Western Digital (WDC) Falls on Q3 Earnings Miss, View Weak

Shares of Western Digital Corp. WDC went down 3.8% in after-hours trading yesterday, after the company reported lower-than-expected third-quarter fiscal 2016 results. Also, a tepid fourth-quarter guidance impacted the share price.

The company reported non-GAAP earnings per share (excluding amortization of intangibles and other one-time items) of $1.21, which missed the Zacks Consensus Estimate of $1.25 per share. Also, earnings were down from $1.87 per share reported in the year-ago quarter.

Quarter Details

Western Digital's revenues of $2.82 billion for the third quarter not only decreased 20.5% year over year but also lagged the Zacks Consensus Estimate of $2.92 billion. Reported revenues were also toward the lower end of management's guided range of $2.8 to $2.9 billion. The year-over-year decline was due to weak hard disk drives (HDDs) total addressable market TAM during the quarter. Also, soft enterprise volumes during the quarter impacted revenues.

During the quarter, Western Digital shipped 43.1 million hard drives at an average selling price ASP of $60. ASP was down from $61 reported in the last quarter and the year-ago quarter. Also, reported shipments were down from 54.5 million in the year-ago quarter and from 49.7 million HDDs shipped in the previous quarter.

Western Digital's market share in the total addressable market TAM was flat on a quarter-over-quarter basis and came in at 43.2%. Market share declined from 43.6% reported in the year-ago quarter.

Furthermore, the company reported $200 million in revenues from the Enterprise Solid State Drive SSD segment, which decreased from $224 million in the year-ago quarter and $270 million in the previous quarter.

Western Digital's top 10 customers contributed 45% to revenues, up from 43% in the year-ago quarter and from 44% in the prior quarter.  

Western Digital's non-GAAP gross profit decreased 25.7% on a year-over-year basis to $794 million. Non-GAAP gross margin also decreased 197 basis points (bps) to 28.1%.

Non-GAAP operating expenses were down 19.3% year over year, primarily due to lower selling, general and administrative and research and development expenses. Non-GAAP income from operations came in at $317 million, which decreased from $478 million reported in the year-ago period. Operating margin also decreased 223 bps on a year-over-year basis to 11.2%. The decrease in margin was primarily due to higher operating expenses as a percentage of revenues (up 25 bps on a year-over-year basis).

Non-GAAP net income came in at $283 million or $1.21 per share compared with $441 million or $1.87 per share in the year-ago quarter.

Cash and cash equivalents were $5.89 billion compared with $5.36 billion in the previous quarter. Long-term debt during the quarter was $2 billion.

During the quarter, Western Digital generated $485 million in cash from operations compared with $598 million in the previous quarter. The company generated free cash flow of $352 million. The company declared a cash dividend of 50 cents during the quarter.

Guidance

For the fourth quarter of fiscal 2016, revenues are expected in a range of $2.6 to $2.7 billion. The Zacks Consensus Estimate is pegged at $2.91 billion.

Non-GAAP gross margin is expected to be up on a sequential basis. Total operating expenses (research and development, and selling, general and administrative) are expected to be approximately $475 million. Management expects non-GAAP earnings per share to be between $1.00 per share and $1.10 per share for the fourth quarter. The Zacks Consensus Estimate is pegged at $1.32 per share.

Our Take

Western Digital reported lower-than-expected third-quarter fiscal 2016 results, wherein both the top- and bottom line missed the Zacks Consensus Estimate. Both revenues and earnings decreased on a year-over-year basis, primarily due to lower HDD TAM. The company also provided a tepid revenue and earnings guidance citing seasonal factors.

Nonetheless, the shift toward non-PC applications, secular growth of digital data and growing exposure to the small and medium business space are long-term positives. Additionally, higher demand for storage is expected to lead to a positive earnings surprise in the ongoing quarter.

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.

Also, 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 expected to be growth catalysts, going forward.

It is worth mentioning that Western Digital and SanDisk Corp. SNDK entered into a definitive agreement on Oct 21, 2015. Per the deal, Western Digital will acquire SanDisk. Notably, the proposed merger moved a step ahead after more than 90% shareholders of both the companies voting in favor of the deal on Mar 15.

The SanDisk acquisition will open growth avenues for Western Digital and help it to gain market traction in advanced storage technology and the Solid State Drive SSD segment.

Similar strategic acquisitions are expected to expand its offerings in the SSD segment and place Western Digital in a better position compared to its peers such as Seagate Technology STX.

Western Digital currently carries a Zacks Rank #3 (Hold).

Intuit Inc. INTU is a better-ranked stock in the technology space, carrying a Zacks Rank #1 (Strong Buy).

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