Western Digital Corporation (NASDAQ:WDC) Q3 2024 Earnings Call Transcript

Western Digital Corporation (NASDAQ:WDC) Q3 2024 Earnings Call Transcript April 25, 2024

Western Digital Corporation beats earnings expectations. Reported EPS is $0.63, expectations were $0.21. Western Digital Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, everyone, and thank you for standing by. Welcome to Western Digital's Third Quarter Fiscal 2024 Conference Call. Presently, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this event is being recorded. Now I will turn the call over to Mr. Peter Andrew, Vice President, Financial Planning and Analysis and Investor Relations. You may begin.

Peter Andrew: Thank you, and good afternoon, everyone. Joining me today are David Goeckeler, Chief Executive Officer; and Wissam Jabre, Chief Financial Officer. Before we begin, let me remind everyone that today's discussion contains forward-looking statements based upon management's current assumptions and expectations, and as such, does include risks and uncertainties. These forward-looking statements include expectations for our product portfolio, our business plan and performance, the separation of our flash and HDD businesses, ongoing market trends and our future financial results. We assume no obligation to update these statements. Please refer to our most recent financial report on Form 10-K and our other filings with the SEC for more information on the risks and uncertainties and that could cause actual results to differ materially from expectations.

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 other materials that are being posted in the Investor Relations section of our website. With that, I'll now turn the call over to David.

David Goeckeler: Thank you, Peter. Good afternoon everyone and thanks for joining the call to discuss our third quarter of fiscal year 2024 performance. Western Digital delivered excellent results in the quarter with revenue of $3.5 billion, non-GAAP gross margin of 29.3% and non-GAAP earnings per share of $0.63, all of which exceeded expectations. Our strategy of developing a diversified portfolio of industry-leading products across a broad range of end markets, coupled with structural changes we have made to both of our businesses, is unlocking our true earnings potential and allowing us to continue improving through-cycle profitability and dampening business cycles. This strategy enables us to generate higher earnings per share even in a constrained supply environment.

In addition, our commitment to achieving operational efficiency and enhancing our agility has allowed us to run our flash and HDD businesses more efficiently and further drive innovation to take advantage of new opportunities. In particular, as the technology landscape continues to evolve, the demand for AI solutions is becoming increasingly apparent across our end markets. The uptick in AI adoption is highlighting the incredible value of data and will drive increased storage demand across both HDD and flash at the edge and in the core, providing greater long-term growth and margin expansion opportunities for Western Digital. We are in the early innings of unlocking the full potential of this company, and our team remains focused on improving the profitability of our business to drive long-term margin expansion and shareholder value as these new demand opportunities present themselves.

Before I dive further into the demand environment, I want to briefly comment on the status of the separation of our flash and HDD businesses. I am proud of the team's ongoing efforts as we drive towards completion of the separation in the second half of the calendar year. We remain focused on achieving the separation as soon as possible, and we'll continue to provide further updates on our progress as appropriate. Moving on to end market commentary. I am pleased to report that during the quarter, revenue in all of our major end markets returned to year-over-year growth. In cloud, we experienced 29% growth in revenue from a year ago, highlighting the incredible success of our industry-leading HDD product line. In addition, we began to experience an increase in demand for our flash-based solutions, signaling a long-awaited recovery in this end market.

In client, 20% revenue growth from a year ago was driven by increased bit demand for our flash-based solutions, coupled with an increase in ASPs. In consumer, we experienced 17% revenue growth from a year ago, highlighting the power of the SanDisk premium brand. Higher flash bit sales, combined with a better pricing environment more than offset the continued decline in consumer HDD demand. I'll now turn to business updates, starting with flash. Our sequential revenue growth in the quarter reflects the continuing commitment to disciplined capital spending and carefully optimizing bit shipments into our most profitable end markets to take advantage of the improved pricing environment. This approach, combined with the strength of our product portfolio has enabled us to drive significantly higher profitability while strategically managing our inventory.

On the technology front, we achieved a significant milestone by initiating mass production of our QLC-based client SSD, leveraging BiCS 6 technology. This is yet another significant milestone demonstrating our continued commitment to innovation and market leadership. These advancements pave the way to spearhead the market's transition to QLC-based flash solutions in calendar year 2024. Additionally, our progress with BiCS 8 is on track. While this technology is ready to be productized as market conditions warrant, our innovative offerings will remain at the forefront of the market, further strengthening our competitive position and bolstering our growth prospects. As noted earlier, in the third quarter, we began to experience an increase in demand for our enterprise SSD solutions.

We are seeing demand returning for NVMe SSDs that we qualified before the downturn. We are also experiencing significant interest in providing these products in dramatically higher capacities for AI-related applications which we expect to ship in the second half of the year. In addition, we are also sampling our newest high-performance PCIe Gen 5, BiCS 6-based enterprise SSD. We are preparing for qualification at a hyperscaler and the product is generating significant interest in the enterprise market. We expect to ramp in the second half of the calendar year. Turning to HDD. The sequential revenue increase was driven by improved nearline demand and higher pricing as we focused on optimizing profitability per exabyte sold. In particular, nearline revenue reached a fixed quarter high, reflecting the successful strategy we put in place to bring the most innovative, high-capacity and high-performance drives to market.

We have the right products at the right cost structure, which are reflected in our financial performance. Our cloud customers continue to transition to SMR with our 26-terabyte and 28-terabyte UltraSMR drives, quickly becoming a significant portion of our capacity enterprise exabyte shipments. SMR-based drives represented approximately 50% of nearline exabyte shipments in the quarter. Our portfolio strategy to commercialize ePMR, OptiNAND and UltraSMR technologies in advance of our transition to HAMR, has proven to be the winning strategy and enables us to deliver to customers the industry's highest capacity and leading TCO drives, all of which can be produced at scale with controlled costs. We are confident that our product strategy, which combines UltraSMR technology with upcoming advancements in nearline drives is enabling Western Digital to deliver best-in-class gross margin in HDDs all at a time when AI is emerging as another growth engine for the industry.

As we move toward a new supply and demand environment, characterized by higher demand, supply tightness and product shortages, we are leveraging our proven technology we've already introduced to the market to meet the demands of our customers with the right portfolio at the right time, while also operating with a lean cost structure for continued profitability improvement in our HDD business. Although the actions we are taking have improved profitability, we remain focused on driving higher margins to appropriately value the incredible amount of innovation and TCO improvements we continue to deliver to our customers. Before I turn it over to Wissam, I wanted to share some perspectives on our outlook. Within Flash, in addition to growth opportunities at the edge, which is Western Digital strength, we are encouraged by the returning demand within the enterprise SSD market and expect growth throughout this calendar year.

AI-related workloads are driving increasing demand for enterprise SSDs, and our portfolio is well positioned to support those use cases. Looking ahead, we anticipate bit shipments to remain flat into the fiscal fourth quarter and look to Flash ASP increases to be the primary revenue growth driver led by our focus on allocating bits to the most high-value end markets amidst the tightening supply environment. While we're pleased to see pricing trends moving in a positive direction, it's crucial to acknowledge the importance of maintaining capital discipline and only reinvesting capital back into the business once profitability improves further, and we see sustained demand. Overall, our continued focus on improving profitability through our innovation road map, disciplined capital spending and strategic pricing initiatives position us well for continued success in calendar year 2024 and into 2025 by offering the most capital and cost-efficient bits in the industry.

In HDD, the success of our portfolio of leading capacity enterprise products, combined with the restructuring efforts we've implemented in recent years are yielding improved unit economics and greater visibility. As cloud demand is recovering, we anticipate continued growth driven by higher nearline demand and better pricing as we are now in a supply-constrained environment. We're optimistic about aligning the pricing of our products to better mirror the innovation we are integrating into them, supporting long-term margin expansion in our HDD business. As we reap the rewards of the innovation and operational efficiencies that we've implemented, we will look for opportunities to reinvest in the business when the conditions are ripe for expansion.

We will approach every capital allocation decision with a focus on discipline. Let me now turn the call over to Wissam, who will discuss our financial third quarter results.

Wissam Jabre: Thank you, and good afternoon, everyone. Following on David's comments, Western Digital return to profitability and free cash flow generation and delivered great results in the quarter, which exceeded expectations. Total revenue for the quarter was $3.5 billion, up 40% sequentially and 23% year-over-year. Non-GAAP earnings per share was $0.63. Looking at end markets, cloud represented 45% of total revenue at $1.6 billion, up 45% sequentially and 29% year-over-year. The growth was primarily attributed to higher nearline shipments and improved nearline per unit pricing with Flash revenue up both sequentially and year-over-year. Nearline bit shipments of 108 exabytes were up 60% sequentially. Client represented 34% of total revenue at $1.2 billion, up 5% sequentially and 20% year-over-year.

Sequentially, the increase in Flash ASP more than offset a decline in Flash bit shipments, while HDD revenue decreased. Year-over-year, the increase was driven by growth in both Flash and HDD ASPs and Flash bit shipments. Consumer represented 21% of total revenue at $0.7 billion, down 13% sequentially and up 7% year-over-year. Sequentially, both Flash and HDD were down at approximately similar rates and in line with seasonality. On a year-over-year basis, the increase was driven by growth in flash bit shipments and ASP. Turning now to revenue by business segment for the fiscal third quarter. Flash revenue was $1.7 billion, up 2% sequentially as ASP increased 18% on both blended and like-for-like basis. Bit shipments decreased 15% from last quarter as we proactively focused our flash bit placement to maximize profitability.

Flash revenue grew 30% from fiscal third quarter of 2023 on higher bits and ASP. HDD revenue was $1.8 billion, up 28% from last quarter, as exabyte shipments increased 41% and average price per unit increased 19% to $145. Compared to the fiscal third quarter of 2023, HDD revenue grew 17%, while total exabyte shipments and average price per unit were up 25% and 33%, respectively. Moving to gross margin and expenses. Please note, my comments will be related to non-GAAP results unless stated otherwise. Gross margin was 29.3%, well above the guidance range. Gross margin improved 13.8 percentage points sequentially and 18.7 percentage points year-on-year due to better pricing, our continued focus on cost reduction, and lower underutilization charges.

Flash gross margin was higher than expected at 27.4%, up 19.5 percentage points sequentially and 32.4 points year-over-year. There were no underutilization charges in the quarter. HDD gross margin was 31.1%, up 6.3 percentage points sequentially and 6.8 percentage points year-over-year. This includes underutilization charges of $17 million or 1 percentage point headwind. HDD gross margin is within our long-term target range, including underutilization charges. This underscores the team's focus on cost reduction and profitability as previously, this level of gross margin was achieved with higher revenue. Operating expenses were $632 million for the quarter, up 13% sequentially and 5% year-over-year. The sequential increase was mainly driven by higher variable compensation associated with better-than-expected financial results.

Operating income was $380 million, which included HDD underutilization charges of 17 million. Tax expenses in the quarter was $51 million, reflecting the improved financial outlook for the fiscal year. Fiscal third quarter earnings per share was $0.63. Operating cash flow was $58 million, and free cash flow was 91 million. Cash capital expenditures, which include the purchase of property, plant and equipment and activity related to flash joint ventures on the cash flow statement represented a cash inflow of $33 million. Third quarter inventory was flat from the prior quarter at 3.2 billion, with days of inventory increasing 4 days to 119 days. A decline in HDD inventory offset an increase in Flash inventory. Gross debt outstanding was $7.8 billion at the end of the fiscal third quarter.

Cash and cash equivalents were $1.9 billion, and total liquidity was $4.1 billion, including revolver capacity of $2.2 billion. For the fiscal fourth quarter, our non-GAAP guidance is as follows. We expect revenue to be in the range of $3.6 billion to $3.8 billion and project sequential revenue growth in both HDD and Flash. In HDD, we expect continued momentum with our industry-leading SMR product portfolio aimed at the cloud. In flash, we anticipate bits will be flat and ASP is up as we continue optimizing our bit placement to maximize profitability. Gross margin is expected to be between 32% and 34%. We expect operating expenses to be between $670 million and $690 million with the increase mainly related to certain project-driven investments, coupled with higher variable compensation as the financial outlook has continued to strengthen.

Interest and other expenses are expected to be approximately $105 million. We expect income tax expense to be between $30 million and $40 million for the fiscal fourth quarter and $130 million to $140 million for fiscal year 2024 as the financial outlook improved. We expect earnings per share to be $1.05, plus or minus $0.15, based on approximately 342 million shares outstanding. The financial outlook has strengthened, and we will remain disciplined in executing the business, controlling our capital spending and improving our profitability. I will now turn the call back over to David.

David Goeckeler: Thanks, Wissam. Let me wrap up, and then we'll open up for questions. I'm pleased with the team's performance in developing a diversified portfolio of industry-leading products across a broad range of end markets. As industry supply and demand dynamics continue to improve, we will remain disciplined around our capital spending and focused on driving innovation and efficiency across our business. Coupled with the structural changes we have made to our businesses, we are confident in our ability to drive greater through-cycle profitability and dampen business cycles. As we move forward, we remain uniquely positioned to capitalize on the promising growth prospects that lie ahead, solidifying our leadership position in the industry, particularly as AI continues to drive new storage solution opportunities and growth. Okay. Peter, let's start the Q&A.

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