威騰電子 (WDC) 2018 Q2 法說會逐字稿

Good afternoon and thank you for standing by.

Welcome to Western Digital's Second Fiscal Quarter 2018 Conference Call.

(Operator Instructions) As a reminder, this call is being recorded.

Now I will turn the call over to Mr. Bob Blair.

You may begin.

Thank you, Latifa, 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 onetime 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.

(Operator Instructions)

I thank you in advance for your cooperation.

I also 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 tonight on the IR section of our website along with our quarterly fact sheet.

With that, I will now turn the call over to our Chief Executive Officer, Steve Milligan.

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 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 reacceleration 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 solution 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 NAND 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'm 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.

Thank you, Steve.

Good afternoon, everyone.

We are pleased that we've finished calendar 2017 with strong December quarter results.

Well -- we executed well across our business with continued strength in demand for our products and solutions.

As Steve indicated, we saw a year-over-year growth in each of our end market categories, reflecting the power of our platform and 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 increases in Client Solutions highlighted the continued preference for our G-Tech, SanDisk and WD brands during the 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 Datacenter Devices and Solutions, demand for our capacity enterprise drives remains strong.

Shipments of our 10-terabyte helium drives grew further and the transition to the 12-terabyte capacity point accelerated.

We also began shipments of our industry-leading 14-terabyte drives for hyperscale applications during the December quarter.

In terms of exabyte growth in capacity enterprise, as previously 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 in 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 calendar -- 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.

Data center 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 the midrange.

For Western Digital, the midrange part of the capacity enterprise market has been an area of lower exabyte share.

We have responded to the rising demand for 4-terabyte to 8-terabyte 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 midrange capacity drives to support a higher rate of exabyte consumption in calendar 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 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 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 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 outcome in a variety of market conditions.

In calendar 2018, we expect that -- 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.

Thank you, Mike, and good afternoon, everyone.

I'm 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 deleveraging and improving our capital structure.

We had record revenue for the December quarter of $5.3 billion, an increase of 9% year-over-year, driven by strong performance in each of our end markets.

Revenue in Datacenter Devices and Solutions was $1.4 billion, Client Devices was $2.6 billion, and Client Solutions was $1.3 billion.

Our Datacenter business continues to be fueled by cloud-related storage demand.

Our December quarter revenue for the Datacenter 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.

This included ongoing 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 overachievement on our 6-month variable compensation plan.

Our non-GAAP net interest and other expense for the December quarter was $180 million, a year-over-year decrease of approximately 19%.

This includes $197 million of interest expense for the December quarter, a decrease of $8 million 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 due primarily to the onetime 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 3 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 of 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 or $3.95 per share.

On a GAAP basis, we had a net loss of $823 million or $2.78 per share, driven by the onetime 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 in operating cash flow, an increase of 12% year-over-year.

We continued to reinvest in our business with $629 million in capital investments, resulting in free cash flow of $553 million.

On a fiscal year-to-date basis, we generated $2.3 billion in operating cash flow, an increase of 54% year-over-year.

We deployed $915 million on capital investments, resulting in year-to-date free cash flow of $1.4 billion.

We paid the previously declared cash dividend totaling $148 million during the quarter, and also declared a dividend in the amount of $0.50 per share.

We closed the quarter with cash, cash equivalents and available-for-sale securities totaling $6.4 billion, resulting in approximately $7.9 billion of available liquidity, including our $1.5 billion of undrawn revolver capacity.

We repaid our Euro Term Loan B in full, and our net debt has decreased approximately $500 million to $5.8 billion 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 inorganic business investments; deleveraging; optimizing our cost of capital and capital structure while enhancing our financial flexibility; and delivering returns for our shareholders through our dividend and reauthorized 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.

We expect 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 million and $850 million, which includes the annual payroll tax reset; interest and other expense to be between $180 million and $185 million; an effective tax rate in the 5% to 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 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?

(Operator Instructions) Our first question comes from Mehdi Hosseini of SIG.

One, I want to start off with a -- like a longer-term question.

In the past year, we were distracted by Toshiba.

Now that -- looking forward, I would like to revisit your longer-term message that you presented at Analyst Day December of '16.

It's been a while.

How should we think about those longer-term growth and longer-term objectives beyond the next few quarters?

Is there any change to the strategy?

And how do you see the company evolving over the next few years, especially in the context of updating us since you've been kind of absent over the past year or so?

Yes.

So Mehdi, I would say that there's essentially been no fundamental change to our long-term strategy since we had our Analyst Day.

And growth rates from an industry perspective, from our perspective remain consistent.

We constantly think about how the market is evolving and changes and re-look at our strategy.

But I would say that right now, there's no real fundamental changes.

One of the things that we are contemplating is, does it make sense to have an Investor Day coming up here in the fall?

We haven't made a formal decision on that, but we will certainly, from an internal perspective, be refreshing our view on everything and providing appropriate updates to our investor base.

But as a general statement, there's been no fundamental or big change to either our strategy or the fundamentals as we saw them at our Investor Day.

Sure.

But when I look at your segment information, especially for the December quarter, your Client Devices, on a Q-over-Q basis, was, to me, was a little bit below expectation.

It was down 1%.

And your Datacenter, yes, I understand you may have been constrained by NAND shortage.

But it doesn't show the kind of scaling that I thought it would happen maybe 18 months after acquisition of SanDisk, and this is why I was asking for an update.

So is there -- with the Toshiba overhang distraction, had an impact?

If not, how come we're not seeing the kind of outperformance that should have happened by now?

Well, I'm not quite sure what numbers you're referring to.

So I think we should probably take that offline and maybe dive into it a little bit.

But fundamentally, I think that we're pleased.

As Mike indicated, I'll comment on 2 things.

One, if you want to call it being a slight negative in that versus expectations that we had capacity enterprise last year grew a little bit less than what we had anticipated, that's a short-term statement.

We talked about the reacceleration that we're seeing here in the first half and through calendar 2018.

So I would say that our Datacenter and devices business kind of grew a little bit less than what we would expect longer-term.

On the positive side, Client Solutions, which is a market segment that we had expected to kind of modestly decline over a period of time, actually saw extraordinary growth, really speaking to the strength of our market position, the strength of our products, our brands, et cetera.

So there's always going to be puts and takes within a particular segment.

But on balance, I have to say that I'm very pleased with the way that the last 12 years -- there is no Toshiba overhang from an execution perspective.

And as I said, I'm extremely proud of what our people have accomplished both from an operating and from a financial perspective.

Our next question comes from Aaron Rakers with Wells Fargo.

If I can, one quick housekeeping question, I'm just -- and then one other question.

Can you just talk a little bit about where you stand today as far as debt to adjusted EBITDA?

And how that relates to your capital return strategy?

And then the question is -- and I'm just curious if you could address the enterprise SSD market.

I didn't hear a lot about that during the script of the call.

I'm just curious of how you would characterize your performance there, and if there's anything that we should think about going forward that might change the trajectory of that business.

Yes.

Let me take the enterprise SSD question first.

So I think as we've stated, our product portfolio sort of execution and expansion would happen in 2018 largely and also towards the mid- to second half of '18.

So we are continuing to hold serve, if you will, but we have more to do at the product of level that we expect will become more meaningful as the year progresses for the midpart of the year, summer and beyond.

With respect to our debt-to-EBITDA, in terms of the way our EBITDA is calculated under our debt instruments, we are now below 2x debt-to-EBITDA.

So we are in a very good position.

We have achieved a level that gives us strong flexibility in terms of what we want to do from a capital allocation standpoint.

And we will be evaluating our priorities and kind of executing accordingly over time.

Our next question comes from Amit Daryanani of RBC Capital Markets.

I guess, I have a question and a follow-up as well.

Maybe we'll start on the flash side.

I think you guys mentioned industry and your bit growth would be at the high end of this 35% to 45% range.

That seems fairly in line with, I think, a lot of your peers are saying.

I'm just wondering, though, how do you think of cost per bit decline trajectory as you go through that high end of that range, if you may?

And if you do have normalization, as you characterize it, in the flash market in '18, what do you think that does to your gross margin structure?

Does that -- is normalization a stable driver, an upside driver or a downside driver to your gross margins?

Yes.

So we've talked about in this new 3D regime, the sort of way to think about annualized cost reduction is approximately 20% per year.

I think in our previous call, we talked about our view of the environment is such that ASP declines, which we are seeing some of, are largely offset by cost declines.

We see that happening in the current period and we expect that to happen going forward.

Right.

And as I indicated in my guidance for the calendar year, as a result, that's what gives us confidence that we will operate above our total gross margin model of 33% to 38% for the entire year.

Got it.

And if I could just follow-up.

Mark, OpEx for March quarter, slightly higher than, I think, what most of us were modeling.

I'm just wondering, how much is the payroll tax reset driving that in the March quarter?

And then just broadly, how do I think about OpEx through calendar '18 for you guys as a range?

Good question.

So the reset for payroll tax is something in the order of $15 million or $17 million.

And as a result, you can think about a -- I think, what we had talked about in terms of an $830 million kind of baseline quarterly run rate that we expect to decline.

And we have a number of activities ongoing to enhance efficiency so that, that will decline on a quarterly basis throughout the year.

Our next question comes from Wamsi Mohan of Bank of America Merrill Lynch.

Steve, I must wondering, you spoke about this pretty strong global economic backdrop, the datacenter buildouts.

Obviously, you're guiding on both high-capacity drives as well as NAND on the upside of these ranges.

On the NAND side, the 35% to 45% range that you have for bit growth, how much of that is based on this improving economic backdrop?

Or are you building in any elasticity of demand once you see this price normalization?

And I have a follow-up.

Well, I'll answer the question this way.

We have been saying and anticipating that the industry is going to grow at that high end of that 35% to 45% range for a while.

And so it really is more of a longer-term statement as opposed to something that has changed over the last 3 to 6 months because of macroeconomic environment or something like that.

And so it takes a while to invest in these things, long-term plans.

And so we've seen the investment levels be pretty consistent of the growth levels.

The one thing that we have seen recently that is an interesting dynamic is some companies that, one, are in the DRAM market as well as the NAND market and then have the flexibility to convert 2D NAND to DRAM, they appear to be doing that more so.

So relative to that 35% to 45% or at that high end, there appears to be a little bit more of a downside bias to that as opposed to -- that it would exceed that.

So we're beginning to see that kind of come down a bit, which is obviously good from a NAND perspective.

And the other thing I'll comment on as we look at the demand side of the equation, sort of expected capacity upgrades as we progress through the year and how they translate through the demand cycle for NAND, we think that those numbers, not only are we in sort of a constructive period as we see the year, we have the possibility of getting into a more constrained environment in the second half of the year.

I appreciate that color.

And if I could quickly follow up.

You spoke about this hyperscaler pick up.

Any color geographically where you're seeing the most activity in the first half of 2018?

And what is the average capacity of the drives of these hyperscalers?

Yes.

So I think we're seeing strong demand domestically as well as certainly in China.

That would be the ones that would stick out to us.

And if you look at capacity points, as a general statement, the domestic, relative to us here in the U.S., they tend to take the highest cap drives.

In China, they don't always necessarily take the highest cap drives.

That then speaks to this area where we had a bit of a hole in our product portfolio in terms of 4 to 8 terabyte in Air products, which we recently introduced in Air cost competitive products that will help to better address that portion of the market at least vis-à-vis our product portfolio.

Our next question comes from Ananda Baruah of Loop Capital.

Just 1 or 2 around gross margin, SSD gross margin, if I could.

Just to clarify.

I believe the comment around gross -- SSD gross margin in December was that you guys could hold them flattish.

And in flattish, I might be paraphrasing, but I think that was the spirit of it.

Does that still hold?

I just want to check that.

And then what are you guys anticipating for NAND ASP declines through this year?

And I have a quick follow-up on gross margin there.

Well, as you can see, our guidance for the quarter for total gross margin is 42% to 43%.

So we're looking at very small changes in gross margin.

And I think it's -- we are seeing, as Mike pointed out, some normalization in the flash market, but it's mostly offset, from an ASP decline standpoint, by the cost declines.

And as a result, our gross margins are healthy.

Or relatively stable.

Yes, and relatively stable.

I apologize, I was actually referring to the calendar year '18 guide.

Yes.

So what we're seeing, I think, in December what we talked about was being in a position where we would maintain total gross margins above the long-term range that we talked about, and that's certainly the case.

With respect to the trajectory of flash gross margins, I think the latest commentary that you heard from Mike suggests that, again, while we may have some declines in gross margin -- remember, some of the declines in our total gross margin are also going to be a function of the seasonally weaker first half of the calendar year.

And then in terms of the visibility into the back half, as Mike pointed out, the gross margin trajectory will be a function of, on the flash side, how much this tightness in the market materializes.

So at this point, we continue to feel that it is a constructive market.

And as Mike pointed out, there is this potential for tightening, which would certainly have a positive effect on gross margin.

And what's your sort of base case expectation for NAND ASP declines for calendar '18?

We haven't disclosed that.

The only thing we've said around that is our expectation would be that the ASP declines would be largely offset by our cost declines.

So that gives you an idea.

Yes, with cost declines being in the 20% range.

20% range, right.

Right.

Okay.

Is there any reason to think it would be tremendously different from past cycles, ASP declines?

Well, I think if you look at it, that part of what we're saying is that, yes, it will be different than past cycles in a positive way.

And we've tried to talk to it and explain it as best to our ability.

But it's a bigger market, so the incremental impact of capacity additions.

I think that you're seeing also this -- some degree, this conversion from 2D NAND into DRAM that's moderating.

And I think you're just seeing a more rational set of behaviors economically focused that is resulting in still some volatility but not the same level of volatility that's been seen in the past.

And the maturity of the end markets.

So the secular trends for demand remain strong.

And I think as Mike highlighted, some normalization of the NAND market is actually very healthy because it will open new markets, and it will increase demand in those mature markets to the extent those are price sensitive.

So we feel that calendar 2018 is a very constructive period and it's -- as Steve was highlighting, there are dynamics both on the supply side and on the demand side that you can't just go and apply the patterns from previous cycles and think you're going to really get to the right outcome for this period.

Our next question comes from Stanley Kovler of Citi Research.

I just wanted to clarify some of the trends in the nearline market.

So how should we think about the impact of mix?

You talked about selling more midrange drives versus high end.

And as we think about the entire nearline revenue line within your HDD mix, especially going into the first half of the year, can you remind us the levers there on gross margin between overall HDD volumes for you guys versus mix?

The nearline shipments are 60% there.

And I have a follow-up.

Yes.

So I think the thing to think about is it's a more diverse market now.

So we're -- certainly, we have been focusing our strategy at the highest capacity drive, which remains a robust part of the market.

We're now seeing demand across a range of capacities.

So from a unit volume perspective, that helps, right?

The way to think about leverage through our model, though, is ultimately about our component utilization.

So when you think about it, most of our CapEx on the drive side is tied up in heads and media manufacturing.

And whether we configure those as 12 or 14 terabytes or 8, the combination of those to get to the expected exabyte growth rate remains fairly common.

So your modeling just ought to contemplate a different unit volume scenario than just the sort of historical skew to the high cap.

Got it.

So when I think about the volume impact there versus the overall portfolio coming down, can you help me understand how the mix shift is going to improve overall ASPs as well?

So we do expect overall ASPs to benefit from a mix standpoint on the HDD side.

And as a result, we have the -- we'll have some volume declines from a seasonal standpoint in parts of the business.

We do -- we see relatively stable gross margins.

If I can ask a separate follow-up more related to cash.

You authorized or, I should I say, reauthorized the buyback program, back in November.

And if I look at the outlook for the share count, it looks about flattish with the current quarter.

What are you contemplating in terms of share repurchases there?

Yes.

We have not made any public statements about our repurchase plans at this point.

Any sense of timing on that to provide an update or use of cash?

I think we've already indicated our priorities.

I mean -- and I don't want to go through what was already read.

But first thing is reinvest back in our business, optimize our capital structure, deleverage; and repurchases is on that list.

And it will be contemplated within a broader set of capital allocation considerations as we look to drive longer-term value creation.

Our next question comes from Rob Cihra of Guggenheim.

A clarification and one question, if that's all right.

Just the clarification, just in your slides, you briefly mentioned -- I don't know if there's no more development or pulling back development on performance drives.

And so is that like stopping development on 10k?

And does that mean they go end of life or do they go end of life at one point or is it just pulling back?

I just was wondering if you could give a little more info there.

Rob, yes, let me be very clear.

We have ceased development on 10 and 15k RPM hard drives.

So our products in the market are the last of our products, and we will obviously manage them through a long tail.

But we don't intend to introduce new products.

Can you tell us what that tail might be?

I mean, is this a tail of months or years?

No, it's a long tail, years.

Okay.

All right.

And then quickly, if I could ask the actual question.

There's just been a decent amount of debate, frankly, for several months now in terms of how much the tightness in NAND has helped the drive market.

And given you obviously sell both, can you tell us if you think there's been a meaningful help for drives or less cannibalization than there would have otherwise been because of NAND tightness?

Or do you really think it's had that much impact, obviously, looking back and then looking forward, if you think that's about to change at all?

Yes.

So there's only one real area that, that has had an effect and it's really in mobile, so 2.5-inch disk drives.

And we would say it had a modest positive effect on the size of the HDD market looking in the rearview mirror.

So our penetration rate, if you will, of flash to HDD is running behind our original expectations.

What we see happening this year is more normalizing of that trend.

In other words, the penetration of SSD in notebook-based configurations will accelerate, which we are agnostic to positive.

Our next question comes from Karl Ackerman of Cowen and Company.

I actually wanted to focus on your progress and strategy of your systems business, particularly now that you have had some time to integrate Tegile in your operations.

In addition to your JV with Unis over a year ago now that strengthens your opportunity to go after Asia hyperscale players who actually have a large contribution to the increasing global hyperscale CapEx.

So could you elaborate on what you have done so far to integrate those businesses?

And whether or not you actually have all the pieces in your portfolio you'd like to target this area of the storage market?

And I have a quick follow-up, please.

Sure.

Yes, so I think the recent acquisition of Tegile was a positive step forward across all markets, but particular to your question on China because the adoption of object storage in China is lagging slightly.

So the ability to have a file front-end and be able to lead with a product that's more mature in the market is advantageous to our participation in the China market.

So I think from an overall portfolio standpoint, we're encouraged by the addition of the products that came through the Tegile acquisition.

We continue to make steady progress.

Although we don't talk specifically about the growth rate and size and that, it is growing sequentially and we're making good progress.

And I think we're happy with the results, particularly in the last couple of quarters as we've added the addition of these file all-flash array products to our portfolio.

Great.

As a follow-up, I would appreciate if you could elaborate on how much of your cost-savings assumption in your NAND business this year includes the qualification of your internal NAND supply in your own enterprise SSD business?

That's an easy question.

I'll take it.

The answer is none.

So when we did the SanDisk acquisition, we talked about this vertical integration opportunity.

And we actually decided, especially when the markets went into a constrained position, that extending out our relationship with Intel would give us access to more bits.

And that has worked well for us and we've got some product introductions that are going well with Intel.

So from a business standpoint, not having our own NAND in all of our enterprise SSDs -- we have it in some, but not all -- that's actually yielding a better long-term economic outcome than had we replaced all the Intel products immediately.

Right.

And I'll just add to that.

Certainly it's a testament to the way that relationship is going, the quality of those products in the marketplace and what we think we can do with them, also allowing us to focus our product R&D on other things.

So there's a number of benefits in this choice that's advantaging us through calendar 2018.

Right.

And the good news is, as I indicated, we do still have the 2020 targets for the SanDisk transaction that will include significant benefits from vertical integration.

So intersecting with our own product line that has our own NAND by that time period.

Our next question comes from Vijay Rakesh of Mizuho.

Just looking at the hard disk drive side.

I saw you guys mention this, starting the ramp of 12- and 14-terabyte drives.

I assume they are small now.

Just wondering what the mix would be as you exit 2018 with 12 and 14 terabyte?

Yes.

We would expect, as we exit calendar 2018 on the high cap range, it will be the majority of our mix.

But I did mention -- 12 and 14, yes.

12 and 14 together.

And -- but I did mention what we do expect is this more diverse market as we pursue continued growth.

So we will see a continued and steady mix up at the highest end of our portfolio.

But given different use cases and workloads, both technologically but also geographically, we do think we'll see a longer tail of shipments at the lower capacities as we referenced in this announcement of these midrange products that we announced a week or so ago.

Got it.

And on the NAND side, I saw BiCS3.

I assume that 64 layer was almost 70%-plus of shipments now.

So as you go through 2018, what are the puts and takes on the NAND gross margin?

Where can you drive costs down?

I guess, 96 layer is more later in the year.

But just wondering, as you go through the year where would the puts and takes on the gross -- NAND margins?

Well, so 2 things.

One is continued yield and productivity on the existing ramps and throughput, which is ongoing on -- that's a BiCS3 statement.

And then, of course, as we move to the new node in the second half of the year, that gives us additional opportunity.

All right.

So 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.

This concludes today's conference call.

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