112 depending upon where Toshiba lands. The TAM that we are using for purposes of our guidance or assuming for purposes of guidance would approximate 115 million. The increase from -- let’s just use 110 because it’s round number, from 110 to 115, that increase is driven by two factors. Seasonal increase in gaming, seasonal increase in branded, that would imply that other segments of the market are flat from a unit perspective. And when you get into the PC market we would expect that to be roughly flat at least as it relates to hard drive shipments into the market from an Enterprise perspective, we believe that units will be roughly flat. Keep in mind one of the comments that we made is that we believe that there will be meaningful increase in terms of exabyte shipments that as we are mixing up the higher capacities and shipping six terabytes and eight terabyte, obviously the unit consumption gets affected by that such that the unit increase is more muted.

[Operator:]

And the next question is from Rich Kugele with Needham and Company. Your line is open. Rich Kugele Just my two questions will be, first and foremost on helium. Can you give us a sense on how much of your enterprise business today is based on helium and competitively when you do come up against another offering that is more traditional based. Presumably you're coming in at a premium because of the --. So just competitively when you go up against someone else with more traditional drive and air based drive with helium. Can you just talked about your win rates there? Just understand that dynamic as we move to higher and higher capacities that are exclusively helium based. Steve Milligan Sure the first thing Rich is that I'm not going to provide any additional color on the volume of our capacity enterprise drives that’s helium versus traditional in-air drives at this point. But obviously as we have indicated overtime, we'll be transitioning particularly when we move to the 10 terrabyte and things like that, the 6 terra byte is intended to be our last in-air product. So as customers mix up, larger and larger percentage of our business is going to be helium based. Relative to head-to-head competition, a couple of things to keep in mind. First thing is that we -- the customers that we’re dealing with have pretty sophisticated total cost of ownership algorithms that allow them to look at more than just simply the price of the hard drive. And we recognize the fact that clearly the price of hard drive is one element. But when we factor in from a total cost of ownership perspective and we're going head-to-head at a similar capacity point we actually have pretty good win rates. And in some cases, obviously, we’ve transitioned to the 8 terrabyte right now, we got a distinct advantage from that capacity perspective which sets us apart in terms of winning business. Rich Kugele And then in terms of the non-PC percentage of revenue. Do you have a sense for that might be exiting fiscal '16? Steve Milligan That’s a good question Rich. And I dare to speculate, to tell you the truth because the lots of it will depend upon what happens with the PC business. So I don’t think I want to try to forecast a number at this point. Because I would happily have it remain the same because that would mean that the PC business was actually looking a little bit better. But if we don’t see the PC market pick-up than obviously our non-PC business is going to continue to increases as a percentage of the total. So that’s a long non-answer to your question.

[Operator:]

And the next question is from Ananda Baruah from Brean Capital. Your line is open. Ananda Baruah One for each Steve and Olivier, Steve just kind of following up on the last question just think out, kind of past this year into and even through '16. What is a prudent way for us to think about how you guys -- do you normalize exabyte growth? I know it might be -- there is a lot of moving part in the current environment. But every year your latest thought-process there would be helpful. Then I have a follow up, thanks. Olivier Leonetti So if you look at exabyte today, we see it to be easy, high single digit with some nuances as you go bilateral [ph] business, capacity enterprise was a big oversees focus. We would expect it to grow in the 50% range which is what we've observed on average for the last four quarters. Strong performance on that standpoint. Ananda Baruah And then Olivier for you just on the OpEx level to just sort of expect going forward. I believe last quarter before PC [indiscernible] that they did, that you are looking sort of at a like 590 plus or minus level depending on were in the year you are. You pulled that kind of cost this quarter. Although it sounds like maybe this was sort of a little on the prudent side. So would love to get your take on how we should think about OpEx level going forward. Olivier Leonetti So we guided to a lower number $575 million for the next quarter, it's probably a number we would stick to for the coming four quarter basic on the adjustment we have to do to our cost based on the time level.

[Operator:]

The next question is from Sherri Scribner with Deutsche Bank. Your line is open. Sherri Scribner I just wanted to ask your view and what you're hearing from your cloud enterprise customers at this point given the fact that a number of the big cloud providers Twitter, Amazon Facebook are all cutting their CapEx plan. You guys sound on the call to be very bullish on capacity growth. I just wanted to get your sense of what those company’s plans are given their cutting their CapEx thanks. Steve Milligan Yes so let me talk about kind of them in general terms. The first thing is, which may sound very much like an obvious statement. We have a number of customers and relative to anyone particular period we may see relative strength or relative weakness in particular accounts and by the way, obviously part of our job from the management perspective is to manage whatever either call it segment or customer volatility from a demand perspective that we might happen to see. And so there is always going to be noise in that regard that we have to deal with. In general as an overall statement, we feel very good about our positioning from a product perspective from a technology perspective, from a customer perspective positioning standpoint and the numbers that we're looking at are relatively consistent. With our previous expectations and we continue to expect that in the back half of the year we're going to see pretty healthy pick up from an overall exabyte perspective and we'll see how that translate from a unit perspective as we ship higher capacity drives. But it should also drive a pretty healthy first half to back half revenue increase in terms of its contribution to our overall business. Sherri Scribner And just thinking about that exabyte growth accelerating in back half of the year. What is driving is that? Is that further builds by some of your customers is that something that you see sort of seasonally? I’m just trying to understand that a bit better. Thanks. Steve Milligan Let me give you a little bit of context. So if you look over the last roughly three years particularly in that space about 40% of exabyte shipments are in the first half of the year about 60% and in the second half of the year. We're expecting roughly speaking that kind of a split to continue and I would suggest that’s just due to normal seasonality in terms of the nature of that business. It doesn’t necessarily mean that there is an acceleration per say in that segment from a year-on-year perspective.

[Operator:]

Next question is from Wamsi Mohan of Bank of America. Your line is open. Wamsi Mohan Headcount is down 8% year-on-year. Can you talk a little bit about where those adjustments were made, how much was manufacturing related versus maybe G&A that can persist into the back half? And I have a follow up. Steve Milligan The majority of that is our manufacturing workers in Asia. All of it. Wamsi Mohan And on the MOFCOM side you sound more optimistic today versus 90 days ago, first, am I correct in assuming that? Clearly you’ve been meeting them throughout this process. So what's giving you an increase confident of a speedy resolution? And if you don’t have a resolution six months will you be like negatively surprise? Steve Milligan The comments that I made in my prepared remarks, frankly speaking, kind of stands on its own in terms of the commentary. And the reasons why we believe that or that we’re hopeful for a decision in the near term. So I'd refer you back to my script for a detail in terms of that. Your question with regards to would I'd be surprise if we didn’t have a decision before the end of the year is obviously a tricky question. I don’t know if I would say surprise, but obviously I would be surely disappointed if we didn’t have a decision by them.

[Operator:]

The next question is from Steven Fox from Cross Research. Your line is open. Steven Fox I was wondering if you could talk a little bit more about your SSD business. It has some fantastic growth over the past year. What are the key drivers and how do you think your growth is comparing to the marketplace at this point? Steve Milligan Sure couple of comments on that, the first thing is that from an overall growth perspective we do believe that we are gaining market share in that market. And so we are exceeding industry growth averages. The lion’s share -- this is consistent with the past, the lion’s share of revenue continues to be related to our SaaS based SSD product. The one really encouraging thing from my perspective is that we're beginning to see a much more meaningful contribution from our PCIe NVM product. It's still relatively small compare to the 244 but we saw a nice pick up from counter in Q1 into counter Q2, we’re gaining increasing momentum and we expect, as I indicated in my prepared remarks that the revenue contribution from those products will continue to increase as we move through fiscal 2016. Steven Fox And just as a quick follow up given where units are right now and some of the average capacities you’ve talked about. What are the chances that you would consider writing down some capacity at certain parts of the production process in the near term? Steve Milligan So we are constantly evaluating and constantly looking that. And you can see that we have taken -- as the market has decline -- let's be clear, the market has decline significantly over the last two or three years. And we have consistently evaluated our investments and our capital levels as we've seen the market come to new and different level. We are going to continue to do that and continue to take actions to make sure we right-size not only our manufacturing capabilities, but also our investments from OpEx perspective to make sure that we do our best to provide appropriate financial performance for our shareholders.

[Operator:]

And the next question is from Christian Schwab, Craig-Hallum Capital Group. Your line is open. Christian Schwab I have a follow up similar to that line of thinking. Our non-PC revenue has been your revenue, I should say is been fairly consistent and about 2 billion to 2.2 billion a quarter for the last few years. When we look at your gross profit dollar generated, I would assume that it’s higher than then the non-PC revenue. Meaning that 70% plus of your gross profit dollars are generated a non-PC product. Is that fair? Steve Milligan Without confirming the exact the number that you quoted. The non-PC areas of our business carry a higher gross profit than our traditional client business and so if 65% of our revenue contribution is non-PC, then obviously the profit contribution in that is greater. Christian Schwab Right, so I guess where I’m going with that is if we get MOFCOM approval and we started to right down more capacity in notebooks and PCs. We're going to print cash for as long as that non-PC revenue doesn’t dissipate, right? Steve Milligan Yes, we would believe that there will be significant synergies as a result of the lifting of the hold separate, which will not only benefit our company, our shareholders. But we'll also be able to benefit consumers in the form of more competitive pricing. Christian Schwab And if you look at the 76,000 people we got left working for us. Can you remind us the break out of those employees roughly? Olivier Leonetti There is nothing to remind you off, we've not broken that out. Christian Schwab You haven’t broken that out? Steve Milligan No.

[Operator:]

The next question is from Keith Bachman from Bank of Montreal. Your line is open. Keith Bachman Olivier, can you help with -- what was the charge for the -- there is a 104 million charges this quarter that was reversed out from GAAP to non-GAAP. What was that for? Olivier Leonetti The modernity of that, all of it was due to us resizing our business into [indiscernible] the current time level. So all of it is the adjustment of our supply chain, end-to-end to, face the new reality. Keith Bachman So was it a permanent reduction the fixed cost base, just trying to understand was it a onetime -- truly a onetime event or does that carry forward and reduce your fixed cost? Olivier Leonetti That will be one adjustment we have done among others in the past and this one will carry its impact going forward indeed. Keith Bachman Steve one for you then, in terms of MOFCOM is it a zero sum game and what I mean by that is, this has been puts and takes here. It feels like it ebbs and flows over the last year and change. What happens if the Chinese Government just doesn’t say anything and this goes on for perpetuity? And what I mean by that is this does Western Digital have plans -- contingency plans whereby they could reduce cost even without the hold separate that would at least [Audio Gap] or do you need to get MOFCOM to really take your cost structure meaningfully lower from this juncture? Steve Milligan We're going to continue to evaluate all of our option. But I think it's very dangerous, Keith, for me to speculate as to what we would do if we have no response from MOFCOM. Keith Bachman Okay fair enough. Nice job on the gross margin guys.

[Operator:]

The next question is from Monika Garg from Pacific Crest Securities. Your line is open. Monika Garg Could you maybe talk about what was like-for-like pricing in the quarter and what do you expect in the September quarter as well? Olivier Leonetti Monika nothing half of beyond entry [ph]. The market remains competitive and we wouldn’t characterize this quarter, the one we closed very differently from the prior one. And we would expect that to prevail in the September quarter. Monika Garg As a follow your enterprise revenue has grown significantly this year. Is it fair to think in fiscal 2016 that could be greater than $1 billion business? Steve Milligan I don’t know if we provided a specific estimate in terms of what our revenue level will be. But we continue to expect that we're going to see nice growth in our overall enterprise business.

[Operator:]

The next question is from Bill Shope, Goldman Sachs. Your line is open. Bill Shope Could you give us some color on how we should think about margin transfer enterprise SSD business relative to the enterprise HDD business? I know you don’t give the absolute levels, but if you could just give us some color on how we should think about the trends relative, particularly now that they’re becoming much more significant part of the overall business. Steve Milligan What we said in the past and it continues to be true is that, the gross margin generally speaking for our SSD business is below the corporate average, I mean it’s still very good margin, but below the corporate average. But it is clearly above the corporate average from a return on investment capital. Because we don’t have the same form of, call it, vertical integration in investments. Bill Shope And then I guess looking at your capital allocation obviously you continue give back cash to shareholders each quarter. But do you see any incremental change to the capital allocation plans or near term activity given the recent fell off in the stock price and some of the concerns that have pressured the stock relative to the market recently? Olivier Leonetti So we look at capital allocation regularly. But we still believe that even at this point in time giving back 50% of our free cash flow back to shareholders in the form of dividends and buyback is a balance approach. To reward our shareholders today but also to keep rewarding our shareholders tomorrow, to keep investing in the business and we mentioned some attractive investments, helium, enterprise SSD and active cloud being a few examples.

[Operator:]

The next question is from Joe Yoo with Citi Group. Your line is open. Joe Yoo Steve, I wanted to ask more general question about mission critical performance wise if I could. So I know you don’t break out performance versus near-line. But if you look at industry data, mission critical has been fairly flat and actually it's been growing in the last couple of quarters. And you’re in sort of an interesting position where you can -- you sell both the SaaS drives and SaaS SSDs and which are largely viewed as substitute. So can you help us understand why fast drives remains so resilient despite such strong adoption from SSD? Steve Milligan Are you telling relative to us or in general? Joe Yoo Either, I mean but may be you can start with WD. Steve Milligan Well if relative to us, if you remember we had a hole in our portfolio where we did not have a competitive 2.5 inch small form factor SaaS hard drive. We now have a competitive product and so in that space, which albeit a relatively small part of the performance enterprise market we've been able to pick up some share in that space just by having a competitive product. So that’s help strengthen our relative performance, from a performance enterprise standpoint. From a standpoint of SaaS versus -- not SaaS, enterprise SSD versus a small form factor hard drive, right now we're not seeing much cannibalization per say, we do expect that there will be cannibalization overtime. And it tends to be work load driven in terms of the way the systems are configured. So there hasn’t been cannibalization so far, but we do expect that that will happen in the future and that there will be some cross-over between 2.5 inch 15k drives and SSDs in the future. Joe Yoo And what is the critical factor in actually making that happens? Is it pricing, as in the cost of NAND? Steve Milligan Pricing and also work load driven, in terms of how the systems are configured.

[Steve Milligan:]

Thank again for joining us today. In closing I want to thank all of our employees and suppliers for their commitment and outstanding execution and our customers for their continued business. Thank you so much.

[Operator:]

Thank you for your participation on today's conference. All parties may now disconnect.