Robert Blair - Vice President Investor Relations
Good afternoon everyone.
This conference call will contain forward-looking statements within the meaning of the federal securities laws, including statements concerning: our expected financial performance for our third fiscal quarter ending March 31, 2017; our market positioning; expectations regarding growth opportunities; our financial and business strategies and execution; integration activities and achievement of synergy goals; demand and market trends; our product portfolio, product features, development efforts, and expansion into new data storage markets; and our joint venture partnership with Toshiba. These forward-looking statements are based on management's current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including those listed in our quarterly report on Form 10-Q filed with the SEC on November 8, 2016. We undertake no obligation to update our forward-looking statements to reflect new information or events.
Further, references will be made during this call to non-GAAP financial measures. Reconciliations of the differences between the non-GAAP measures we provide during this call to the comparable GAAP financial measures will be posted in the Investor Relations section of our website. We have not fully reconciled our non-GAAP financial measure guidance to the most directly comparable GAAP measures because material items that impact these measures are out of our control and/or cannot be reasonably predicted. Accordingly, a full reconciliation of the non-GAAP financial measure guidance to the corresponding GAAP measures is not available without unreasonable effort.
In the question/answer part of today's call we ask that you limit yourselves to one question to allow as many callers as possible to ask their question. I thank you in advance for your cooperation.
With that, I will now turn the call over to our CEO, Steve Milligan.
Steve Milligan - Chief Executive Officer
Good afternoon and thank you for joining us. With me today are Mike Cordano, president and chief operating officer; and Mark Long, chief financial officer. After my opening remarks, Mike will provide a summary of recent business highlights and Mark will cover the fiscal second quarter financials and wrap up with our guidance for the fiscal third quarter.
At our Investor Day in December, we took the opportunity to present our differentiated platform, strategy and business model and to describe the significant growth opportunities for our company. With a growing storage industry and evolving data driven requirements, we are uniquely positioned to help define and drive the storage architectures of the future. We are pleased with the increasingly strategic interactions we are having with customers, validating our approach to value creation.
We reported strong financial performance in the December quarter enabled by excellent operational execution by our team. The favorable trends across all of our end markets that began earlier in 2016 continued. This included healthy demand for capacity enterprise hard drives, all NAND based products and hard drives in client applications, helped by stronger than expected PC demand. We reported revenue of $4.9 billion, non-GAAP gross margin of 37% and non-GAAP earnings per share of $2.30 – outperforming the revised guidance provided at our Investor Day.
We continue to execute well on two key strategic priorities — the integration of HGST, SanDisk and WD, and the ramp of our 3D NAND technology.
The transition to 3D NAND technology continues as planned with the ramp of our 64 layer architecture. We commenced retail shipments and OEM sampling of our 64 layer products in the December quarter. As we demonstrated at Investor Day, we are executing methodically and thoughtfully on our technology strategy and we fully expect our leadership in 2D NAND to extend into 3D NAND. In 2017 and beyond, you will see the deployment of our 64 layer 3D NAND across our product portfolio, spanning removable, embedded, client SSD and enterprise SSD offerings.
As we all know from recent disclosures by Toshiba and news reports, our Flash joint venture partner is facing challenges. We have been in regular communications with them over the last several weeks. We are confident that their semiconductor memory business remains healthy and strategically viable. Under any circumstance, we will act to protect Western Digital's interests and work to ensure that we maintain the leadership position of our joint venture.
In closing, I want to express my gratitude to our chief technology officer Steve Campbell, who is leaving the company after 20 years of distinguished service to Western Digital. I also want to welcome Martin Fink on board as our new CTO. Martin brings deep storage systems and memory-driven computing expertise that will help us accelerate our ongoing transformation. I am sure Martin is known to many of you from his years at HP, where he most recently served as CTO and director of HP Labs at HP Enterprise. I am delighted to have him on the senior team at Western Digital.
I will now turn the call over to Mike to provide business highlights in the December quarter….
Mike Cordano - President & Chief Operating Officer
Thank you Steve, and good afternoon everyone. Our December quarter results reflect strong execution across our portfolio amidst a favorable industry environment in both flash and hard disk drive markets. Demand remained robust throughout the quarter and we launched several new products, further expanding the breadth of our offerings. We made additional gains in the ongoing conversion to 3D NAND technology and the commercial ramp of our 64 layer technology is accelerating. We are building stronger and deeper partnerships with our customers as our platform is increasingly aligned with our customers' strategic directions. Overall, we had a strong finish to calendar 2016 providing business momentum as we entered 2017.
In client devices, our participation with OEM customers has meaningfully increased as our broadening portfolio of hard drives and flash based solutions addressed a PC market that is healthier than expected. Our revenue from client devices increased sequentially, primarily driven by client SSDs and embedded products, as revenue synergies from the SanDisk acquisition benefited us further in a seasonally strong quarter. Increasing storage capacities in mobile phones and market preference for client SSDs are long-term tailwinds for this portion of our business.
Switching to client solutions, we experienced robust holiday seasonal demand and achieved sequential revenue growth driven by key NAND based products. We are pleased to note that the combined revenue contribution from new products such as the iXpand and Dual USB drives also grew underscoring continued consumer enthusiasm for our retail branded solutions. We announced new retail products including the 4 terabyte My Passport, the 8 terabyte My Book hard drives for the PC and a new 4 terabyte hard drive for the Mac. Shipments of our 64 layer 3D NAND based retail products began in the December quarter and we expect an increasing use of this underlying technology in our portfolio in 2017 and beyond.
In the datacenter category, demand for high capacity storage devices remained very strong. Year-over-year petabyte growth for capacity-optimized hard drives met our upwardly revised expectation, which we had estimated at 40% growth. We are pleased with the mainstream adoption of our 10 terabyte, third generation Helium drive. We have revised our planning to anticipate petabyte year-over-year demand growth for capacity optimized hard drives to continue at approximately the same 40% rate, compared to our prior forecast of about 35%. At our Investor Day, we announced a 12 terabyte capacity Helium drive, as well as a derivative SMR based 14 terabyte drive, marking the start of our fourth-generation Helium product line. The traction we have achieved for our Helium drive offerings, which were launched four years ago, demonstrates true cost of ownership value for our customers and we look forward to providing them with ongoing innovation around this platform. Notably, the December quarter marked a cumulative shipment milestone of more than 12 million helium drives, reflecting our leadership in this category.
From an enterprise SSD standpoint, we experienced strong demand across our products at both hyperscale and OEM accounts driving sequential revenue growth. In the December quarter, we announced our latest NVMe PCIe enterprise-class SSD with leading performance and a high capacity SAS enterprise SSD contributing to a further expansion of our portfolio.
In our data center solutions category, our disk and flash storage platform business achieved several new design wins at leading system OEM customers for their cloud-scale storage systems. We are achieving new customer wins and solid repeat business from existing customers in key verticals around the world. This nascent business continues to represent a strong growth opportunity for the company.
Turning to silicon operations, we are very pleased with the progress we are making commercializing our 3D NAND technology. As I indicated earlier, we have already begun retail product shipments containing 64 layer BiCS3 and we also expect to launch client SSDs and embedded mobile offerings with this technology throughout the year. Additionally, we are on track to begin sampling enterprise SSD products utilizing 64 layer BiCS3 this calendar year. We expect our broad implementation of BiCS3 across our portfolio will result in Western Digital having the industry's richest mix of 64 layer 3D NAND based products in calendar 2017, underscoring our growing confidence in our ability to successfully commercialize this technology.
In the March quarter, we expect to break ground for the construction of Fab 6, along with our joint venture partner Toshiba. Fab 6 will provide new clean room space to support the continued conversion of our existing 2D NAND capacity to 3D NAND. We expect operations in Fab 6 to commence in calendar 2018.
In closing, our December quarter results reflect the positive impact of the Western Digital platform. Deepening customer relationships helped by our portfolio and technology expertise along with our global go-to-market capabilities further strengthen us as a leading storage solutions provider. I will now turn the call over to Mark for the financial discussion.
Mark Long - EVP Finance, Chief Financial & Strategy Officer
Thank you, Mike.
I am pleased with our financial performance this quarter. Our team executed well in a healthy market environment as we capitalized on our strong product offerings, achieved targeted cost and efficiency improvements and improved our liquidity position with continued strong cash flow performance. We exceeded the revised guidance from our Investor Day on December 6th across our key financial metrics.
Our revenue for the December quarter was $4.9 billion dollars, driven by strong performance in each of our end markets. Revenue in Data Center Devices and Solutions was $1.4 billion dollars, Client Devices was $2.4 billion dollars and Client Solutions was $1.1 billion dollars. In each end market, our revenue was flat to up from the September quarter, which underscores our strong performance as the September quarter is typically our strongest period.
Our Data Center revenue growth continues to be fueled largely by Cloud-related storage demand. As a result, this quarter, we saw continued strength in capacity enterprise hard dives, sequential growth for performance enterprise hard drives, as well as increased demand for enterprise SSDs. Client Devices, which include both hard drives and flash based products, benefited from a healthier PC market as well as traditional seasonal trends. Embedded solutions experienced strong growth primarily from increases in storage capacity in mobile phones. In Client Solutions, our revenue grew as a result of strong demand for removable and other Flash-based products during the holiday season.
Our non-GAAP gross margin grew to 36.7%, up 280 basis points versus the September quarter. We achieved this expansion through continued product cost improvements and healthy pricing for our products. Our product cost improvements resulted from consistent execution and ongoing progress with our integration activities.
Turning to operating expenses, our non-GAAP OPEX totaled $797 million dollars, down $66 million dollars from the September quarter. We continue to make progress towards our integration synergy targets while making on-going investments in product development, go-to-market capabilities and IT projects as part of our transformation to enable future growth.
Our non-GAAP interest and other expense for the quarter was $221 million dollars. Our non-GAAP interest expense was $205 million, a reduction of $31 million from the September quarter driven by the debt repricings and reductions. Our non-GAAP other expenses, net of interest income, were $16 million for the December quarter. These expenses were primarily a result of foreign exchange revaluations that had no economic or cash impact. While it was an expense in the second quarter, it will result in lower expenses in future periods.
Our non-GAAP effective tax rate for the December quarter was approximately 13%.
On a non-GAAP basis, net income in the December quarter was $675 million dollars, or $2.30 per share. On a GAAP basis we had net income of $235 million dollars, or $0.80 per share. The GAAP income for the period includes intangible amortization and charges associated with our acquisitions and stock based compensation. Therefore, the net difference between our GAAP and non-GAAP net income is primarily a result of non-cash charges.
In the December quarter we generated $1.1 billion dollars in cash from operations with $189 million dollars spent on capital investments, resulting in free cash flow of $871 million dollars. We also had strong working capital performance contributing to our significant operating cash flows in the quarter.
We paid the previously declared cash dividend totaling $142 million dollars during the quarter and also declared a dividend in the amount of $0.50 cents per share.
We closed the quarter with cash, cash equivalents and available for sale securities totalling $5.2 billion dollars. We have approximately $6.2 billion dollars of liquidity available to us including our $1.0 billion undrawn revolver capacity. Our net debt position has decreased approximately $800 million from the September quarter driven by higher cash balances. We remain committed to our long-term deleveraging plans while also evaluating strategic investment opportunities as they arise.
As Steve indicated, we have continued to make very good progress with respect to our integration. We remain on track to achieve the $800 million dollars of annualized savings from the HGST integration by the end of calendar 2017. As of the end of our fiscal second quarter this year, we achieved approximately $175 million dollars of cost of revenue synergies and approximately $300 million dollars of operating expense synergies, each on an annual run-rate basis. With respect to the SanDisk integration, as of the end of our fiscal second quarter, we have realized synergies of approximately $130 million dollars on an annual run-rate basis, toward our 18 month target of achieving $500 million dollars of total run-rate synergies on an annualized basis.
To build on what Steve said about our Flash Joint Ventures, it is important to note that the operations and financial position of Flash Ventures are healthy and investments are on track for the significant ramp of our 64 layer BiCS3 technology throughout calendar 2017. As a reminder, the Joint Ventures generate positive cash flow that is used to finance a significant portion of the capital requirements for both partners.
I will now provide our guidance for the March quarter on a non-GAAP basis.
- As I have previously indicated, we generate slightly more revenue in the second half of the calendar year than in the first half. In that context, we expect revenue for our March quarter to be approximately $4.55 billion which represents significant year-over-year growth on a pro forma basis. As a result, for fiscal 2017 we currently expect to generate pro forma revenue growth that is consistent with our long-term financial model.
- We expect non-GAAP gross margin to increase to approximately 38%, primarly driven by continued favorable pricing and product mix across our business.
- Turning to non-GAAP operating expenses, we expect those to total approximately $800 million dollars consistent with our December quarter. We continue to make progress with reductions in our costs and at the same time support our integration and growth with certain incremental investments. Additionally, we expect opex to be essentially flat in our fourth fiscal quarter, consistent with second and third quarter levels.
- Interest and other expense is expected to be approximately $205 million dollars.
- We expect an effective non-GAAP tax rate in the 12-14% range.
- As a result, we expect non-GAAP earnings per share between $2.00 and $2.10 with an estimated share count of 298 million diluted shares.
I will now turn the call over to the operator to begin the Q&A session. Operator?
I want to thank you for joining us today. We look forward to seeing many of you at upcoming investor conferences. Thank you very much.