Western Digital (WDC) Beats Q2 Earnings; '17 View Positive

Western Digital Corp.WDC reported second-quarter 2017 adjusted earnings of $2.30 per share, which increased 33.7% from the year-ago quarter. Earnings were much better than management's revised guided range of $2.10-$2.15 per share.

Moreover, including stock-based compensation, earnings were $1.98 per share, which beat the Zacks Consensus Estimate by 33 cents. Further, revenues of almost $4.89 billion surged 47.4% year over year and comfortably surpassed the Zacks Consensus Estimate of $4.75 billion.

Western Digital witnessed strong demand for both hard drive and NAND-based products from all categories of customers, largely driven by cloud and mobility based applications, as well as better than expected PC demand in the reported quarter.

Western Digital Corporation Price, Consensus and EPS Surprise

Western Digital Corporation Price, Consensus and EPS Surprise | Western Digital Corporation Quote

Segment Revenue Details

Client devices (49.5% of total revenue) surged 52.9% year over year to $2.42 billion. The revenue synergies from SanDisk acquisition benefitted results in the quarter. Management noted that increasing storage capacities in mobile phones and market preference for client SSDs are long-term tailwinds for this business.

Client solutions (22% of total revenue) increased a whopping 134.4% to $1.08 billion. Robust holiday season sales drove results. The company noted that the combined revenue contribution from new products such as iXpand and dual USB drives also grew in the quarter.

During the quarter, Western Digital announced new retail products including the four terabyte My Passport, eight terabyte My Book for the PC and a new four terabyte hard drive for Apple's AAPL Macintosh. During the quarter, Western Digital commenced retail shipments and OEM sampling of its 64-layer product.

Data center devices and solutions (28.5% of total revenue) increased 9.2% to $1.39 billion on the back of strong demand for high capacity storage devices. Petabyte growth of almost 40% year over year for capacity optimized hard drive was in line with management expectations. Solid adoption of 10 Terabyte third generation Helium drive was also noted in the quarter.

During the quarter, Western Digital shipped 44.8 million HDDs at an average selling price (ASP) of $62, up from $61 reported in the year-ago quarter. However, reported shipments of 44.762 million were down from 49.688 million in the year-ago quarter.

Western Digital's market share in the total addressable market (TAM) came in at 39.9% compared with 43.2% in the year-ago quarter.

Operating Details

Adjusted gross margin expanded 810 basis points (bps) year over year to 36.4%. The figure was better than management's guidance of 35%. The expansion was driven by lower product cost and pricing improvement.

Reported operating expenses, as percentage of revenues climbed 50 bps to 20.2%, owing to 20 bps increase in research and development (R&D) expense and 10 bps growth in selling, general and administrative (SG&A) expense.

As a result, adjusted operating margin expanded 590 bps to 17.6% in the reported quarter.

Interest expense was $224 million a massive increase from $7 million reported in the year-ago quarter.

Acquisition Synergies

Western Digital stated that it is on track to achieve the $800 million of annualized savings from the HGST integration by the end of calendar 2017. The company achieved $175 million of cost of revenue synergies and $300 million of operating expense synergies each on an annual run rate basis at the end of the reported quarter.

In terms of SanDisk integration, at the end of second quarter the company realized synergies of approximately $135 million on an annual run-rate basis. This is in line with the company's 18-month target of achieving $500 million of total run rate synergies on an annualized basis.

Balance Sheet/Cash Flow

As of Dec 30, 2016, cash and cash equivalents were $4.94 billion up from $4.33 billion as of Sep 30. Long-term debt during the quarter was $12.94 billion down from $13.06 billion at the end of previous quarter.

During the quarter, Western Digital generated $1.06 billion in cash from operations compared with $440 million in the previous quarter.


For third-quarter fiscal 2017, revenues are expected to remain flat on a sequential basis.

Adjusted gross margin is expected to be 38% backed by continued favorable pricing and product mix across the company's businesses. Total operating expenses are expected to be approximately $800 million.

Interest expense is anticipated to be almost $205 million.

Management expects adjusted earnings to be in the range of $2.00-$2.10 per share for the third quarter.

Our Take

We believe that the shift toward non-PC applications, secular growth of digital data and growing exposure to the small and medium business space are the long-term positives for Western Digital. The company's growing footprint in the automotive as well as the connected home and industrial categories is significantly positive, in our view.

We remain encouraged by the company's launch of a string of storage devices under the mobile and cloud segment. Continued investments in product innovation could result in flattish margins in the near term.

Further, Western Digital's entry into the wireless devices market comes at a time when storage services related to smartphones and tablets are witnessing large-scale adoption. These factors are anticipated to be growth catalysts, going forward.

Moreover, the SanDisk acquisition not only expands Western Digital's offerings in the SSD segment but also provides a competitive edge against peers such as Seagate Technology STX .

We note that Western Digital shares have outperformed the Zacks Computer Storage Devices industry in the past one-year. While shares gained 80.9%, the industry advanced 22.4% in the same period. We expect the momentum to persist given the impressive result and positive guidance in the rest of fiscal 2017.

Zacks Rank & Key Picks

Western Digital currently has a Zacks Rank #1 (Strong Buy). You can see the complete list of today's Zacks #1 Rank stocks here . Applied Optoelectronics AAOI with the same Zacks rank is another stock worth watching in the broader sector.

Applied Optoelectronics is expected to report earnings results on Feb 23.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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