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.
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