Western Digital Corporation (NASDAQ:WDC) Q2 2024 Earnings Call Transcript

Western Digital Corporation (NASDAQ:WDC) Q2 2024 Earnings Call Transcript January 25, 2024

Western Digital Corporation beats earnings expectations. Reported EPS is $-0.69, expectations were $-1.13. 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, and thank you for standing by. Welcome to Western Digital’s Second Quarter Fiscal 2024 Analyst Call. Presently, all participants are in listen-only mode. We will open the lines up for questions shortly. [Operator Instructions] Now, I will turn the call over to Mr. Peter Andrew, VP of FP&A and IR. You may begin.

Peter Andrew: Well, 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 on management’s current assumptions and expectations. And as such, does include risks and uncertainties. These forward-looking statements include expectations for our product portfolio, business plans and performance, market trends and dynamics, and 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 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 will now turn the call over to David for introductory remarks.

David Goeckeler: Thank you, Peter. Good afternoon, everyone, and thanks for joining the call to discuss our second quarter of fiscal year 2024 results. Western Digital second quarter results demonstrate that the structural changes we have put in place over the last few years and the strategy we have been executing are producing significant outperformance across our Flash and HDD businesses. I am confident that building leading products across a broad range of end markets, closely controlling our product cost through focused R&D and manufacturing, and bolstering the agility of our business will allow us to improve through-cycle profitability and dampen business cycles. As a result, we reported revenue of $3 billion, non-GAAP gross margin of 15.5%, and a non-GAAP loss per share of $0.69, all of which met or exceeded the non-GAAP guidance ranges we provided in October.

Before discussing the business details, I want to provide some comments on the emerging trends we are seeing and how the changes we have made position our Flash and HDD businesses to benefit. In Flash, we’ve been able to navigate business cycles by managing inventory proactively, offering a broad range of products, and optimizing capital efficiency through our joint venture partnership with Kioxia. These successful efforts are reflected in our best-in-class gross margin throughout the cycle. During the quarter, our portfolio strategy to dynamically allocate bit shipments drove upside in ASPs and gross margin. Looking ahead, we will continue to take a disciplined approach to our supply and capital investments. Consequently, we continue to proactively manage our bit shipments to structurally align our supply and inventory with customer demand and improve through-cycle profitability into the future.

In addition to the recovery in both Flash and HDD markets, we believe storage is entering a multi-year growth period. Generative AI has quickly emerged as yet another growth driver and transformative technology that is reshaping all industries, all companies, and our daily lives. Importantly, industry analysts estimate that the edge now represents approximately 80% of total NAND bit shipments, an increase from approximately 75% in calendar year 2022, which is another indication that cloud demand was significantly pulled in during the pandemic. In addition, we believe the second wave of generative AI-driven storage deployments will spark a client and consumer device refresh cycle and reaccelerate content growth in PC, smartphone, gaming, and consumer in the coming years.

Our Flash portfolio is extremely well positioned to benefit from this emerging secular tailwind. In HDD, Western Digital’s leading EPMR platform and enhanced UltraSMR technology allow us to provide the highest capacity drives for mass market deployment. We believe this innovative technology and portfolio strategy enable us to offer the best TCO to our cloud customers and outperform our peers throughout the cycle. We are confident that the multi-quarter near-line demand headwinds have subsided as our major cloud customers have reengaged with us. We anticipate our financial outperformance resulting from profitable share gains to become more evident as nearline demand accelerates into the second half of fiscal year 2024 and beyond. Moving on to end market commentary.

During the quarter, revenue in the cloud end market returned to sequential growth for the first time in six quarters. The sequential revenue growth was led by an increase in nearline shipments. In client, sequentially, revenue declined slightly as the increase in Flash ASPs was offset by a decline in bit shipments as we proactively optimized product mix. In consumer, the sequential revenue growth was led by seasonal strength in Flash bit shipments into retail and an increase in Flash ASPs. I’ll now turn to business updates starting with Flash. During the quarter, the sequential revenue increase was due to stronger execution and driving price inflection by optimizing bit shipment across our broad go to market channels into the consumer and client end markets, resulting in stronger than planned ASP increase.

In particular, our WD Black gaming SSD product, which offers high reliability, best-in-class performance, expansive storage capabilities, and a hyper realistic gaming experience, achieved a new record revenue with bit shipment growth of over 50% year-over-year. On the technology front we remain on track to ramp an array of QLC-based client SSDs utilizing BiCS6 technology. Our ability to combine this new high-performance node with our in-house controller development allows us to offer a portfolio of client SSDs with unmatched performance and value. We expect these products to lead the transition to QLC Flash in calendar year 2024. Additionally, BiCS8 yield is progressing well and we remain on track to productize this technology. Turning to HDD, the sequential revenue increase was driven by improving nearline demand and pricing.

Moreover, we are encouraged by demand in China with revenue doubling on a sequential and year-over-year basis, both of which were ahead of our expectations. We anticipate year-over-year growth in HDD throughout this calendar year. In both the first and second quarters, we shipped approximately 1 million UltraSMR drives per quarter. We forecast UltraSMR hard drive shipments to increase significantly in the fiscal third quarter and SMR drive shipments to continue to outgrow that of CMR drives going forward. Importantly, the adoption of UltraSMR is broadening to our major customers worldwide, including a third cloud titan in the US this year, as well as hyperscale and smart video customers in China. We expect to complete the qualifications of our 26 terabyte and 28 terabyte UltraSMR drives at these customers this quarter and throughout the calendar year and forecast SMR to comprise the majority of nearline demand by calendar year 2025.

We have strong conviction that our portfolio strategy of first commercializing Western Digital’s industry-leading UltraSMR technology, which will be followed by our transition from EPMR to Hammer offers the best TCO to our customers in both the near and long term, while delivering leading portfolio profitability in the industry. Over the next several years we will be introducing a number of exciting products, including multiple generations of nearline drives combining EPMR, OptiNAND, and UltraSMR technologies in the 30 to upper 30 terabyte capacity range, all of which will be ready for high volume production to support the explosion of AI training data and content. Before I turn over to Wissam, I wanted to share some perspectives on our outlook.

In Flash, starting with demand in calendar year 2024, we estimate industry bit growth to be around the mid-teens percentage, similar to the growth rate in calendar year 2023. On the supply side, we estimate that fab-out bit production growth to remain in the mid-single digit percentage range. We believe our business agility and our highly capital efficient and low cost BiCS architecture have enabled us to align supply with demand via nodal transition much more quickly than our peers. We will continue our disciplined approach to dynamically managing our inventory capacities and capital expenditures to keep our supply aligned with end customer demand. Although Flash pricing has started to increase, our profitability and cash generation continue to be well below the level that justify an increase in capital investments.

We anticipate wafer equipment spending will remain at historic lows in the near term and Flash to be undersupplied for an extended period of time. Overall, we will continue to focus on allocating our bids to the most attractive end markets and anticipate Flash ASP increases to be the primary revenue growth driver throughout this calendar year. In HDD, our competitive portfolio strategy has enabled us to consistently achieve profitable share gain in the last two calendar years. We are confident that this trend will continue as nearline demand continues to improve and we continue to ramp our UltraSMR enabled products. Let me now turn the call over to Wissam, who will discuss our financial second quarter results.

Wissam Jabre: Thank you, and good afternoon, everyone. Following on David’s comments, the success of the strategy we have been executing is reflected in our financial performance. Non-GAAP results in the fiscal second quarter exceeded or were at the high end of the guidance ranges we provided in October. Total revenue for the quarter was $3 billion, up 10% sequentially and down 2% year-over-year. Non-GAAP loss per share was $0.69, as strong execution with our broad go-to-market channels benefited Flash ASP and gross margin. Looking at end markets, cloud represented 35% of total revenue at $1.1 billion, up 23% sequentially and down 13% year-over-year. Sequentially, the growth is attributed to higher nearline shipments to that of center customers and better nearline pricing.

Nearline bit shipments were 67 exabytes, up 23%. The year-over-year decrease was due to lower eSSD bit shipments. On a year-over-year basis, HDD cloud revenue increased for the first time in six quarters. Client represented 37% of total revenue at $1.1 billion, down 2% sequentially, and up 3% year-over-year. Sequentially, an increase in Flash ASP was more than offset by a decline in flash bit shipments. The year-over-year increase was due to higher flash shipments, primarily driven by client SSD shipments into PC applications, more than offsetting a decline in ASP. Consumer represented 28% of total revenue at $0.8 billion, up 15% sequentially and 6% year-over-year. Sequentially, the growth was primarily due to seasonal strength in Flash bit shipments.

On a year-over-year basis, the increase in Flash bit shipments was partially offset by a decline in Flash ASP, as well as lower HDD shipments. Turning now to revenue by business segment. In the fiscal second quarter, Flash revenue was $1.7 billion, growing 7% sequentially, as Flash ASPs increased 10% on a blended basis and 7% on a like-for-like basis, stronger than anticipated entering the quarter. Bid shipments decreased 2% after record shipments in the prior quarter. On a year-over-year basis, Flash revenue grew slightly with a 21% increase in bit shipments, offsetting lower prices. HDD revenue was $1.4 billion, increasing 14% sequentially. As total exabyte shipments increased 14%, an average price per unit increased 9% to $122. On a year-over-year basis, HDD revenue declined 6%, while total exabyte shipments increased 2% and average price per unit increased 23%.

Moving to gross margin and expenses. Please note my comments will be related to non-GAAP results unless stated otherwise. Gross margin was 15.5% above the guidance range provided in October and improving 11.4 percentage points sequentially, while declining 1.9 percentage points year-over-year. The sequential increase was primarily driven by higher Flash ASPs as we proactively optimized product mix, which more than offset higher than anticipated underutilization charges of $156 million or a 5.1 percentage points headwind. Flash gross margin was higher than expected at 7.9%, up 18.2 percentage points sequentially, and down 6.6 percentage points year-over-year. This includes underutilization charges of $107 million or a 6.4 percentage points headwind to gross margin.

HDD gross margin was 24.8%, up 1.9 percentage points sequentially and 4.1 percentage points year-over-year. This includes underutilization charges of $49 million or a 3.6 percentage point headwind. We continue to tightly manage operating expenses, which were $561 million for the quarter, down 15% year-over-year, and at the lower end of the guidance range. Operating loss in the quarter was $91 million, which included underutilization charges of $156 million. Fiscal second quarter loss per share was $0.69, inclusive of a $14 million dividend associated with the convertible preferred shares. Operating cash flow for the second quarter was an outflow of $92 million, and free cash flow was an outflow of $176 million. Cash capital expenditures, which include the purchase of property, plant, and equipment, and activity related to our Flash joint ventures on the cash flow statement represented a cash outflow of $84 million.

The quarter ending inventory was $3.2 billion, declining $281 million from the prior quarter. Days of inventory decreased five days to 115 days. The majority of the decline was in Flash, where Flash days of inventory remained at a four-year low. During the quarter, we issued $1.6 billion in convertible notes, repurchased $508 million of the outstanding 2024 convertible notes and paid down $300 million of the delayed draw term loan. Gross debt outstanding was $8.5 billion at the end of the fiscal second quarter. We expect to retire the remaining balance of approximately $600 million of the 2024 convertible notes at maturity in February 2024. At the end of the fiscal second quarter, cash and cash equivalents were $2.5 billion and total liquidity was $4.7 billion, including the undrawn revolver capacity of $2.25 billion.

For the fiscal third quarter, our non GAAP guidance is as follows: we expect revenue to be in the range of $3.2 billion to of $3.4 billion; we expect sequential revenue growth to be mainly driven by an increase in HDD; we anticipate Flash revenue to be up slightly as we remain focused on optimizing bit shipments and ASP; we expect gross margin to be between 22% and 24%, which includes HDD underutilization charges of $30 million to $40 million; we expect operating expenses to be between $600 million and $620 million with the increase driven by the reinstatement of certain incentive compensation programs as the financial outlook has strengthened. Interest and other expenses are expected to be approximately $95 million. We continue to expect income tax expenses to be between $20 million and $30 million for fiscal third quarter and $80 million to $120 million for fiscal year 2024.

We expect a preferred dividend of $15 million. We expect earnings per share to be $0.05, plus or minus $0.15, based on approximately 330 million shares outstanding. As the financial outlook has improved, we will remain disciplined in executing the business, proactively managing our supply and inventory to meet customer end demand and controlling capital spending, all with the goal of improving profitability. I’ll 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 want to emphasize that the steps the Western Digital team has taken to instill and deploy an industry leading product portfolio, while also moving quickly to adapt to both volatile market dynamics and anticipate future trends have enabled us to capitalize on the upswing we see ahead. Through our product leadership and ability to dampen business cycles and improve through-cycle profitability, I am confident we are well positioned to execute on our current strategy, which will reaffirm our strength over the long term. Let’s now begin the Q&A.

See also 20 Highest Quality Rums in the World and 15 Best Blue Chip Dividend Stocks To Buy.

Q&A Session

Operator: [Operator Instructions] Our first question comes from Joe Moore with Morgan Stanley. Your line is now open.

Joe Moore: Great. Thank you. I wonder if you could talk about the gross margin improvement in Q1. I guess, how would — how do you portion that between the drive business and the NAND business? And I guess, I would think with being judicious on volume, you get some pretty good NAND pricing. I guess, I might have expected a little bit more gross margin improvement. So just curious what I’m missing there? Thanks.

David Goeckeler: Yeah, Joe. So we’ve been it’s good to see the pricing inflect. If you look into Q1, we were happy with the gross margin we delivered in the Flash business in the December quarter at 7.9%. I think we were able to capture the turn in the market well. So it gives us a little higher base going into the March quarter. But if you look at both businesses, you see Flash will be down on bits and up on price. So we see — we still see strong price increases quarter-to-quarter, but we’re down on volume. Let’s call it, low double digits. And then in the HDD business, we see increase in volume and increase in price.

Joe Moore: Thank you.

David Goeckeler: Thanks.

Operator: Our next question comes from Aaron Rakers with Wells Fargo. Your line is now open.

Aaron Rakers: Yes, thanks for taking the question. Just kind of building off that last question, I know you talked about hard disk drive underutilization, expectation in this current quarter kind of embedded in that 22% to 24% guide. What’s the underutilization assumption you’re making on the Flash business? And just in general, how do you think about the trajectory of Flash gross margin? Let’s say, in theory of pricing and your implementation of price increases continues, how do we think about the return to kind of a 30% plus gross margin in Flash? So just trying to think about the puts and takes in the guidance and then the longer term kind of view at what you characterize as normalized gross margin?

David Goeckeler: Hey, thanks, Aaron. So for Flash, in our guide, we don’t have underutilization for Q3. In fact, we executed ahead of schedule and reached our targeted supply and inventory goals faster than what we anticipated. And so, as you know, we continue to dynamically manage supply and inventory to meet our end demand and so the fab utilization reflects that. If you recall, in our results in Q1, Flash inventory was down almost $400 million, last quarter we saw another over $200 million dollar decline in inventory. We exited the quarter at levels that we haven’t see in few years. So having said that, obviously, we will continue to be disciplined in how we manage our supply and inventory to meet end customer demand on Flash and also, of course, control our capital spend. With respect to your question at the 30%, let me clarify. Was your question 30% on the Flash or on the HDD side?

Aaron Rakers: Well, I guess, I’m going to say both, but [Multiple Speakers]

David Goeckeler: Yes, I thought I heard you say Flash. I was going to start talking about it. Well, let me start talking about HDD. Look, at HDD, we’re pretty much very close to that level. When you look at what we delivered in the second quarter and when you also look at the guide, it does reflect the continuous margin improvement on the HDD side. And so, I also anticipate that there should be continuous improvement as the recovery continues in that business. So 30% is very much within reach. And we should be able to achieve it pretty soon. On the flash side, the –lot has to do with continuing to optimize the product mix to drive that ASP up. And also, of course, continuing to deliver on our cost reduction. And so, on the cost reduction, we’ve done well so far.

We’ve been in the mid-teens. I expect us to also hit that mid-teens percentage cost reduction for this fiscal year. So, as the pricing continues to improve, I’d anticipate that we would be — we would also be there — let’s say in the next few quarters.

Aaron Rakers: Thank you.

Operator: Our next question comes from CJ Muse with Cantor Fitzgerald. Your line is now open.

CJ Muse: Yes, good afternoon guys. Thanks for taking the question. I guess I was hoping to focus on the NAND bit side of the house. You’re talking about optimizing product mix, but here we have bits down in December. It looks like they’re down — implied down again in the March quarter. So can you speak to, I guess, your plans there? When do you think that will open up? And can you be a little more specific in terms of which end markets you’re focused on and how we should think about when they come to market and the timing and implications to pricing?

David Goeckeler: Yeah. So I’ll start and Wissam can add some too. So yes, we had bits down, we had a record quarter last — two quarters ago and then we were down a little bit this past quarter, then we’ll be down more. I mean, it’s just a reflection of the flow through the underutilization that we were doing to kind of keep supply and demand matched. We’ve talked about this a lot and not let our inventory get out of control. I think we’ve been very good about keeping our inventory — we’re at a four-year low on inventory, so on the NAND side. So, look, CJ, we’re just going to keep very focused on what demand is, where we’re at in inventory, and adjust the utilization of the fab to make sure those stay aligned as we go forward. So I think as we said in the script, you kind of assume that throughout this calendar year, you’re going to see most of the growth in Flash be from pricing.

CJ Muse: [Multiple Speakers] Go ahead, please.

Wissam Jabre: Now, I was going to move on to the second part of your question.

CJ Muse: Yeah, please go ahead.

Wissam Jabre: Okay. So mix is like — mix is just a very dynamic process, literally day-by-day, week-by-week in the business. We have a big consumer franchise, we sell all over the world, we have hundreds of thousands of points of presence and retail platforms. We have a big channel business where pricing can get adjusted weekly, then all the way up to, obviously, the quarterly negotiated markets. So we’re just always dynamically understanding where pricing is going to be. And then again, in each of those segments, we have different products. We have client SSDs that are WD Black all the way down to WD Green. So in different segments of the market, all with different price points, all with different margins, all with different demand profiles.

And it’s a constant process of just making sure we put the supply where we’re going to get the best return. This last quarter we talked about, we mixed a little bit out of client and into consumer, as you would expect in a strong consumer quarter. And we’ll continue to do that. The place where we’re still waiting for it to come back is enterprise SSD, that’s still been pretty depressed and as that market starts to come back, we expect to mix into that as well.