Western Digital Corp

NASDAQ:WDC

Earnings Call Transcript 2018-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the Western Digital Corp. Third Quarter Fiscal 2018 Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded.

I would now like to introduce Mr. Jay Iyer in Investor Relations. Please go ahead, sir.

[Jay Iyer, Western Digital Corp.]

Thank you, Andrew, 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 our growth opportunities, our financial and business strategies, demand and market trends, our product platform, product and technology development efforts, joint ventures with Toshiba, and our expected capital allocation plans.

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 on our Annual Report on Form 10-Q filed with the SEC on February 6, 2018. 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 April 26, 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 reconciled fully 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 measure is not available without unreasonable effort.

In the Q&A part of today's call, we ask you that you limit yourself to one question to allow as many callers as possible to ask a question. Thank you in advance for your cooperation.

As also a quick reminder, we are also providing a concurrent presentation on this webcast and a copy of the slides and our prepared remarks will be available later today on the IR section of our website, including with our Quarterly Fact Sheet.

With that, I will now turn the call over to our CEO, Steve Milligan.

[Stephen D. Milligan, Western Digital Corp.]

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 results and wrap up with our fourth quarter guidance. We will then take your questions.

We reported strong financial performance in the March quarter with revenue of $5 billion, non-GAAP gross margin of 43%, and non-GAAP earnings per share of $3.63. Our operating cash flow reflected solid execution supported by healthy demand for our products, particularly high capacity enterprise drives, which achieved record quarterly revenue.

Macroeconomic conditions remained supportive in the quarter with Cloud Computing and Mobility serving as primary demand drivers. The positive third quarter dynamics included continued strong demand for our NAND flash products. Our results in the March quarter demonstrate the power and agility of our platform and a sustained focus on operational execution by our global team.

We continue to pursue a long-term value creation strategy underpinned by secular growth in Big Data and Fast Data applications. Rapid advancements in Artificial Intelligence, Machine Learning, and IoT applications are fueling creation of valuable data at an unprecedented pace.

The number of connected devices worldwide is expected to grow from 9 billion today to upwards of 75 billion by 2025. This exponential growth will require robust storage infrastructures and purpose-built solutions that allow users to capture, preserve, access, and transform an ever-increasing diversity of data. The Western Digital platform is strategically positioned to play a key role in supporting these long-term growth trends.

Enterprise and hyperscale cloud customers continue to accelerate their CapEx spending to keep pace with the rapid growth in data, and this represents a significant opportunity for our data center storage solutions. In the Mobile market, we are well positioned to capture growth opportunities with our comprehensive product portfolio. We expect increasing average capacity in smartphones to be a continued driver of growth for Western Digital.

In a moment, Mike will provide some color on our strong ongoing performance in these categories and update you on what we are seeing in terms of long-term exabyte growth. He will also discuss progress towards delivering high capacity enterprise drives based on our innovative MAMR technology.

In Flash, during the third quarter, we saw the market environment continue to normalize with expected price declines. We continue to deploy our 64-layer 3D NAND technology across our product portfolio and will be ramping our 96-Layer technology as planned throughout calendar 2018.

I am pleased to report that our joint venture operations with Toshiba Memory Corporation continued to perform exceptionally well, and our plans for continued joint investment in Fab 6 in Iwate remain on track. In March, we celebrated the opening of our shared memory development center in Yokkaichi, strengthening the ongoing collaboration among our engineers.

I am excited about the future of Western Digital. The power of our platform allows us to deliver sustainable long-term revenue growth, healthy gross margins, and industry-leading profitability. As markets evolve and grow, our ability to optimize product and portfolio mix towards higher-value opportunities will continue to be an important lever for managing the business. I would like to sincerely thank the Western Digital team and our partners for their ongoing support.

With that, I will now ask Mike to share our business highlights.

[Michael D. Cordano, Western Digital Corp.]

Thank you, Steve, and good afternoon, everyone. The Western Digital platform performed well during the March quarter. Demand trends in the Cloud Data Center, Embedded Mobile and PC markets were positive, leading to strong pull for our Hard Drive and Flash products.

Operational execution was solid, and our responsive supply chain capabilities allowed us to optimize resource allocation and product mix. We shipped a record industry-leading 100 exabytes of total storage as we optimized our output during a period of strong demand for our products.

Flash market conditions were as expected, which we have previously described as normalizing. We expect the Flash market to continue to be constructive with the possibility of a constrained supply environment in the second half of calendar 2018.

In Datacenter Devices and Solutions, demand for our 10 terabyte and higher capacity enterprise drives for cloud customers grew substantially, both on a year-over-year and sequential basis. Our exabyte shipments for this category more than doubled on a year-over-year basis. Just a few days ago, we launched our fifth-generation helium drive at the 14 terabyte capacity point. Customer qualification activities for this new product have begun, and we expect commercial ramp to begin later this year. Additionally, we have begun meaningful revenue shipments of our midrange capacity air-based drives launched earlier in the calendar year.

We now estimate that on a year-over-year basis in the first half of calendar 2018, the capacity enterprise market is expected to grow at least 75%, well above our prior estimate of 60%-plus. We are also increasing our previous estimate for exabyte growth for the full calendar 2018 of greater than 50% to more than 65%. Our long-term exabyte growth estimate of 40% remains unchanged.

In enterprise SSDs, our Ultrastar SN200 has been qualified and is ramping at leading Tier 1 customers. This NVMe product delivers best-in-class performance metrics for a variety of workloads.

From a hard drive technology standpoint, we are on track to begin sampling our groundbreaking MAMR Recording Technology in the second half of calendar 2018 with a meaningful production ramp expected in calendar 2019.

Switching to Client Devices, we experienced strong demand for our mobile, embedded, and compute products. Sales of our 64-Layer 3D flash-based iNAND offerings expanded during the quarter. The design win funnel for our iNAND solutions for the connected home, automotive and industrial verticals deepened, further strengthening our position to capture long-term revenue opportunities in these sectors. Our comprehensive Flash storage solutions portfolio for the mobile embedded market covers a full range of eMMC, UFS and proprietary interfaces for a diverse customer base. With average capacity in smartphones estimated to double every two years to three years, we see continued long-term growth opportunities for our mobility business.

From a PC market standpoint, the March quarter was slightly better than expected. We announced our first client SSDs based on new internal controller and firmware technologies. We also announced a differentiated high-performance WD Black SSD for serious gamers, leveraging the same architecture. The expansion of our product portfolio highlights the successful execution of our accelerated R&D investments.

In the Client Solutions category, strong consumer preference for our G-Tech, SanDisk and WD brands delivered healthy year-over-year revenue growth for both our drive and Flash-based products in a seasonally slow March quarter. Our offerings for this market continue to garner accolades. In our Flash joint ventures, Fab 6 operations have commenced and we expect initial output in the third calendar quarter of 2018 as indicated.

The ramp of our BiCS3, our 64-layer 3D flash technology, progressed further, and manufacturing yields approached mature levels. In particular, BiCS3 yields are also approaching levels achieved by our 2D flash technology. This is a very significant milestone that demonstrates our leadership in Flash technology development and manufacturing. For calendar 2018, we expect BiCS3 to constitute more than 70% of total bit supply and the manufacturing ramp of 96-Layer 3D Flash has commenced, with meaningful output expected in the third calendar quarter.

Western Digital's estimate for industry bit growth in calendar 2018 remains unchanged at the high end of our long-term range of 35% to 45%, with our bit supply growth consistent with the industry. Publicly stated estimates of bit growth rates from industry participants as well as market analysts appear to have converged into the 40% to 45% range. The expectations for calendar 2018 bit growth rates reflect the complexities of 3D Flash technology conversion along with some companies utilizing their flexibility to convert 2D NAND capacity to DRAM.

In summary, our strong March quarter results reflect the flexibility of our model to allocate resources and supply to deliver the optimal mix of product. With our unique portfolio, we are able to capitalize on fundamental drivers of data growth and the increasing value of data as evidenced by the record-setting exabyte shipments. With further expansion of our product portfolio in calendar 2018 and beyond, we continue to believe that the Western Digital platform is positioned to deliver the best financial and strategic outcomes in a variety of market conditions.

I will now turn the call over to Mark for the financial overview.

[Mark P. Long, Western Digital Corp.]

Thank you, Mike, and good afternoon, everyone. I'm very pleased with our financial performance in the March quarter. We executed well across our broad array of markets as we capitalized on the power of our platform, increased gross margins, achieved expense targets and reduced interest expense, all of which resulted in significant earnings growth. We also finished the March quarter with a strong liquidity position as a result of improving our capital structure and continued strong cash flow generation.

Revenue for the March quarter was $5 billion, an increase of 8% on a year-over-year basis. The March quarter revenue for Datacenter Devices and Solutions was $1.7 billion, an increase of 25% year-over-year. Our Data Center business continues to be driven by growth in cloud-related storage. As Mike stated earlier, this was led by strong demand for capacity enterprise hard drives. Client Devices revenue was $2.3 billion, which was essentially flat year-over-year. We had significant growth in Mobile and Embedded products, offset by client compute devices. Client Solutions revenue was $1 billion, an increase of 4% year-over-year, driven by strength in our hard drive and Flash retail products.

Non-GAAP gross margins was 43.4%, up 410 basis points year-over-year and up 20 basis points from the prior quarter driven by significant growth in our capacity enterprise products along with a higher mix of Flash revenue.

With respect to operating expenses, our non-GAAP OpEx totaled $850 million. This included ongoing investments in product development, go-to-market capabilities, IT transformation projects and short-term incentive compensation. Our non-GAAP net interest and other expenses for the March quarter was $137 million, a year-over-year decrease of approximately 33%. This includes $157 million of interest expense for the March quarter, a decrease of $48 million year-over-year primarily due to the recent financing transactions which lowered the effective interest rate on our debt. In the March quarter, our non-GAAP effective tax rate was 6%.

On a non-GAAP basis, net income was $1.1 billion or $3.63 per share, an increase of 52% year-over-year. In the March quarter, we generated $1 billion of operating cash flow, an increase of 3% year-over-year. As part of our recent financing transactions, we paid approximately $190 million of interest expense in the third quarter that was originally scheduled for the fourth quarter. We continued to reinvest in our business with $411 million in capital investments, resulting in free cash flow of $616 million for the March quarter.

On a fiscal year-to-date basis, we generated $3.3 billion in operating cash flow, an increase of 34%. We deployed $1.3 billion on capital investments, resulting in year-to-date free cash flow of $2 billion. In the third quarter, we had an increase in inventory primarily due to seasonality and ongoing hard drive manufacturing transformation activities. 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 bought $155 million worth of shares as part of our buyback program.

We closed the quarter with cash, cash equivalents and available for sale securities totaling approximately $5.1 billion. In addition, we have $1.75 billion remaining out of our $2.25 billion of total revolver capacity. As a result, we ended the quarter with approximately $6.8 billion of available liquidity. Recent capital restructuring activities decreased total debt principal outstanding by $825 million during the quarter to approximately $11.4 billion.

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 to our shareholders through our dividend and share buyback program.

I will now provide our guidance for the fourth quarter of fiscal 2018 on a non-GAAP basis. We expect revenue of $5 billion to $5.1 billion, gross margin of 41% to 42%, operating expenses between $840 million and $850 million, interest and other expense of approximately $100 million, an effective tax rate in the 5% to 7% range, and diluted shares of approximately 309 million. As a result, we expect non-GAAP earnings per share of $3.40 to $3.50.

I would like to point out that, based on our current outlook, we remain on track to meet or exceed our prior expectations for revenue growth and non-GAAP EPS for fiscal 2018. For calendar 2018, we continue to expect revenue growth at the high end of our long-term model. Previously, we had indicated that our quarterly non-GAAP gross margin for calendar 2018 would be above the high end of our long-term model of 33% to 38%. We now expect that non-GAAP gross margin will be at least 40% for each of the remaining calendar quarters of 2018.

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

[Operator]

Thank you. And our first question comes from the line of Mark Moskowitz with Barclays. Your line is now open.

[Mark Moskowitz, Barclays Capital, Inc.]

Yes. Thank you. Good afternoon. I wonder if you can give us a little more context around the Data Center strength; very nice number there. But just in terms of contribution to growth, how much came from disk drive revenue versus Solid State Drive revenue?

[Stephen D. Milligan, Western Digital Corp.]

Mark, the majority of it was high-capacity drives, so enterprise hard drive activity; hyperscale build-out as we indicated.

[Mark Moskowitz, Barclays Capital, Inc.]

Okay. And then, just as a follow up, with respect to solid state, is the composite revenue of solid state, is that improving versus the last few quarters where it kind of seems like it was kind of going sideways or maybe even down on a year-over-year basis?

[Stephen D. Milligan, Western Digital Corp.]

Are you talking about a particular part of the market or just in total?

[Mark Moskowitz, Barclays Capital, Inc.]

Just in total. Thank you.

[Stephen D. Milligan, Western Digital Corp.]

Yeah, Mark. I don't know if we can comment. I mean, I know it was down seasonally, but that's consistent with seasonal revenue trends. But we haven't provided specific breakout in terms of Flash-based memory or Flash-based revenue versus hard drives. But we are seeing good momentum in terms of our Flash-based products. And so, things are in good shape in that regard.

[Mark Moskowitz, Barclays Capital, Inc.]

Okay. And then just one last question for Mark. Just given the ability now or the flex in the model with the refinancing recently to buy back stock, how should investors think about the runway for stock buyback over the next year or so? Thank you.

[Mark P. Long, Western Digital Corp.]

Well, in terms of the buyback, as you remember, we executed $155 million of the $500 million that we had announced, and we did that to take out the hedging shares as part of the convertible bond issuance. And the additional $350 million approximately we intend to execute on an opportunistic basis, and this is part of the broader $2.1 billion worth of authorized buyback that we had reinstituted following the closing of the SanDisk transaction.

[Stephen D. Milligan, Western Digital Corp.]

Thank you, Mark.

[Operator]

Thank you. And our next question comes from the line of Aaron Rakers with Wells Fargo. Your line is now open.

[Aaron Rakers, Wells Fargo Securities LLC]

Yeah, thanks for taking the questions, and also congratulations on the quarter. I'm curious on the gross margin kind of trajectory of the business. You guys now are talking about a 40%-plus gross margin. So the first question on that is, should we think about that as potentially raising the long-term sustainable target gross margin range? And then as we think about the mix of the business, particularly around the hard disk drive business, are you now seeing a gross margin in HDDs that is solidly above what the historical range had been? I think was past 27% to kind of 32% range.

[Stephen D. Milligan, Western Digital Corp.]

Yeah, so, Aaron, this is Steve. I'll take both questions. In terms of our long-term margin range, we continue to have the long-term margin range of 33% to 38%. Of course, we will continue to look and evaluate whether or not that margin range should change, based upon our experience and what we see from a go-forward perspective; but for the time being, we're sticking with the 33% to 38%.

If you look at our hard drive margins – and obviously we don't disclose our Flash-based margins or our hard drive margins, but if you look – just to give a little bit of color, our hard drive margins for several quarters have been very, very stable. And without disclosing the specific number, if you look at this past quarter, driven almost entirely by mix. We actually saw a nice pickup in our hard drive margins and that was due to the strong demand that we saw from a capacity enterprise perspective. Obviously we'd like to see that continue, but we'll have other mix dynamics that will affect our business going forward. But very strong margins in the hard drive space this past quarter.

[Mark P. Long, Western Digital Corp.]

And we'll be providing kind of more insights into the long-term model at our Investor Day that we indicated would be in the back half of this year.

[Aaron Rakers, Wells Fargo Securities LLC]

And real quickly...

[Stephen D. Milligan, Western Digital Corp.]

Yeah, go ahead, Aaron. But one of the things I wanted to add is that – because I think this is a really important point – is that this past quarter, in my opinion, really is a very strong proof point as to why we thought that it made sense to put these two businesses together.

What we've got is, we've got a portfolio of businesses – or of products that allows us to play across various markets. And you see that you've got very strong margins in terms of the hard drive market. We've got a normalizing Flash market, which means that we're seeing a little bit of normalization in terms of our margin rate there. But when you add that up all together, our margins went up on a quarter-on-quarter basis. I think that's pretty impressive.

[Aaron Rakers, Wells Fargo Securities LLC]

Yeah, I agree. Just to follow on that though is, I mean, as we look forward – and you've consistently said, normalizing. Do we take normalizing as being a view that the company can sustain kind of the implied Flash gross margin? And just remind us on where you stand on the cost downside. I think you'd referenced that last quarter, but I didn't hear that this quarter of where you think you can execute cost down on Flash.

[Stephen D. Milligan, Western Digital Corp.]

Yeah, well, I'll talk a little about normalizing. And my first comment, it'll sound like a little bit of a wise aleck comment, but normalizing means normalizing. And what I mean by that is obviously we were in a allocated environment with rising ASPs and that sort of thing, and when we're looking at a normalizing environment that means that we're going to more normal, more consistent ASP declines like we've seen historically in a controlled environment.

So, you're basically seeing even the margin percentage drift down a bit, but in a very measured way. And so, we're seeing a bit of that. We're not alarmed by it. It's still a great environment for us. And so that's really what we mean by normalizing. But as you can see, in terms of what Mark said in terms of our calendar 2018 margins, we're still going to have margins greater than 40 percentage based upon our current forecast, and so that's a pretty good gross margin for us. And so that's a little bit of color on normalizing. And then I'll ask Mike to comment on the cost declines in the Flash area.

[Michael D. Cordano, Western Digital Corp.]

Yeah. So, Aaron, we've talked about, in the 3D era, if you think about on annualized basis, it's between 15% and 25%, and that depends on exactly where the nodal transition is and where we are with sort of capital and footprint build-out. So that's what you should expect, and we remain confident with that. We expect that to happen throughout this year. And a little more color to Steve's normalizing and to add where I commented last quarter, our ASP reductions are largely offset by cost reductions, which does not mean, entirely offset.

[Mark P. Long, Western Digital Corp.]

And another factor I think we should just keep in mind is that we get some margin pressure as the MCP revenue increases, which it's doing.

[Aaron Rakers, Wells Fargo Securities LLC]

Thank you very much.

[Stephen D. Milligan, Western Digital Corp.]

Thanks, Aaron.

[Operator]

Thank you. And our next question comes from the line of Amit Daryanani with RBC Capital Markets. Your line is now open.

[Amit Daryanani, RBC Capital Markets LLC]

Thank you. I have two questions as well, guys. I guess maybe first one, your June quarter guidance is essentially implying gross margin is going to be down almost 200 basis points on slightly higher revenues on a sequential basis. Just maybe help us understand. I think you were fairly positive on the HDD commentary there. What's driving the downtick in gross margin by 200 basis points while revenues are very stable on a sequential basis?

[Mark P. Long, Western Digital Corp.]

Yeah, it's really two factors. It's the continued normalization of Flash that Steve referred to, and it's product mix, which is higher gaming revenue for HDD and as I was alluding to, higher MCP revenue.

[Amit Daryanani, RBC Capital Markets LLC]

Got it. Perfect. And then I guess, Mike, you mentioned potential constraints in the back half of 2018 on the NAND side. I'm wondering, is that a Western Digital comment or is that an industry comment, given I think the 96-Layer transition may be more complicated for everyone? And in that scenario, if it is somewhat constrained, how do you think ASPs will track on the NAND side for June versus the back half of the year if that scenario plays out?

[Michael D. Cordano, Western Digital Corp.]

Yeah. So I think the way to think about it is, you got to look at the individual market sectors and how they play and the products in those markets. So, it will sort of play by that. And really what we see is this progression and the challenges at an industry level of making the progression to 64-Layer and then 96-Layer. That's all more difficult than was previously predicted such that the bit growth rate, as you've seen over time, has been at industry level being – sort of moving in a shrinking direction. So, it's those factors combined with what we expect to be strong seasonal demand in the second half of the year that let's that possibility be in play. And I won't comment specifically on ASPs in that environment.

[Stephen D. Milligan, Western Digital Corp.]

But, obviously, that statement that we could be in a more constrained environment is reflective in the gross margin indication that Mark gave for the balance of the calendar year.

[Amit Daryanani, RBC Capital Markets LLC]

Understood. Thank you. And congrats on the quarter, guys.

[Stephen D. Milligan, Western Digital Corp.]

Thank you so much.

[Operator]

Thank you. And our next question comes from the line of Mehdi Hosseini with SIG. Your line is now open.

[Mehdi Hosseini, Susquehanna International Group]

Yes. Thanks for taking my question. Looking into the second half and with your new product introduction, should we assume that the MAMR samples are going to be out? And how should we think about customers sampling? Obviously, this is very critical. And just want to get a sense as to when the PR campaign is going to start and when we would be able to hear from customer and kind of compare and contrast to the alternative technology. And I have a follow-up.

[Michael D. Cordano, Western Digital Corp.]

Yeah, so by samples, meaning we will do that in a broad-based way in the second half of the year. So that will translate to production ramp in 2019. So depending on those customers and how they feel about it, we'll see what they have to say. But I think we'll be very active. We feel very confident in the progress we've made, so we're basically hitting our internal milestones. And the milestone checkpoints we needed to get confident about both those major milestones have been reaffirmed in the recent month or so. So we're feeling very good about it.

[Mehdi Hosseini, Susquehanna International Group]

Okay. And then, Mark, you talked about inventory upticking due to seasonality and hard disk drive manufacturing. Can you elaborate on it, because the uptick was very significant? Is there a new product that you're building inventory for, or what else is there that led to this uptick?

[Mark P. Long, Western Digital Corp.]

Yeah, it's really two factors. So, the seasonal builds for Flash and HDD is one aspect of it. And then, the second is what you are referring to, the inventory builds for our hard drive manufacturing transformation activities. So that's our ability to reconfigure our manufacturing footprint and optimize our loading of the factories and our ability to evolve the HDD side of the business, so...

[Mehdi Hosseini, Susquehanna International Group]

Is that for 14 terabyte that you highlighted that the ramp just started?

[Stephen D. Milligan, Western Digital Corp.]

Let me add color to that, Mehdi. I mean, basically what you've got is – you can remember that we – I mean, although we've largely accomplished a lot of the integration activities, we still are working on optimization activities regarding the remaining factories that we have in our HDD space. What that means is, it means reshuffling production around to get the kind of optimum mix from a variety of different directions. At times, that requires you to build some buffer inventory as you ship from point A to point B. That's all that it is.

[Mehdi Hosseini, Susquehanna International Group]

Got it. Thank you.

[Operator]

Thank you. And our next question comes from the line of Joseph Wittine with Longbow Research. Your line is now open.

[Joe H. Wittine, Longbow Research LLC]

Yeah, thank you. Congrats on really sturdy results while the cycle kind of unwinds here. I want to start out on nearline. Hope you could put a finer point on where the most activity is today from the perspective of capacity points and how you expect capacity points to evolve over the course of the year and beyond, including your mid-range air drives.

[Michael D. Cordano, Western Digital Corp.]

Yeah, so let me talk about that. I think what we're seeing is very strong growth at the high end, so 10 terabyte and 12 terabyte. That continues on a global basis, primarily with the large hyperscale players. But in addition to that, we see very nice growth at the lower-capacity points, so 4 terabytes, 6 terabytes, 8 terabytes as well. So, as you see more diverse workloads out there, different players optimize around at different capacity points. So the growth is really across the board, but we still see very strong growth at the high end as well.

[Joe H. Wittine, Longbow Research LLC]

Okay. And along similar lines, the $72 hard drive ASP obviously jumped off the page. There were some (36:02) component shortages throughout the quarter, so I'm curious if you saw those and to what extent shortages either at the component level or the end device level served to boost those ASPs, or is that ASP jump mostly on the natural benefit of rising cap per drive?

[Michael D. Cordano, Western Digital Corp.]

Yeah, so it's mostly on the mix and capacity per drive, but I would describe the overall market as tight. So the demand was very strong and the supply versus demand balance was quite tight.

[Joe H. Wittine, Longbow Research LLC]

Okay. And then, a final quick hit for Mark. If you could just remind us of the jump in the tax rate you expect in 2019, and I'll step aside. Thanks.

[Mark P. Long, Western Digital Corp.]

So we expect the tax rate as a function of tax reform to go to the high end or just above our long-term model, so in the sort of 12% range.

[Joe H. Wittine, Longbow Research LLC]

Thank you.

[Stephen D. Milligan, Western Digital Corp.]

Thank you.

[Operator]

Thank you. And our next question comes from the line of Vijay Rakesh with Mizuho. Your line is now open.

[Vijay Raghavan Rakesh, Mizuho Securities USA LLC]

Yeah, just wondering, on the NAND side for 3D NAND, what was your mix on 64-Layer here and where do you see that exiting the year? And if you could remind us on what the cost benefit was with the transition.

[Stephen D. Milligan, Western Digital Corp.]

Yeah, so I said in my statement, 70% exiting.

[Vijay Raghavan Rakesh, Mizuho Securities USA LLC]

And the cost benefit was?

[Stephen D. Milligan, Western Digital Corp.]

All we said about cost is that nodal transitions allow us to maintain this 15% to 25%. So we haven't been explicit around nodal benefit.

[Vijay Raghavan Rakesh, Mizuho Securities USA LLC]

Got it. And I know you mentioned second half 2018 potential for tighter NAND could happen. But if you look at this cost, 15%, 20% down, wouldn't you expect margins to be – continue to trend up unless pricing comes in a bit more? Just wondering – we would assume your guidance on margin is a little bit conservative here.

[Stephen D. Milligan, Western Digital Corp.]

I don't know if I would characterize it that way. I mean, one of the things is that's part of the normalization trend. We have been operating in an allocated environment. And as we move to a more balanced scenario, we will see a bit of normalization in terms of our gross margin. But, on a collective basis, for the balance of this calendar year, our gross margins we expect to exceed 40% – 40%, or greater.

[Mark P. Long, Western Digital Corp.]

And that does not – that 40% rate per quarter does not contemplate a return to an allocated environment.

[Vijay Raghavan Rakesh, Mizuho Securities USA LLC]

Okay. Thanks.

[Operator]

Thank you. And our next question comes from the line of Sherri Scribner with Deutsche Bank. Your line is now open.

[Sherri A. Scribner, Deutsche Bank Securities, Inc.]

Hi. Thank you. I was hoping you could maybe provide a little detail on how you are thinking about the calendar year playing out in terms of HD versus the NAND business. The HD business drove all of your growth this quarter and helped you reach the high end of your range. Do you expect the cloud business to continue to be strong through the calendar year, or do you think that NAND business will get a bit stronger as we move into the back half?

[Stephen D. Milligan, Western Digital Corp.]

Yeah, so really both. So as we stated on our expectation for cap enterprise, the growth is strong in the first half, will remain strong in the second. That was – really drove our upgraded exabyte growth commentary. And we would expect that the Flash-based product growth will be traditionally seasonally strong in the second half. So, everything we see leads us to that conclusion. I think our visibility is pretty solid.

[Sherri A. Scribner, Deutsche Bank Securities, Inc.]

Okay. So in terms of the year-over-year growth in the back half, you would expect NAND to accelerate in terms of the growth rate versus...

[Stephen D. Milligan, Western Digital Corp.]

That's right.

[Sherri A. Scribner, Deutsche Bank Securities, Inc.]

...the March quarter? Okay. Thank you.

[Operator]

Thank you. And our next question comes from the line of Rob Cihra with Guggenheim Partners. Your line is now open.

[Robert Cihra, Guggenheim Securities LLC]

Great. Thanks very much. A couple more, not surprisingly, questions on the high cap enterprise and cloud. So, I mean, a question obviously for – cloud CapEx is booming here, which is great. What kind of visibility do you genuinely have beyond the next couple quarters? You obviously need some for your own capacity planning and whatnot. How do you get visibility and how do you get – or can you get commitments beyond a quarter or two? And then I have one quick follow-up if that's possible.

[Mark P. Long, Western Digital Corp.]

Yeah, so, Rob, I think our expression of our estimates for the year would lead you to believe for the calendar year we believe we have pretty good visibility, and that comes from a variety of things. Some of our customers, we have longer commercial arrangements and some we have just more tightly integrated sort of, a view of their demand and their CapEx plans. So, it's a combination of those things that give us confidence in that increased estimate.

[Robert Cihra, Guggenheim Securities LLC]

Okay.

[Stephen D. Milligan, Western Digital Corp.]

And I would add to that. I would add to that, Rob, that – this is at the expense – I don't want to sound too optimistic, but there's nothing on the horizon that – at this point that would indicate that we're seeing any weakness, if you know what I mean. So there's no kind of storm clouds on the horizon regarding the cloud build-out.

[Robert Cihra, Guggenheim Securities LLC]

All right. Okay. Makes sense. And then if I can just ask a quick follow-up. Just obviously the upside in nearline, you had weaker, even in seasonal drives and sort of desktop and consumer electronics. Obviously, there's seasonality there, but was there any amount of you needing to allocate head and media capacity to the higher margin nearline that maybe takes away from it – were you sort of selectively maybe not shipping as much in terms of desktop consumer electronics, or was it just seasonality? Thanks.

[Stephen D. Milligan, Western Digital Corp.]

Yeah, well, Rob, you really – you hit on a good point, which I was kind of alluding to earlier in that we're going to use the power of our product portfolio – the strength of our product portfolio, the depth of our customer relations to allocate our resources to those areas where we think we can derive the most bang. And in this case, clearly, because of the strong demand in capacity enterprise, we felt that it served us and our customers' best longer term to allocate our heads and media to those capacity enterprise opportunities. So you are absolutely spot on.

[Robert Cihra, Guggenheim Securities LLC]

Great. Thanks very much.

[Operator]

Thank you. And our next question comes from the line of Mark Miller with Benchmark. Your line is now open.

[Mark Miller, The Benchmark Co. LLC]

Congratulations on another strong quarter. I'm just – was wondering, your projections for a tightening or constrained NAND supply, how much of that is projected to be due to improved smartphone shipments?

[Stephen D. Milligan, Western Digital Corp.]

So I think from our standpoint, we have probably a reasonably modest view of unit growth in smartphones. What's unique to us is capacity mix. So, we look at it as bit consumption, and albeit the unit growth rate has muted in the smartphone industry, we still are seeing the benefit as we did in the quarter just completed of a better mix. So that's what's feeding into our view of demand in the back half of the year.

[Mark Miller, The Benchmark Co. LLC]

And as NAND pricing has moderately declined, are you seeing an expansion in terms of the lasting demand for the product? Are you seeing some new opportunities come up because of the lower pricing?

[Michael D. Cordano, Western Digital Corp.]

I think what's really happening is, that was – if we go back into calendar 2017, because of allocation, it was actually delayed in 2017. What we've really seen in 2018 as we've entered, is a continuation of the penetration of Flash into certain markets such as client SSD as an example.

[Mark Miller, The Benchmark Co. LLC]

Thank you.

[Stephen D. Milligan, Western Digital Corp.]

Thank you, Mark.

[Operator]

Thank you. Ladies and gentlemen, we only have time for questions from two more participants. And our next question comes from the line of C. J. Muse with Evercore. Your line is now open.

[Ada Menaker, Evercore Group LLC]

Hi. This is Ada calling in for C. J. You had talked about nodal transitions getting you about 15% to 25% cost reductions. Can you talk about how that changes as you get past 96-Layer and as QLC enters the mix?

[Stephen D. Milligan, Western Digital Corp.]

So in general, we see that 15% to 25% to be a long-term cost reduction forecast in the 3D era, including QLC.

[Ada Menaker, Evercore Group LLC]

Thank you. And then, in terms of your JV with Toshiba, are there any implications for the JV if the sale to the Bain consortium doesn't go through?

[Stephen D. Milligan, Western Digital Corp.]

The short answer is, no. When we constructed our, if you want to call it settlement agreement, it was constructed with the intent that it simply protected our long-term interest effectively, no matter who the buyer or owner was of the asset – of the TMC asset. So, we're not affected one way or the other in that regard.

[Ada Menaker, Evercore Group LLC]

Thank you.

[Operator]

Thank you. And our final question comes from the line of Ananda Baruah with Loop Capital. Your line is now open.

[Ananda Baruah, Loop Capital Markets LLC]

Hey, guys. Congratulations on strong results. I guess two for me. The first is just a clarification. I believe that the past couple quarters, at least quarter-and-a-half, you guys had talked about cost offsetting NAND price declines such that you expected gross margins to be stable. And I just wanted to see if you're altering that outlook at all here. Then I have a quick question after that. Thanks.

[Stephen D. Milligan, Western Digital Corp.]

So, what we've said previously as we talked about the normalizing market was that the cost declines would largely offset the ASP declines. And that's what we've seen.

[Ananda Baruah, Loop Capital Markets LLC]

Got it. So, no change in what you were expecting and (46:52)?

[Stephen D. Milligan, Western Digital Corp.]

Yeah, just for clarification, largely does not mean entirely.

[Ananda Baruah, Loop Capital Markets LLC]

Got it. And then just my question would be, with regards to NAND supply constraint potential in the second half of the year – and this is particularly because of the comments that Mike made that it's not baked into the gross margin thought process right now; it's incremental if it happens (47:15). Can you just walk us through what you see – I know you touched on one or two, but can you walk us through what all the signposts could be as you see them that could lead to a supply constrained environment in the second half? Thanks.

[Stephen D. Milligan, Western Digital Corp.]

Yeah, so signpost number on, we've already talked about, which is our expectation for bit growth at a industry level, which has been coming down sort of quarter-over-quarter in terms of the estimate for the year. So that combined with what we think the demand side's going to look like. So I think we will see – actually see more clearly in the coming months. But I think there remains that possibility. And obviously at this point, for the majority of our business, we are still not booked out in the second half of the year. So as we progress through this quarter, we'll have a better feel.

[Ananda Baruah, Loop Capital Markets LLC]

Okay. That's really helpful. Thanks so much.

[Stephen D. Milligan, Western Digital Corp.]

Okay.

[Stephen D. Milligan, Western Digital Corp.]

Okay. All right, thank you. So thank you everybody for joining us today. And we look forward to speaking with you going forward. Have a great rest of the day.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.