WESTERN DIGITAL THIRD QUARTER ENDED MARCH 31, 2017 CONFERENCE CALL REMARKS, 4/27/2017

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 future financial performance; 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 and business ventures 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 February 7, 2017. 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 third quarter financials and wrap up with our guidance for the fiscal fourth quarter.

We reported strong financial performance in the March quarter enabled by excellent operational execution by our team and favorable trends across all of our end markets. We reported revenue of $4.6. billion, non-GAAP gross margin of 39% and non-GAAP earnings per share of $2.39.

With three consecutive quarters of strong financial results following the completion of the SanDisk acquisition, we are seeing continued validation of our growth strategy and our ongoing transformation into a comprehensive provider of diversified storage products and technologies. We have constructed a powerful platform with the broadest set of products enabling us to be a leader in the storage industry. Our transformation over the last several years provides us with the opportunity to not only compete in today's marketplace but to be strongly positioned to grow and thrive into the future. And I would remind you that the results we are achieving today do not yet reflect the full impact of our targeted synergies from our HGST and SanDisk integrations.

The healthy current demand environment underscores the unabated growth in data and its increasing value in our professional and personal lives. As the new Western Digital, we are enjoying increasingly strategic relationships with our customers as they contemplate pivotal technology and architectural transitions, strengthening our ability to play a leading role in the storage industry.

Our team continues to execute very well on two key strategic priorities — the integration of HGST, SanDisk and WD, and the ramp of 3D NAND technology, each of which Mark and Mike will elaborate on.

I want share some thoughts on Toshiba's efforts to divest their memory business. Since 2000, Western Digital has been a partner with Toshiba, driving flash memory innovation and contributing significant value to our respective stakeholders through our joint venture in Japan.

Our goals throughout the current process have remained consistent and resolute:

  • First, to protect and preserve the health of the JV, which we believe is one of the most successful in the technology industry and in which we have invested more than $13 billion over its 17 year duration.
  • Second, to protect our interests with respect to any transaction involving the JV interests or assets, none of which could be completed without our consent; and
  • Finally, to explore potential long term value creation opportunities for both Western Digital's and Toshiba's stakeholders.

We are committed to continuing this storied partnership in Japan. As we have communicated directly to Toshiba, we believe Western Digital is best positioned to lead and implement a transaction that will achieve the goals of all of Toshiba's stakeholders and we are working with them to develop a win-win solution. We have been communicating with key stakeholders and partners to evaluate a full range of potential alternatives to this challenging situation.

I will now turn the call over to Mike to provide business highlights in the March quarter….

Mike Cordano - President & Chief Operating Officer

Thank you, Steve and good afternoon everyone.

Our March quarter results reflect continued strong demand for our products and focused operational execution. Industry-wide demand for NAND flash remained very strong and the industry-wide hard drive demand was stable, together contributing to a favorable environment for our overall business. Demand was healthy across all of our end markets and this helped mitigate typical seasonality. We made further progress in our ongoing conversion to the 3D NAND technology and our helium hard drives achieved new milestones as well.

In Client Devices, we saw strength for embedded products and for hard drives in surveillance applications while traditional compute demand was softer as expected. Demand for our solid state drives for client applications increased sequentially, reflecting expansion of attach rates of SSDs to PCs and the ongoing adoption of our client SSDs, enabling us to expand our market presence. We commenced shipments of our 64 layer 3D NAND in the client SSD form factor, and we expect to further expand the usage of this industry-leading technology across our product portfolio during the remainder of calendar 2017.

In the mobile embedded category, we further deepened our OEM customer engagement through increased acceptance of our eMMC solutions, including our three bit per cell (X3) offerings. Our design win pipeline expanded within the traditional mobile categories as well as in emerging growth areas such as auto, connected home and the internet of things.

Turning to Client Solutions, our comprehensive portfolio of flash and HDD products performed strongly and it significantly mitigated typical seasonal revenue decline. The strong market appeal for our WD, SanDisk and G-Technology brands continues, demonstrated by ongoing consumer preference for our products on a global basis.

In Data Center Devices and Solutions, we saw sustained strength for enterprise class SSDs and a growing requirement from hyperscale customers for our 10 terabyte Helium capacity hard drive. We completed several additional key qualifications for the 10 TB drive with these customers during the March quarter. Yesterday, we announced that we have begun customer shipments of our 12 TB drive, our fourth generation Helium product, underscoring our generational lead in this category. I am pleased to note that we have now shipped approximately 15 million Helium hard drives cumulatively since the platform's launch four years ago.

From a Memory technology and operations perspective, we are ahead of our previously communicated expectations. First, we have already achieved cost crossover for our 64 layer 3D NAND vs. our 15 nanometer X3 node. Second, we now plan to produce more than 75% of our total 3D NAND bit output based on the 64 layer architecture in calendar 2017. These achievements are particularly noteworthy, indicating that our joint venture remains focused on executing our technology, manufacturing and operational strategies.

Looking forward, our estimates for NAND industry bit growth rates for calendar 2017 are at the low-end of our long term industry outlook of 35-45% and for calendar 2018 somewhat higher than in 2017. When combined with the secular growth drivers for NAND flash, we believe that the NAND industry supply/demand environment will likely remain favorable through at least the first half of calendar 2018.

With that, I will turn the call over to Mark for the financial overview.

Mark Long - Chief Financial Officer

Thank you, Mike.

I am pleased with our financial performance in the March quarter. Our team executed well in a healthy market environment as we capitalized on our diversified product offerings, achieved cost targets and improved our liquidity position with continued strong cash flow generation.

Our revenue for the March quarter was $4.6 billion dollars, driven by strong performance in each of our end markets. Revenue in Data Center Devices and Solutions was $1.3 billion dollars, Client Devices was $2.3 billion dollars and Client Solutions was $1.0 billion dollars. Our revenue was only down 5% from our December quarter, versus the typical decline of approximately 15% on a pro forma basis, which underscores our strong performance.

Our Data Center business continues to be fueled largely by Cloud-related storage demand. Our March quarter revenue for data center devices and solutions declined 2% year-over-year on a pro forma basis. We saw sustained strength in capacity enterprise hard drives and sequential growth for our enterprise SSD's, offset by a decline in performance enterprise hard drives. Client Devices revenue for the March quarter increased 23% year-over-year on a pro forma basis, primarily driven by significant strength in embedded flash, surveillance HDD and client SSD. Client Solutions revenue for the March quarter, increased 6% year-over-year on a pro forma basis due to strong demand for removable and other Flash-based products.

Our non-GAAP gross margin was 39.3%, up 260 basis points quarter-over-quarter and up 650 basis points year-over-year on a pro forma basis. This gross margin expansion resulted from a favorable supply/demand environment, product cost improvements, and a higher mix of flash based revenue.

Turning to operating expenses, our non-GAAP OPEX totaled $811 million dollars. We were slightly above guidance due to higher performance based compensation driven by our better than expected financial results. We continue to make progress toward our integration synergy targets while also 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 March quarter was $206 million dollars, inclusive of $205 million dollars of interest expense. In our March quarter, we successfully repriced both our Euro denominated Term Loan B and our US Dollar Term Loan B. The aggregrate annual savings from these two repricings will result in approximately $42 million dollars of annual interest savings starting in our June quarter.

Our non-GAAP effective tax rate for the March quarter was approximately 11%.

On a non-GAAP basis, net income in the March quarter was $716 million dollars, or $2.39 per share. On a GAAP basis we had net income of $248 million dollars, or $0.83 per share. The GAAP income for the period includes intangible amortization, 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 March quarter we generated $1.0 billion dollars in operating cash flow with $257 million dollars spent on capital investments, resulting in free cash flow of $741 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 $144 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 $5.8 billion dollars, resulting in approximately $6.8 billion dollars of liquidity available to us, including our $1.0 billion undrawn revolver capacity. Our net debt outstanding has decreased approximately $1.5 billion since the beginning of the fiscal year mostly driven by strong cash flow generated by the business. We remain committed to our long-term deleveraging plans while also assessing value-creating strategic investment opportunities as they arise.

As Steve indicated, we have continued to make very good progress with respect to our integration activities. 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 third quarter this year, we achieved approximately $300 million dollars of cost of revenue synergies and approximately $325 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 third quarter, we have realized synergies of approximately $150 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.

I will now provide our guidance for the June quarter on a non-GAAP basis.

  • We expect revenue for our June quarter to be approximately $4.8 billion which would represent double digit year-over-year growth on a pro forma basis. As a result, for fiscal 2017, we expect to generate pro forma revenue growth that will be in line with our long-term financial model of 4-8%.
  • We expect gross margin to be approximately 40%.
  • Turning to operating expenses, we expect those to be similar to our March quarter results.
  • Interest and other expense is expected to be approximately $200 million dollars.
  • We expect an effective tax rate in the 10-13% range.
  • As a result, we expect earnings per share between $2.55 and $2.65 with an estimated share count of 302 million diluted shares.

As we described in detail during our last Investor Day, we believe our integrated product and technology platform will enable strong long-term growth and profitability. Based on our current business outlook and capital structure, we see an opportunity to achieve non-GAAP earnings per share of approximately $12.00 for the full calendar year 2017.

I will now turn the call over to the operator to begin the Q&A session. Operator?

CLOSING REMARKS:

Thank so much. I want to thank everybody for joining us today. And we look forward to speaking with you going forward. Have a great rest of the afternoon.