Western Digital Corporation (NASDAQ:WDC) Q2 2023 Earnings Call Transcript January 31, 2023
Operator: Good afternoon, and thank you for standing by. Welcome to the Western Digital Fiscal Second Quarter 2023 Conference Call. Presently, all participants are in a listen-only mode. . And as a reminder, this call is being recorded. Now I will turn the call over to Mr. Peter Andrew. 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, including expectations for our product portfolio, cost reductions, business plans and performance, demand and market trends and financial results based on management's current assumptions and expectations, and as such, does include risks and uncertainties. We assume no obligation to update these statements. Please refer to our most recent financial report on Form 10-K filed with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially.
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, and thank you for joining the call to discuss our 2023 second quarter results. The Western Digital team worked diligently within a dynamic market and delivered revenue at the high end of the guidance range we provided in October. We reported second quarter revenue of $3.1 billion and non-GAAP operating loss of $119 million. Our non-GAAP loss per share was $0.42. Our ongoing efforts to control expenses, optimize working capital and deploy capital judiciously helped us manage cash flow amidst a challenging flash pricing environment and larger-than-expected ACD underutilization that pressured gross margins. Before we discuss the details of our second quarter results, I wanted to cover two other announcements that we are making today.
First, we disclosed that Western Digital has entered into agreements with Apollo Global Management and Elliott Investment Management for convertible preferred equity investments totaling $900 million. In connection with the agreement, Reed Raymond, a partner at Apollo, will join our Board starting immediately. On behalf of the Board, I am pleased to welcome Reed, a leading technology investor who will provide us with additional financial and strategic expertise, which will be critical as we continue to execute on our business strategy and complete our strategic review. Second, on January 25, we secured access to $875 million of financing through a delayed draw term loan. When combined with the actions we undertook to structurally lower our cost structure, these financings provide valuable financial optionality and flexibility to Western Digital as we continue our strategic review.
Regardless of the outcome of the strategic review, our goal is to ensure the business is in a solid financial position to invest in innovation and create long-term shareholder value. Given the ongoing nature and confidentiality of the process, we will not be answering any questions about the strategic review process or making comments on market rumors. We will provide updates as we have them. Over the past three years, we have worked continuously to reinvigorate innovation and bolster business agility for both our flash and HDD organizations, which enabled the Western Digital team to stay ahead of the market. Over the same period, we paid down $2.7 billion in debt and arranged for settlement of a long-standing tax dispute. Since the beginning of fiscal year 2023, we have taken additional actions to reset the business in response to the post-pandemic environment.
These actions include: first, we have further reduced our capital expenditures across Flash and HDD to moderate our supply. As a result, our projected cash capital expenditure for fiscal 2023 has declined nearly 40% from six months ago. Second, we have decreased supply bid growth across both Flash and HDD. In Flash, we reduced wafer starts by 30% in January. In HDD, during the fiscal first quarter, we consolidated production lines across our manufacturing facilities and idled certain media production lines in Asia, reducing client hard drive capacity by approximately 40%. During the fiscal second quarter, we continued to optimize our capacity enterprise manufacturing footprint to align our supply with the new demand environment. Third, we have reduced our quarterly non-GAAP operating expense by over $100 million since the close of fiscal year 2022, driven by lower headcount, discretionary spending and variable compensation.
We are targeting to reduce quarterly non-GAAP operating expense level to below $600 million by the time we exit the fiscal year. And lastly, in December, we successfully executed an amendment to the existing financial covenants under our credit agreement. Turning to end market demand during the fiscal second quarter. Demand for consumer-oriented products stabilized as we discussed in October. In Consumer, we experienced a seasonal uptick across both Flash and HDD. In client, channel demand for both SSD and HDD have improved. However, commercial PCs are now being impacted by tightening budgets and spending across corporations, which is negatively affecting client SSD shipments. In cloud, we experienced a decline in nearline shipments as our customers were undergoing inventory digestion and ongoing subdued China demand.
I'll now turn to business updates, starting with HDD. During the fiscal second quarter, our HDD revenue declined significantly as cloud inventory digestion intensified, while demand for retail and client HDD improved. We continue to successfully execute on our product road map as we completed qualifications and commenced shipments of our latest generation 22-terabyte CMR hard drives at multiple cloud and major OEM customers last quarter. We are aggressively ramping this 22 terabyte CMR product this quarter and expect this drive along with its SMR variants to be our growth engine going forward. Qualifications of our 26 terabyte UltraSMR drives are also progressing well. Our major customers remain committed to adopting SMR drives as the 20% capacity gain that UltraSMR drives over CMR offers multi-generation TCO benefits to the most complex data centers worldwide.
We expect sequential growth in revenue and margin into our fiscal third quarter and continued recovery as we move through calendar year 2023. Turning to Flash. Thanks to our broad portfolio, diverse routes to market and leading retail franchise combined with strong seasonal demand, bit shipments increased 20% sequentially, exceeding our forecast. While we continue to experience pricing pressure in the market, our premium brands, including SanDisk, SanDisk Professional and WD_BLACK continued to deliver strong share and profitability to support the business. Our premium WD_BLACK client SSD, which is optimized for gaming continues to be well received in the marketplace. It achieved a record exabyte shipments, unit shipments and average capacity per drive resulting in exabyte shipment increase of 73% sequentially and 41% year-over-year for this product.
On the technology front, BiCS5 represented 70% of our flash revenue in the December quarter, while BiCS6 will reach cost crossover in the fiscal third quarter. Our next-generation 3D NAND node BiCS8 has entered productization phase. BiCS8 incorporates several groundbreaking 3D NAND architectural innovations to deliver a major leap in performance and cost-effective solutions to a broad range of exciting products, demonstrating the benefits of Western Digital's strong partnership with Kioxia and our innovation leadership in 3D NAND architecture. As we look into the fiscal third quarter, in hard drives, overall demand in cloud has stabilized, and we expect modest improvement in near line to offset a seasonal decline in client and consumer hard drives.
We expect stronger improvements in the second half of this calendar year, led by the aggressive ramp of our 22 and 26 terabyte hard drives. In flash, we expect enterprise SSD product demand for the fiscal third quarter to be sharply reduced as certain large cloud customers have entered a digestion period. In addition, a reduction in commercial PC demand is expected to impact client SSD shipments in the near term. Driven by the lower customer demand forecast in enterprise and client SSDs, we anticipate bit shipments to decline in the fiscal third quarter and return to growth in the fiscal fourth quarter. As I mentioned earlier, Western Digital lowered wafer starts in January, and we remain flexible in adjusting the magnitude and duration to restore our flash supply and demand balance.
As noted, for calendar year 2023, we expect reduced capital investment and lower utilization in response to the new demand environment. Our initial estimate is for flash demand bit growth to be in the low 20% range with production bit growth to be well below that of demand. With that, let me turn the call over to Wissam, who will discuss our second quarter results in greater detail and provide an outlook for the third quarter.
Wissam Jabre: Thank you, David, and good afternoon, everyone. Total revenue for the quarter was $3.1 billion, down 17% sequentially and 36% year-over-year. Non-GAAP loss per share was $0.42. Looking at our end markets, cloud represented 39% of revenue at $1.2 billion, down 33% sequentially and 36% year-over-year. Sequentially, the declines in capacity enterprise drives sold to our cloud customers and smart videos were partly offset by an increase in Flash shipments. Nearline bit shipments were 61 exabytes, down sequentially, driven by inventory digestion. The year-over-year decline was also primarily due to inventory digestion in hard drives. Client represented 35% of total revenue at $1.1 billion, down 11% sequentially and 41% year-over-year.
Sequentially, the decline was driven by pricing pressure across our Flash products, which was partly offset by an increase in hard drive shipments. The year-over-year decline was also due to pricing pressure in Flash as well as lower client SSD shipments for PC applications. Finally, consumer represented 26% of revenue at $0.8 billion, up 17% sequentially and down 25% year-over-year. Sequentially, the increase was driven by a seasonal uptick in both retail hard drives and Flash shipments. The year-over-year decline was driven by lower retail hard drive shipments and pricing pressure in Flash. Turning now to revenue by segment. We reported HDD revenue of $1.5 billion down 28% sequentially and 34% year-over-year. Sequentially, total HDD exabyte shipments decreased 35% and average price per hard drive decreased 21% to $99.
On a year-over-year basis, total HDD exabyte shipments decreased 33%, and average price per unit increased 2%. Flash revenue was $1.7 billion, down 4% sequentially and 37% year-over-year. Sequentially, Flash ASPs were down 20% on a blended basis and 13% on a like-for-like basis. Flash bit shipments increased 20% sequentially and remained approximately flat year-over-year. As we move to costs and expenses, please note that my comments will be related to non-GAAP results unless stated otherwise. Gross margin for the fiscal second quarter was 17.4%, down 9.3 percentage points sequentially and 16.2 percentage points year-over-year. Our HDD gross margin was 20.7%, down 7.8 percentage points sequentially and 9.9 percentage points year-over-year. On both a sequential and year-over-year basis, the decline was due to underutilization related charges of approximately $100 million.
Our Flash gross margin was 14.5%, down 10 percentage points sequentially and 21.6 percentage points year-over-year. We are continuing to reduce our costs with operating expenses at $659 million for the quarter, down $30 million sequentially. Operating loss was $119 million. Taxes were a benefit of $48 million. Taxes are influenced by several factors, including the projected quarterly profitability for the rest of the year and our corporate tax structure. Earnings per share was a loss of $0.42. operating cash flow for the second quarter was $35 million, and free cash flow was an outflow of $240 million. Cash capital expenditure which includes the purchase of property, plant and equipment and activity related to our Flash joint ventures on our cash flow statement was $275 million.
Our gross debt outstanding remained at $7.1 billion at the end of the fiscal second quarter. Our trailing 12 months adjusted EBITDA at the end of the second quarter, as defined in our credit agreement, was $3.3 billion, resulting in a gross leverage ratio of 2.1 times compared to 1.5 times a year ago. As a reminder, our credit agreement includes $0.8 billion in depreciation add-back associated with the Flash Ventures. This is not reflected in our cash flow statement. Please refer to the earnings presentation on the Investor Relations website for further details. As David mentioned, during the fiscal second quarter, we executed an amendment to the credit agreement that temporarily increased the covenant leverage ratio for the next seven quarters.
Our liquidity position continues to be strong. At the end of the quarter, we had $1.9 billion of cash and cash equivalents and a revolver capacity of $2.25 billion for total liquidity of $4.1 billion. Today, we announced multiple agreements to further enhance our liquidity position by $1.8 billion as follows. On January 25, we closed the delayed draw term loan agreement with our lenders in the amount of $875 million. In addition, as David mentioned, Western Digital entered into an agreement with Apollo Global Management and Elliott Investment Management for a convertible preferred investment of $900 million. Together, these actions significantly increase our ability to access liquidity and provide additional financial flexibility and optionality as we manage through this challenging downturn and execute on our strategic review.
Before I go over guidance for the fiscal third quarter, I'll discuss the business outlook and the financial impact associated with the actions we are taking to rightsize our cost structure. In HDD, we expect revenue to increase modestly in the fiscal third quarter as growth in nearline shipments outpaces decline in consumer. In Flash, we expect both shipments and ASP to decrease sequentially. We expect bit growth to resume in the fiscal fourth quarter. For the fiscal year 2023, we are reducing our gross capital expenditures to approximately $2.3 billion compared to our prior forecast of $3.2 billion entering this fiscal year. We are also aiming to reduce our cash capital expenditure to $900 million which is about 40% below our forecast six months ago.
The primary drivers of our lower capital expenditures are the delay of the BiCS6 transition in flash and reduced investment levels in both client and capacity enterprise hard drive manufacturing. We have reduced our quarterly operating expenses by over $100 million compared to six months ago. We are targeting to exit this fiscal year with quarterly operating expenses below $600 million. These actions will allow us to weather this cycle while also enabling us to continue advancing our innovative product road map going forward. I'll now turn to guidance. For the fiscal third quarter, our non-GAAP guidance is as follows: We expect revenue to be in the range of $2.6 billion to $2.8 billion. We expect gross margin to be between 9% and 11%, which includes underutilization charges in Flash and HDD totaling $250 million, with Flash driven by a 30% reduction in wafer starts.
We expect operating expenses to be between $600 million and $620 million. Interest and other expenses are expected to be approximately $90 million. We expect tax expenses to be between $60 million and $70 million for the fiscal third quarter and approximately $240 million to $260 million for the fiscal year. We expect loss per share of $1.70 to $1.40 in the third quarter, assuming approximately 319 million shares outstanding. I will now turn the call back over to David.
David Goeckeler: Thanks, Wissam. Before we open up for questions, I wanted to reiterate our view of the long-term opportunities for both Flash and HDD storage. Importantly, our efforts have enabled us to regain architectural leadership in both Flash and HDD, and we are preparing these technologies to address the meaningful long-term growth for data storage from client to edge to cloud. With our diverse portfolio, broad go-to-market engine, an enviable retail franchise and a lower cost structure, we remain confident in our ability to deliver long-term shareholder value. Okay. Peter, let's open up for Q&A.
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