WESTERN DIGITAL FOURTH QUARTER ENDED JUNE 30, 2017 CONFERENCE CALL REMARKS, 7/27/2017

Jay Iyer - Sr. Director Investor Relations

Thank you <operator name> and 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; our evolving relationships with customers; 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 May 8, 2017. Any applicable forward looking commentary is exclusive of one-time transactions and does not reflect the effect of any acquisitions, divestitures or other transactions that may be announced after July 27, 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 not in 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 fourth quarter and full year financials and wrap up with our guidance for the fiscal first quarter before we take your questions.

We reported strong financial performance in the June quarter to complete an outstanding fiscal 2017. Our unique platform of diverse storage technologies and value-added products helped drive this performance as we addressed a broader set of markets following the SanDisk acquisition. On a pro forma basis, we operated near the top of our revenue growth model with 7% year-over-year top-line growth, and we delivered very healthy margins. As a result of our unique platform, relationships with our customers are more strategic in recognition of our changing role in the data storage ecosystem.

For the June quarter, we reported revenue of $4.8 billion, non-GAAP gross margin of 41% and non-GAAP earnings per share of $2.93. We generated strong operating cash flow, reflecting continued healthy demand in many of our end markets.

Our financial performance in fiscal 2017 demonstrates the differentiated value we can deliver as a comprehensive data storage solutions leader. With industry leading technologies and demonstrated ability to quickly productize them, we have been able to strategically fulfill the market’s growing storage requirements. Our flexible business model also allows us to realize differentiated financial performance in varied market conditions, giving us greater capability to navigate a range of market conditions than what our legacy companies could achieve on a stand-alone basis.

In addition to our strong financial performance, our team continues to execute very well on the ramp of 3D NAND technology and on the integration of HGST, SanDisk and WD, each of which Mike and Mark will elaborate on.

I would also like to provide a brief update on our ongoing discussions with Toshiba.

Our goal has always been to protect and preserve the health and future of our successful joint ventures. We and our subsidiaries have operated the JVs with Toshiba for the last 17 years – it is a partnership that has been highly successful for both parties and for Japan.

As you may have seen in media reports, Mark and I were in Japan last week to continue our dialogue with Toshiba and its stakeholders. Our discussions were constructive, and we will continue to work to seek a solution that is in the best interests of all parties.

Beyond that, we will not get into more detail on this matter until we have a material update to share with you. We know this is an important topic for the investment community and we are committed to keeping you apprised. Rest assured, this has the full attention of our team as we are committed to the continued success of the joint ventures.

In closing, I want to thank our employees for all that we have done and accomplished over the course of the last several years. We are building a great company with a strong foundation for our future as a differentiated leader in the storage industry.

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

Mike Cordano - President & Chief Operating Officer

Thank you Steve, good afternoon everyone. To build on Steve’s remarks, I am very pleased with the strong finish to our fiscal 2017, with several milestones achieved across the various areas of our business. All of our reported revenue categories grew both sequentially and year-over-year in the fourth quarter. Results from our NAND flash products were strong in the midst of a continued constrained supply environment and HDD results were largely within our expectations. We made further progress towards our 3D NAND technology transition objectives and our operational advancements remained on track. Most importantly, our results since the close of the SanDisk acquisition last year illustrate the power of our platform.

Our client devices business grew by 36% year-over-year on a pro forma basis, despite the PC market being slightly weaker than expected in the quarter. This growth was driven by our progress in diversifying our customer base and continued expansion of our product portfolio, with the gains being most pronounced in mobility and client SSD. Combined revenue from emerging growth applications such as connected home, gaming, and industrial, also delivered strong sequential growth. We have begun multiple sampling activities for our embedded products designed for the automotive market, a compelling long-term growth opportunity.

In Client solutions, the strength of WD, HGST and SanDisk brands combined with our global distribution capabilities allowed us to deliver strong performance in what has historically been a relatively weaker period in retail. This enabled us to achieve a 14% year-over-year revenue growth in the June quarter on a pro forma basis. The ability to serve customers with the broadest array of products and solutions is a key element of our strategy.

Turning to data center devices and solutions, shipments of our 10 terabyte (TB) helium drives increased significantly on a sequential basis as our industry leading product made further inroads in hyperscale data centers. The storage and efficiency requirements of data center customers are driving a sustained shift to the 10TB capacity point and we believe we further increased our market presence in this category. On a cumulative basis since the launch of our helium platform four years ago, we have shipped more than 18 million helium drives. Qualification activities for our 12TB helium drives began at key hyperscale and OEM customers in the June quarter. With the success of our 10TB platform and our expectation to continue our generational lead with the 12TB platform, we are well positioned to maintain product leadership over the next several years.

For the near line drive market, our expectation for the long-term industry exabyte growth at the 40% annual rate remains unchanged. Given certain industry-wide component shortages, we now estimate the industry exabyte growth to be approximately 30% for calendar 2017. However, we expect our own growth rate will be approximately 40% given the strong adoption of our near line offerings.

In our JV fab operations, we continued the strong ramp on our 64 layer 3D NAND, BiCS3, technology during the quarter, with a significant portion of our product shipments now using this industry leading technology. Manufacturing yields of BiCS3 continue to meet our expectations, and we are maintaining our projection for the combined JV output of 64 layer 3D NAND to be the highest in the industry in calendar 2017. Development work on BiCS4, our recently announced 96-layer 3D NAND technology, is ongoing and we expect to begin sampling in calendar 2017 with meaningful production volumes in calendar 2018.

In addition to the solid progress on our BiCS portfolio, we are delivering innovative new technology capabilities such as the recently announced 4 bits per cell 3D NAND.

From a future fab perspective, we intend to participate in the JV’s Fab 6 to provide additional clean room space to support the further conversion of our existing 2D NAND capacity to 3D NAND. We expect production output from the new clean room facility to begin in calendar 2018.

From a NAND industry supply standpoint, our estimate for bit growth rate for calendar 2017 remains at the low end of our long-term industry outlook of 35% to 45%, and for calendar 2018 somewhat higher than in 2017. Combined with the secular growth drivers for NAND flash, we continue to believe that the favorable NAND industry conditions will persist at least through the first-half of calendar 2018.

In closing, our strong fiscal 2017 results highlight the power of our platform. The various ingredients that make up this platform, including technologies, products, go to market capabilities, and our team, are helping us better serve our diversified customer base and manage our business to the best strategic and financial outcomes.

I will turn the call over to Mark for the financial discussion.

Mark Long - Chief Financial Officer

Thank you, Mike.

I am very pleased with our financial performance in the June quarter. Our team executed well across our broad array of markets as we capitalized on our diversified product portfolio, increased gross margins and achieved cost and expense targets. All of which resulted in significant earnings growth. We also finished the fiscal year with an improved liquidity position as a result of our continued robust cash flow generation.

Our revenue for the June quarter was $4.8 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 $1.0 billion dollars. Our revenue for the June quarter was up 4% from our March quarter and increased 21% year-over-year on a pro-forma basis. All of my year-over-year comparisons cited today are on a pro-forma basis.

Our Data Center business continues to be fueled largely by Cloud-related storage demand. Our June quarter revenue for data center devices and solutions increased 7% year-over-year. We saw sustained strength in capacity enterprise hard drives and enterprise SSDs, offset by a decline in performance enterprise hard drives. Client Devices revenue for the June quarter increased 36% year-over-year, primarily driven by significant growth in mobility and client SSDs. Client Solutions revenue for the June quarter, increased 14% year-over-year driven mostly by our valuable global retail brands in removable and other Flash-based products. The execution of our strategy and strength of our broad platform enabled us to achieve 7% year-over-year total revenue growth for our full year fiscal 2017.

Our non-GAAP gross margin was 41.3%, up 200 basis points quarter-over-quarter and up 950 basis points year-over-year. This gross margin expansion resulted from a favorable supply/demand environment for flash based products, product cost improvements, a higher mix of flash based revenue and the strength of our capacity enterprise HDD lineup.

Turning to operating expenses, our non-GAAP OPEX totaled $812 million dollars. 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 June quarter was $197 million dollars, inclusive of $201 million dollars of interest expense. Our interest expense decreased from the previous quarter driven by the March repricings and was partially offset by the increase in Libor rates during the period.

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

On a non-GAAP basis, net income in the June quarter was $881 million dollars, or $2.93 per share. On a GAAP basis we had net income of $280 million dollars, or $0.93 per share. The GAAP income for the period includes intangible amortization, charges related to integration activities 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 June quarter we generated $939 million dollars in operating cash flow with $178 million dollars spent on capital investments, resulting in free cash flow of $761 million dollars. We also had good working capital performance contributing to our significant operating cash flows in the quarter.

We paid the previously declared cash dividend totaling $146 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 totaling $6.5 billion dollars, resulting in approximately $7.5 billion dollars of liquidity available to us, including our $1.0 billion dollars of undrawn revolver capacity. Since the beginning of the fiscal year, our net debt has decreased approximately $2.1 billion dollars to $6.9 billion dollars at the end of the fiscal year, mostly driven by 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.

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 fourth quarter this year, we achieved approximately $350 million dollars of cost of revenue synergies and approximately $350 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 fourth quarter, we have realized synergies of approximately $200 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 first quarter of 2018 on a non-GAAP basis.

  • We expect revenue for our September quarter to be approximately $5.1 billion dollars which would represent approximately 8% year-over-year growth.
  • We expect gross margin to be approximately 41%.
  • Turning to operating expenses, we expect those to be similar to our June quarter results.
  • Interest and other expense is expected to be approximately $208 million dollars.
  • We expect an effective tax rate in the 7-9% range.
  • Our diluted shares are expected to be approximately 307 million, an increase from the June quarter driven mostly by a new accounting standard.
  • As a result, we expect earnings per share between $3.25 and $3.35.

We believe our integrated product and technology platform is a key differentiator that will enable strong long-term growth and profitability. Based on our current business outlook and capital structure, we now see the opportunity to achieve non-GAAP earnings per share that exceeds our prior guidance of $12.00 per share 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:

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 day.