Bob Blair - Investor Relations
Thank you Lateef 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; demand and market trends; our product portfolio and product development efforts; our plans to deleverage, optimize our capital structure, and reduce certain costs and expenses; the expected impact of the Tax Cuts and Jobs Act; our joint ventures with Toshiba; and our long-term access to flash. 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 annual report on Form 10-Q filed with the SEC on November 7, 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 January 25, 2018. 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.
I want to note that we are displaying a Powerpoint deck during today's commentary and that a PDF of the slides and our remarks will be available later today on the IR section of our website, along with our Quarterly Fact Sheet.
With that, I will now turn the call over to our CEO, Steve Milligan.
Steve Milligan - CEO
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 and wrap up with our guidance. We will then take your questions.
We demonstrated the power of our platform with record non-GAAP financial results in the December quarter. I am very pleased that we achieved year-over-year revenue growth in each of our end market categories. We reported revenue of $5.3 billion, non-GAAP gross margin of 43% and non-GAAP earnings per share of $3.95. We once again generated strong operating cash flow, reflecting continued healthy demand in our end markets, most notably for our capacity enterprise hard drives and flash-based products.
Entering the new calendar year, there are several noteworthy trends as we pursue our long-term value creation strategy. The global economic environment is healthy: the GDP growth rates in the U.S., China and the EU are positive, portending significant IT spending. Data is being created at a record pace worldwide and the value of data is increasing too, driven by advancements in mobility, cloud computing, artificial intelligence, and the Internet of Things. The unabated growth in data is creating a global need for a larger and more capable storage infrastructure. The level of capex spending by Cloud Service Providers to accommodate this growth is robust. As Mike will address in more detail, the healthy pace of data center buildouts has resulted in a recent re-acceleration of demand for high capacity enterprise hard drives. Against this backdrop, we are well positioned with our powerful platform to enable our broad customer base to capture, preserve, access and transform an ever-increasing diversity of data.
The flash market is normalizing in a constructive manner. As a diversified, value-added storage solutions provider with a wide breadth of served markets, we will continue to demonstrate the resilience of our model by delivering compelling financial results.
I am very pleased with our progress in technology and product development. The deployment of our 64-layer 3D technology continued across our product portfolio and we will be ramping our 96-layer technology later this calendar year. We continue to lead the industry with our high capacity helium platform and we remain on plan to sample our MAMR-based capacity enterprise hard drives in the second half of calendar 2018.
It was gratifying to end the calendar year with a resolution of our negotiations with our JV partner Toshiba to extend and strengthen our relationship and ensure our long-term access to flash and I am happy to report that our JV operations continue to perform very well. I am very proud of our team, their unwavering focus on execution and the results they have delivered.
With that, I will ask Mike to share our business highlights.
Mike Cordano - COO
Thank you, Steve, good afternoon everyone. We are pleased that we finished calendar 2017 with strong December quarter results. We executed well across our business with continued strength in demand for our products and solutions. As Steve indicated, we saw year-over-year growth in each of our end market categories, reflecting the Power of our Platform in addressing a broadening set of markets and customers.
In Client Devices, revenue grew nicely from the year-ago quarter driven most notably by demand for our embedded flash and client SSD products. We began shipments of our 3D flash based embedded solutions for the mobile and compute markets including our first UFS offering, allowing us to address a broader market opportunity beginning this calendar year. In addition, we saw continued strong demand for our products in growth areas such as connected home, surveillance, and industrial verticals.
Solid year-over-year revenue increase in Client Solutions highlighted the continued preference for our G-Tech, SanDisk and WD brands during a strong holiday season. We made further inroads in our engagement with leading brick-and-mortar and e-tail partners during the December quarter. At CES earlier this month, our products received half-a-dozen awards underscoring the ongoing innovation and differentiated value we are delivering to this market.
In Data Center Devices and Solutions, demand for our capacity enterprise drives remained strong. Shipments of our 10 terabyte (TB) helium drives grew further and the transition to the 12TB capacity point accelerated. We also began shipments of our industry leading 14TB drives for hyperscale applications during the December quarter.
In terms of exabyte growth in capacity enterprise, as previousy indicated, calendar 2017 was a slower period for the market primarily due to industry-wide component constraints, with an overall exabyte growth rate of slightly less than 30%. However, as we noted on our December conference call, we saw strengthening demand for capacity enterprise drives as we ended 2017. In the first-half of calendar 2018, we estimate that the year-over-year industry exabyte growth rate will exceed 60% as the pent-up demand is fulfilled. For the full calendar 2018, we estimate exabyte growth to exceed 50% as broad deployments of capacity enterprise drives are expected to persist throughout the year.
Datacenter buildout by several large hyperscale customers and guided industrial policies are driving significant global infrastructure expansion. These trends are leading to a growing need for capacity enterprise drives in the high-end as well as in the mid-range. For Western Digital, the mid-range part of the capacity enterprise market has been an area of lower exabyte share. We have responded to the rising demand for 4TB to 8TB capacity drives, especially in Asia, with our recent introduction of a new range of cost-advantaged, air-based products. We expect the demand for high and mid-range capacity drives to support the higher rate of exabyte consumption in calendar year 2018, and our long-term annual exabyte growth estimate is unchanged at 40%.
From an operations standpoint, we expect to achieve further cost and expense reductions as the hard drive market continues to evolve. For example, we have reduced development expenses in our product portfolio by eliminating future investments in performance enterprise drives and narrowing our client HDD portfolio. Additional actions include our previously announced closures of manufacturing operations in China and Singapore.
Turning to our flash joint ventures, the ramp of our 64-layer 3D flash technology, BiCS3, progressed well with further improvements in yields and productivity. The mix of our 3D flash bit supply approached 70% exiting the December quarter, with BiCS3 constituting more than 90% of our 3D flash bits. Additionally, we commenced initial production of our 96-layer technology, BiCS4, and began product shipments to retailers in the December quarter. We expect to ramp BiCS4 in the second half of the calendar year. From a fab standpoint, as we had announced in December, we will begin our participation in Fab 6 starting with the second investment tranche. Fab 6 operations are expected to commence in the next few months with our initial bit output in the third calendar quarter of 2018.
From a flash industry perspective, we estimate bit growth in calendar 2017 was at the low end of the long-term range of 35% to 45% with Western Digital's growth somewhat higher than the industry, given our relative strength in 64-layer 3D flash. In calendar 2018, we estimate industry bit growth to be near the high-end of the long-term range due to improving manufacturing yields and continued transition to 3D flash with our growth consistent with the industry.
Before I conclude, let me note that the normalization in the flash markets is both expected and beneficial for the industry, creating new opportunities for flash. In fact, extended periods of supply constraints limit market adoption and the pace of innovation. We view this normalization as part of our business and it is our objective to leverage the strength and breadth of our portfolio to drive the best business outcomes in a variety of market conditions. In calendar 2018, we expect the Western Digital platform to strengthen further from the planned launches of several new products and solutions and I look forward to providing you further updates in the months ahead.
I will now turn the call over to Mark for the financial discussion.
Mark Long - CFO
Thank you, Mike and good afternoon everyone.
I am very pleased with our financial performance in the December quarter. Our team executed well across our broad array of markets as we capitalized on our diverse product portfolio, increased gross margins and achieved cost and expense targets. All of which resulted in significant earnings growth. We also finished the December quarter with a strong liquidity position as a result of our continued robust cash flow generation and we made progress on de-leveraging and improving our capital structure.
We had record revenue for the December quarter of $5.3 billion dollars, an increase of 9% year-over-year, 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 $2.6 billion dollars and Client Solutions was $1.3 billion dollars.
Our Data Center business continues to be fueled by Cloud-related storage demand. Our December quarter revenue for Data Center Devices and Solutions increased 3% year-over-year. We saw significant growth from capacity enterprise hard drives which was partially offset by an expected decline in performance enterprise hard drives. Client Devices revenue for the December quarter increased 9% year-over-year, primarily driven by significant growth in mobility, client SSDs and surveillance products. Client Solutions revenue for the December quarter, increased 17% year-over-year mostly as a result of the strength and reach of our valuable global retail brands.
Our non-GAAP gross margin was 43.2%, up 655 basis points year-over-year. This gross margin expansion resulted from a favorable supply/demand environment for flash based products, cost improvements, and a higher mix of flash based revenue.
With respect to operating expenses, our non-GAAP OPEX totaled $865 million dollars. This included on-going investments in product development, go-to-market capabilities, IT transformation projects and the first full quarter of operating expenses related to our recently acquired companies. As described in our December call, our operating expenses are higher than our October guidance driven entirely by the over-achievement on our 6-month variable compensation plan.
Our non-GAAP net interest and other expense for the December quarter was $180 million dollars, a year-over-year decrease of approximately 19%. This includes $197 million dollars of interest expense for the December quarter, a decrease of $8 million dollars year-over-year primarily from the repricing of our debt and the retirement of our EURO Term Loan B, partially offset by increases in Libor, which were approximately 70 basis points on a weighted average basis.
Let me explain the impact of the recent tax reform on Western Digital. We will benefit from the new tax law by having the ability to access our global cash in the U.S. in a highly efficient manner. As a result, we will have greater flexibility with respect to our overall capital allocation and investment decisions. In the December quarter, we booked a provisional net tax charge of $1.6 billion dollars, due primarily to the one time mandatory deemed repatriation tax, which is included only in our GAAP results. The payment of this repatriation tax will be spread over the next 8 years, which is expected to begin in fiscal 2019, with approximately 60% due in the last three years of the period. Beginning in fiscal 2019, we expect our non-GAAP effective tax rate to be at the high end or slightly above our long-term guidance of 7% to 12%.
In the December quarter our non-GAAP effective tax rate was 4%, which was lower than our expectations because the new tax legislation which resulted in a reduced U.S. corporate tax rate for the first half of fiscal 2018.
On a non-GAAP basis, net income in the December quarter was $1.2 billion dollars, or $3.95 per share. On a GAAP basis, we had a net loss of ($823) million dollars, or ($2.78) per share, driven by the one-time net charge related to tax reform. The GAAP net loss for the period also includes intangible amortization, charges related to integration activities, and stock based compensation. The net difference between our GAAP and non-GAAP results is primarily due to charges that have no cash impact within the quarter.
In the December quarter, we generated $1.2 billion dollars in operating cash flow, an increase of 12% year-over-year. We continued to reinvest in our business with $629 million dollars in capital investments, resulting in free cash flow of $553 million dollars. On a fiscal year to date basis, we generated $2.3 billion dollars in operating cash flow, an increase of 54% year-over-year. We deployed $915 million dollars on capital investments, resulting in year to date free cash flow of $1.4 billion dollars.
We paid the previously declared cash dividend totaling $148 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 $6.4 billion dollars, resulting in approximately $7.9 billion dollars of available liquidity, including our $1.5 billion dollars of undrawn revolver capacity. We repaid our EURO Term Loan B in full, and our net debt has decreased approximately $500 million dollars to $5.8 billion dollars at the end of the December quarter, mostly driven by cash flow generated by the business. We remain committed to the following capital allocation priorities:
- Organic and in-organic business investments,
- Optimizing our cost of capital and capital structure while enhancing our financial flexibility, and
- Delivering returns to our shareholders through our dividend and re-authorized share buyback program.
We achieved our planned cost and opex synergy targets from both the HGST and SanDisk integrations within the expected time frames. The combined savings of the programs have contributed to our strong financial results and validated our strategy for the acquisitions. While we have achieved our synergy targets as of the end of calendar 2017, we will continue to deliver cost and expense benefits from both of these transactions over the coming years.
I will now provide our guidance for the third quarter of fiscal 2018 on a non-GAAP basis.
- Revenue to be approximately $4.9 billion, consistent with a seasonally weaker fiscal third quarter
- Gross margin to be between 42% and 43%
- Operating expenses to be between $840 and $850 million dollars, which includes the annual payroll tax reset
- Interest and other expense to be between $180 and $185 million dollars
- An effective tax rate in the 5-7% range; and
- Our diluted shares to be approximately 309 million
- As a result, we expect non-GAAP earnings per share between $3.20 and $3.30
We believe our integrated product and technology platform is a key differentiator that will enable strong long-term growth, profitability and value creation through industry cycles. While we expect to see normal seasonality in the second half of fiscal 2018, we continue to see the opportunity to achieve revenue growth at the high end of our long-term model of 4% to 8% for fiscal 2018. Based on our current business outlook and capital structure we now expect our non-GAAP earnings per share will be between $13.50 and $14.00 for fiscal 2018.
For calendar 2018, we continue to expect revenue growth at the high end of our long-term model. We also expect that non-GAAP gross margin will be above the high end of our long-term model range of 33% to 38% throughout the year.
I will now turn the call over to the operator to begin the Q&A session. Operator?
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.