Robert Blair - Vice President, Investor Relations Stephen D. Milligan - Chief Executive Officer & Director Michael D. Cordano - President & Chief Operating Officer Olivier Leonetti - Chief Financial Officer & Executive Vice President Mark P. Long - Executive Vice President, Finance & Chief Strategy Officer.

Sherri A. Scribner - Deutsche Bank Securities, Inc. Rich J. Kugele - Needham & Co. LLC Kathryn Lynn Huberty - Morgan Stanley & Co. LLC Aaron Rakers - Stifel, Nicolaus & Co., Inc. Ananda P. Baruah - Brean Capital LLC Mehdi Hosseini - Susquehanna International Group Mark Moskowitz - Barclays Capital, Inc. Amit Daryanani - RBC Capital Markets LLC John M. A.

Roy - UBS Securities LLC Stanley Kovler - Citigroup Global Markets, Inc. (Broker) Joe H. Wittine - Longbow Research LLC Anastazia Goshko - Bank of America Merrill Lynch Mark Miller - The Benchmark Co. LLC Vijay R. Rakesh - Mizuho Securities USA, Inc. David Phipps - Citigroup Global Markets, Inc. (Broker) Nehal Sushil Chokshi - Maxim Group LLC.

Good afternoon, and thank you for standing by. Welcome to Western Digital's Fourth Quarter and Fiscal Year 2016 Conference Call. As a reminder, this call is being recorded. Now I will turn the call over to Mr. Bob Blair. You may begin..

data center devices and solutions, client devices and client solutions. The definitions of these three end market categories can be found in the quarterly fact sheet. In the question-and-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 questions.

Thank you in advance for your cooperation. And with that, I will turn the call over to our CEO, Steve Milligan..

Good afternoon, and thank you for joining us. With me are Mike Cordano, President and Chief Operating Officer; Olivier Leonetti, Chief Financial Officer; and Mark Long, Executive Vice President Finance and Chief Strategy Officer. After my opening remarks, Mike will provide a summary of recent business highlights.

Olivier will cover the fiscal fourth quarter financials, and Mark will wrap up with our guidance for the first fiscal quarter. Earlier this afternoon, we reported revenue and non-GAAP EPS for our fiscal fourth quarter that were better than the preliminary results announced earlier this month.

We are reporting revenue of $3.5 billion, non-GAAP gross margin of 31%, and non-GAAP earnings per share of $0.79. Fiscal 2016 was a transformative year for our company. We took significant steps to continue our evolution into the leading storage solutions company and to return to growth with global scale and extensive product and technology assets.

Given unabated growth in data and the increasing role technology plays in the lives of individuals and organizations large and small, we believe Western Digital is uniquely positioned to address the broadest range of storage opportunities in the marketplace.

We embarked on a journey several years ago with a vision to provide a full spectrum of storage solutions. With the various acquisitions we have made so far, along with organically growing our capabilities, we are much further along today on that mission to help the market determine which solutions work best for a given application.

We are a market and customer driven organization, and we believe this strategy will deliver long-term value for our customers, shareholders, and employees. With our long-term strategy clear, we are focused on execution. I am pleased to report that our integration activities associated with our acquisitions are going well.

We are on target to achieve our synergy goals as a unified entity, focused on addressing the tremendous growth of data and the evolving needs of our customers. Additionally, our near-term priorities include our transition to 3D NAND and the deleveraging of our balance sheet. We have achieved several recent milestones associated with these initiatives.

We have completed the rationalization and alignment of our product and technology roadmaps involving legacy WD, HGST, and SanDisk products, and we have shared this with our customers. We celebrated the opening of the New Fab 2 wafer manufacturing facility in Japan with Toshiba, underscoring the continued strength of our 16-year partnership.

We announced our next generation 3D NAND technology, BiCS3, with an industry leading 64 layers of vertical storage capability, pilot production of BiCS3 has commenced, and we expect meaningful commercial volumes in the first half of calendar 2017.

And we repaid in full the $3 billion bridge loan associated with the financing of the SanDisk acquisition. We also remain focused on innovating and investing in our business to ensure that we continue to remain agile and addressing changing market needs.

At this important time in our company's history, I am inspired by the enthusiasm and positive spirit of our employees and the favorable response to our enhanced value proposition by our customers. I will now ask Mike Cordano to provide his comments on the business operations..

Thank you, Steve. Good afternoon everyone. I'd like to echo Steve's excitement on what we have seen in the company in the last 77 days since the close of the SanDisk acquisition. We are excited about the possibilities created by the combination for our customers, employees and shareholders.

Western Digital now has a broadened portfolio of solutions for the data center, client device, and client solution markets. We have been combining our HGST and WD subsidiaries since last October in compliance with the Chinese Ministry of Commerce decision.

Following the close of the SanDisk acquisition on May 12, we have made substantial progress in integrating all of our assets in the new Western Digital. The team has done a phenomenal job in reconciling and aligning the various product roadmaps, a complicated task executed well on a compressed time line.

We have identified key leaders for our various functions, and we are rapidly aligning the capabilities and talents of our employees.

Coupled with a series of restructuring actions, we have taken over the last two years against the backdrop of a declining HDD TAM, we have further streamlined our manufacturing footprint in recent months with the closure of two facilities in Japan and Malaysia and the announced closure of a facility in Singapore.

Relative to our legacy Western Digital business, we have reduced our overall facilities footprint by almost one fifth and our head count by almost one quarter over the last two fiscal years.

Turning to the specifics of our fourth quarter results, in HDDs we achieved overall exabyte growth of 12% on a year on year basis, primarily driven by shipments of our capacity enterprise HDDs to data center customers.

Exabyte growth in our capacity enterprise product line was 47% on a year on year basis, faster than the market growth rate thanks to the ongoing success of our Helium platform. We believe this trend will continue in the second half of this calendar year as we ramp our 10 terabyte product to high volume, our third generation helium drive.

This product is a key differentiator for the company as it provides us a generational advantage and has already created significant marketplace momentum. In enterprise SSDs, we saw strength in sales in both enterprise and cloud customers.

From a client devices perspective, we are benefiting from the growing attach rate of SSDs to PCs in both the commercial and consumer categories even as client HDD unit shipments decline year-over-year.

In our other flash-related businesses, we saw a broad-based strength across several key markets and our operational execution was strong across the board. Our industry leading 15 nanometer technology remained the workhorse and that accounted for the vast majority of our total supply.

Manufacturing yields on 15 nanometer technologies set another record and our sustained leadership in 2D NAND has continued to position us well in the key markets we serve. Earlier this week, we were pleased to announce our next generation 3D NAND technology called BiCS3.

With 64 layers of vertical storage, BiCS3 will primarily feature our three bit per cell, or X3 architecture, delivering the industry's smallest 256 gigabit chip. The combination of X3 and manufacturing innovations will allow us to extend our cost reduction capabilities beyond our 15 nanometer node.

Consequently, we have decided to allocate a greater portion of our planned 3D NAND capacity conversion to BiCS3 instead of BiCS2. And this will allow us to rapidly convert to our next generation 3D NAND technology in 2017. Additionally, we expect our 2D NAND technology to have a long tail, as we will continue to utilize it for certain markets.

From a wafer fab standpoint, in the June quarter, we completed the planned 5% wafer capacity expansion for 2016, and this will provide us slightly more than 3 million wafers of captive output by the end of calendar 2016.

Given the planned mix of 2D and 3D NAND technologies, for the rest of the year we expect our bit supply growth to be approximately 30% in calendar 2016, somewhat below our estimate for total industry bit supply growth, as we had previously indicated.

However, as we look to 2017, the planned rate of conversion of our 2D NAND capacity to BiCS3 will enable a mix of our 3D NAND wafer capacity to approach 40% of the total capacity by the end of 2017. This will place both our mix of 3D NAND capacity and our overall bit growth rate in line with the industry.

Switching to the near term, we believe the overall demand environment is better than it has been in recent quarters driven by the following, new product cycles in mobile devices and PCs are tailwinds for our client business along with seasonality. Additionally, SSDs are continuing to penetrate further into PCs, even as PC unit volumes shrink.

We are seeing a tight supply of NAND as the industry transitions from 2D to 3D NAND technology. And we are experiencing stronger demand in non-SSD flash markets such as mobile, and there is demand pull from hyperscale customers in our cloud-related data center business.

Offsetting these factors, we have seen share driven price dynamics in certain pockets of the HDD market. These include the low end of the 2.5 inch HDD market and the 8 terabyte capacity point in capacity enterprise. Consequently, we have moderated our participation in those areas.

Our fiscal Q4 performance and forwarded guidance for fiscal Q1 takes these variables into account. To wrap up my comments, Western Digital is very unique in our industry. A combination of WD, HGST, and SanDisk has allowed us to methodically augment our capabilities to become a truly broad-based storage solutions provider.

We look forward to giving you ongoing updates on our business. With that, I will turn the call over to Olivier to review our Q4 financial results..

Thank you, Mike. Our revenue for the June quarter was $3.5 billion. Including the partial payout of SanDisk ownership, our non-GAAP gross margin was 31% and operating expenses totaled $691 million. Interest and other expense for the quarter included $181 million of interest expense related to the debt for the SanDisk acquisition.

Non-GAAP tax benefit for the June quarter was $24 million due to the impact of interest expense related to the SanDisk acquisition. On a non-GAAP basis, net income was $208 million or $0.79 per share. In the June quarter, we generated $355 million in cash from operations and our free cash flow totaled $114 million. Our net CapEx totaled $241 million.

We also declared a dividend in the amount of $0.50 per share. We closed the quarter with total cash and cash equivalents of $8.2 billion, of which approximately $1.3 billion was held in the US. After the close of the June quarter and, as Steve mentioned earlier, we utilized $3 billion to pay off the bridge loan.

Finally, I would like to thank Steve and the rest of the leadership team at Western Digital, our employees, and the investment community for your partnership and support over the last two years during my tenure as CFO.

As I leave Western Digital to pursue other opportunities, I am confident in Mark's leadership to guide the finance and strategy organization and the company through the transformation that we have undertaken.

Mark?.

revenue from top ten customers, enterprise SSDs, and non-PC applications. We believe these metrics are less relevant today given the diversification of our business. As we continue to evaluate the best way for us to disclose the drivers of our business, we will evolve our reporting in the coming quarters.

This may result in the addition or deletion of some of the information provided today. In the coming quarters, we will also provide additional commentary on key operating activities, including achievement of our synergy and cost reduction objectives and key technology milestones.

We believe these reporting modifications provide the best balance considering an evolving market for value creation drivers and our historical reporting practices. Over the near term, we will continue to make certain legacy disclosures available to allow for a transition between our historical and new reporting.

We expect to make a full transition by the end of this fiscal year. At our Investor Day on December 6, we will provide a deeper dive into our overall strategy.

At that time, we will discuss our long-term strategy and target financial and business model, which should provide further clarity on what we expect to deliver across key financial metrics including gross margin, OpEx, operating margin, CapEx, tax and cash flow for the new Western Digital.

Our overall objective as it relates to our disclosures and communication is to provide an appropriate level of transparency while balancing competitive considerations and still allowing for a deep understanding and discussion of our business.

I would like to comment on a couple of items relating to the acquisition of SanDisk and the related financing that will impact our future non-GAAP and GAAP results.

First, relating to debt financing of the SanDisk acquisition, we will be amortizing the debt discount and issuance costs over the term of the debt, and this will result in charges that we will include in interest expense of $23 million in fiscal Q1 and approximately $18 million each quarter thereafter over the next five years.

These debt discount and issuance costs are incremental to the cash interest payments we will make.

Second, due to purchase accounting rules, we had to reset the SanDisk Japanese yen hedges for inventory purchases, eliminating approximately $51 million in unrealized gains that we would have reduced cost of sales by approximately $26 million in fiscal Q1 and $17 million in fiscal Q2.

We will still receive the cash related to these yen hedges With that, I will now provide our guidance for the September quarter. We expect revenue to be in the range of $4.4 billion to $4.5 billion.

On a non-GAAP basis, we expect gross margin of approximately 32%, operating expenses of approximately $875 million, interest and other expense of approximately $245 million, tax expense of approximately $50 million, share count of approximately 290 million, and we estimate non-GAAP earnings per share between $0.85 and $0.90.

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

Operator?.

Ladies and gentlemen, we will now begin the question-and-answer portion of today's call. And our first question comes from the line of Sherry Scribner with Deutsche Bank Securities. Your line is now open..

Hi. Thank you. I just was a little confused about the yen commentary that you made about the hedges. Can you maybe explain where that's going to sit and why that changed? And can you also help us understand what the impact of the yen will be going forward and how we should think about that for earnings. Thank you..

Sure, Sherry. So all we were describing in the commentary was the fact that the purchase accounting rules forced us or required us to eliminate certain benefits we would have otherwise had from the financial statements going forward by mark-to-market rules for the hedge instruments.

So the impact, as we mentioned, is a total of $51 million in unrealized gains. Those gains would have been spread out over the next few quarters. And in fiscal Q1, we would have had a benefit of $26 million, and in fiscal Q2, we would have had a benefit of $17 million. The remainder would have applied in future quarters.

So that accounts for the change in reporting due to purchase accounting. With respect to how we deal with the yen going forward, I think it's important to realize that our current combined company dependence on the yen is now significantly diminished. For SanDisk, their COGS were approximately 45% related to the yen.

For the combined company, that dependence will drop to 15%. Nonetheless, we will continue our active hedging program to ensure that we are able to manage the volatility of the currency during the fiscal quarter and throughout the fiscal year through our hedging mechanisms..

And, Sherry, just this is Steve. Just to add one comment to that. I think that it's important to note, and we've gone through this in terms of our legacy hard drive business. There is always a number of different areas that create potential volatility in our business.

It's our job from a management perspective to manage that volatility and to reduce its impact on our P&L, on our balance sheet, and corresponding impact on shareholders. So a fluctuation in the yen, just like changes in other variables that we deal with, our job is to manage that.

By the way, absent the impact, I don't say absent, but even with the impact of purchase accounting, we're able to offset largely the impact in terms of the change in the value of the yen on our first quarter results. And I think it's important to emphasize that fact..

Thank you..

Thank you. And our next question comes from the line of Rich Kugele with Needham & Company. Your line is now open..

Thank you. A couple questions. I guess first when it comes to the OpEx, I assume that going forward you're just going to give a combined number for OpEx.

Is there any sense you could give us today on the breakdown between the two business lines? And should we assume that from $875 million that it declines at some pace over the balance of fiscal 2017? Thanks..

So Rich, this is Steve. So the first thing is, is that we will only be providing total OpEx guidance going forward. We will not be providing, if you want to call it, separate legacy WDC or legacy SanDisk.

As we move through the integration process, it will become kind of impossible to do that because we'll be combining – we're in the process of combining the companies.

And then your assumption is correct that as we move through, one, through the tail end of calendar 2016 and into 2017 as we begin to realize synergies, we will see our OpEx begin to decline absent other investments that we need to make to continue to innovate in our business..

Okay. Then maybe this is best for Mike.

Can you give us any sense on the high cap demand environment, in particular what the hyperscale build-out plans are over the next call it three to six months? Are you confident that the share, the overall share you've got should improve with the 10 terabyte as an example?.

Yeah, I think that trend relative to overall share should be favorable with the adoption of the 10 terabyte. We also see the trend of petabyte growth moving to the high end of the range.

So we would see the general demand situation in that group of customers as being steady and running at a slightly to the high end of the petabyte growth range, so approaching 40% is what you got to think about..

Okay, and thank you, Olivier, and congratulations, Mark..

Thank you..

Thanks, Rich..

Thank you and our next question comes from the line of Katy Huberty with Morgan Stanley. Your line is now open..

Thanks. Good afternoon. How should we think about the trajectory of gross margins from here, in not just the September quarter as the purchase accounting hit rolls off? It's a better pricing environment given the tighter NAND supply.

And then how negative is the impact of ramping 3D NAND when you take those factors together? How should we just think from a high level about the trajectory of gross margins? Thank you..

Yeah, Katy. So to make a few comments. One thing just to, I'll call it, remind everybody is when we do the December 6 Investor Day, we'll obviously be providing updated margin range.

We'll also be talking more qualitatively about the hierarchy of our margins between the three different, the slices of revenue that we're providing, data center as well as client devices, et cetera. And so we will be providing additional color going forward.

Relative to the trajectory of our margins, it's a little bit early to make a call on that because there's obviously a lot of variables going on, which we sort of alluded to in Mike's commentary. So I don't want to get too over my skis in terms of forecasting of where we think our margins are going to trend. So I'll leave it at that..

Thank you..

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

Yeah, thank you for taking the questions. The first question, and I have a follow-up real quick, you talked about the progression of the synergies and moving forward favorably on that front.

I'm curious as you look specifically at the Hitachi integration and I think the target was exiting this year at $475 million of realized synergies, where did you come out this quarter with regard to realizing that level of synergies? And how do we think about the progression as we look through fiscal 2017?.

So I'll take that and then Olivier or Mark can comment. First off, we are on track to achieving the synergy targets that we set for ourselves as well as outlined externally. We were not specific when we did that as to how that would reflect itself from a quarterly basis.

We talked about where we would end up in terms of calendar 2016 as well as in calendar 2017. I believe that we suggested to the investment community that you use some sort of I'll call it straight-line projection in that regard. And I would say that generally speaking, that's about where we're at.

But we're on track to our calendar year-end synergy targets..

Okay. And then a real quick follow-up.

Can you talk a little bit about the variables we should consider with regard to free cash flow generation as we move out over the next several quarters? What specifically CapEx trends we should think about?.

So for the CapEx considerations, I think it's important to remember what the CapEx requirements were for each of the separate businesses and then we can think about them on a combined basis. So we were looking at 5% to 7% of revenue from the HDD business, although we were running a little below that.

And then for cash CapEx for the SanDisk business, they were running in the 8% to 10% range. On a combined basis, I think it would be safe to look at something in the 6% to 8% range for planning purposes..

And then I would just add in terms of free cash flow, one of the things that we will be doing again in conjunction with the December Investor Day is resetting what we see as our cash conversion targets.

We've got a bit more work to do on that as we increase our understanding and also look for optimization opportunities in terms of the combined business. And obviously with the profit ranges and in terms of margin, OpEx, et cetera, that will allow for a better modeling of where we think our free – operations cash flow will turn out.

And then you would back off the CapEx from that to be able to estimate what our free cash flow would be going forward..

Right. And we tried to provide you with visibility into our cash interest expense by highlighting what we were amortizing in terms of the debt discount and issuance expenses. So I think you have the drivers of our free cash flow laid out..

Okay. Thank you..

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

Hey. Thanks, guys, for taking the questions. Congrats on a solid quarter. Olivier, we'll miss working with you. And, Mark, welcome. Two if I could, guys. I guess a little bit of an old school question.

Steve, what's your TAM view for the second half of the year, calendar year now that the TAM was a little bit firmer than we all thought or at least you guys thought it might be entering the quarter? And then I have a follow-up as well. Thanks..

Yeah, so, Ananda, I would say that in terms of – I'm not going to make a call on the back half in terms of quantitatively, obviously. I'm going to give you a very dissatisfying answer. We would expect that the TAM will be higher in the second half than it was in the first half as a general statement.

But more specifically as it relates to calendar Q3, our fiscal Q1, I would say that we would expect the hard drive TAM to be in the range of about 110 million units..

Okay. Okay. Great. No, that's actually very helpful in both regards. So and then the follow-up for me is just with regards to the near line commentary that you made, it sounds like you're expecting pretty solid near line demand in the second half of the year.

I think the comment with regards to the 10 terabyte Helium ramping was you expect to, was it gain share as you go through that process? If you could clarify that.

And then I guess a follow-on to that was I'd love your view on sort of where normalized share is on 8 terabyte since Seagate obviously seemed to get some meaningful volume back in the June quarter. Thanks..

Yeah, first is seasonality. We see it slightly higher, sort of a 48/52 on across the calendar year relative to petabyte linearity in the year. So heavier in the back half than the first. Yeah, I think my statements around 10 terabyte were interpreted correctly.

I think we have ceded, as you might expect, some 8 terabyte share as our major competitor ramped. We think we're in a leading position on 10 terabyte, which will benefit us in the back half of the year..

And the other thing that I would add is we are not expecting to cede any more share..

That's very helpful. Thanks a lot, guys..

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

Thanks for taking my question. Looking at your guide and your commentary about a tight NAND supply, how should we think about the NAND ASP assumption that is dialed in? And is that a realistic assumption? Or if the tightness were to sustain, would there be a upside from a NAND ASP side? And I have a follow-up..

Yeah, I'll comment a little bit. Well, two things. One is we see the tightness through the end of the year, so that will have a benefit relative to bit price. We won't comment on the specifics of that.

The way we also see it a little longer term, and this really relates to a new industry model, if you will, is the rate of bit cost decline is going to move into a regime that will center around a 20% or so per year we think.

Barring supply/demand dynamics, that's the way the broader market should begin to look at the industry as we proceed into the 3D NAND era..

Okay. Great. And since you mentioned next year and the mix of BiCS3 BIX 3, I'm just trying to better understand your strategy.

And I do realize you're going to have an Analyst Day in December, but if the mix of BiCS3 is going to exceed your product expectation or going to have a higher mix of the 64 layer, do you foresee a scenario where you would better able to price your SSDs, or is that going to better help your raw NAND customer? How should we think about these mix shift and its impact to your product offering?.

Well, my comment on part of this, but let me make one thing clear. Part of the strategy that SanDisk had and accordingly our strategy, which oh by the way, we concurred with, is that we want to manage technology transitions when it makes sense from a cost standpoint. So it, right now, we have the leading 2D planar technology from a cost standpoint.

So we want to intersect 3D NAND technology when we think it is cost competitive to the incumbent 2D NAND technology. We believe that that will occur with our BiCS3 technology. And so, and we're pleased with the progress. We've still got a lot of work that we've got to do to go make that happen.

And, but that's where we believe with 64 layers, that's where we believe that that cost crossover point will begin to occur, and we'll be ramping accordingly when that takes place through 2017. So I'll have Mike comment from kind of a product perspective..

Yeah, so in addition to sort of the general base of cost advantage that Steve just described, it really allows us to allocate sooner and a larger amount of 3D NAND into our broad product base. So we're going to apply it where it gives us most value first, which are our higher density applications or products.

So you can imagine what those are, both classes of SSD and certain classes of off-embedded will benefit directly from that. So our ability to bring those products into the market sooner and at higher volume is the general way to think about that..

Great. And I just wanted congratulate Olivier and best of luck in his next endeavor..

Thank you..

Thanks, Mehdi..

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

Yes, thank you. Good afternoon. Steve and Mike, I was hoping you could maybe talk a little bit more about the underlying business patterns for both SSD and HDD. Especially, Steve, given your comment around the 110 million TAM for September.

Can you talk about the puts and takes in terms of where maybe you're seeing some signs of life and renewal of the TAM (40:32) versus maybe some areas of challenge? And the same thing for the SSD piece.

And then, Mark, I do appreciate the direction in the message in terms of around a more holistic reporting down the road, so we all look forward to that. I had a question though in terms of the gross margin.

Could you talk a little about how we should think about the gross margin in the near to midterm? Is there any business that's going to be underperforming or out-earning before we get to the December Analyst Meeting on the margin side?.

So you want to take it?.

Yeah..

So Mike can take the color on the 110 million TAM..

embedded, client SSD, and ESSD or enterprise SSD. It's sort of as expected, but growth continues..

Yeah, and just a comment on our margins, then I'll ask Mark to add a comment about a little bit about the hierarchy of our margins. But I want to impress one point, that all of our margins by product continue to perform consistent with our expectations and what we would consider to be our own internal margin ranges.

So no issues in terms of that, but I'll ask Mark to talk about kind of the hierarchy of our margins..

Sure. Mark. So basically when we look at the hierarchy of gross margin, the highest performing area for us is in the data center devices and solutions. Then that's followed by our client solutions, and then the third kind of level in the hierarchy is client devices.

And as Steve pointed out, we are seeing the expected performance in each of those categories..

Thank you..

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

Thanks a lot. Thanks for taking my question, guys. Two for me as well..

Hey, we can't hear you..

We can't hear you..

Hopefully this is better..

Yes, it's better..

I guess two questions. One, Mike, you talked about this 20% cost per bit decline as you go forward.

Could you achieve that on the planer NAND side as well and would you have to go down half a node to get there in the next few quarters essentially or was that more a long-term comment you were making?.

That's a long-term commentary and it's enabled by the 3D NAND transition in both initially and then subsequent generations..

Got it.

And then I guess can you guys talk about the Samsung licensing revenues? Is the expectation that – SanDisk was getting that obviously – but is your expectation that that holds firm as you go forward and it gets renewed, or do you think that rolls off to a lower number at some point?.

Well, a few clarifying comments. I mean first off, we nor SanDisk have historically disclosed the amount of the royalty from Samsung. The additional thing is, is that the current royalty arrangement is up for renewal and we're in discussions with Samsung regarding the terms of that renewal.

I have nothing to report in terms of the status of that other than we're currently discussions with them. And then the additional point that I will make, which we talked about as part of the acquisition, is that when we did our forward modeling of the impact of that, we were I will call it relatively conservative in terms of our assumptions.

And so we did not get overly aggressive as to what we thought, so we feel like we're sufficiently protected in terms of how that might turn out from a future financial modeling perspective..

Perfect. Thank you, guys..

Thank you. And our next question comes from the line of John Roy with UBS. Your line is now open..

Great. Thank you. Hey, something a little mundane. Tax rate going forward, I know you guided to 20% to 25% for fiscal 2017 and 10% to 15% for fiscal 2018.

Is that still what your thinking is, or can you narrow that range a little for us?.

Well, as we pointed out, we will be providing a much more fulsome financial model at our Analyst Day in December. But I think it's safe to assume that the ranges we provided for the guidance will actually be slightly lower. And for fiscal 2017, we think it will be something in the range of 15% to 20%..

Great. Thank you..

Thank you. And our next question comes from the line of Stanley Kovler with Citi Research. Your line is now open..

Hi. Good afternoon. Thanks for taking the question. I just wanted to ask you about your plans for production capacity going forward, especially in light of the TAM going up again next quarter.

How should we think about where the industry capacity and specifically your capacity needs go particularly as we exit 2017 if there could be more pressure on PC units in particular? Are we thinking that may be going down to a 45 million sort of capacity level for you is something that could be additive to the cost synergies out there as well? And then again a related cost question, but on the SanDisk side.

If we got the OpEx numbers right for WD standalone, it seems like the guidance for next quarter implies that the SanDisk OpEx is going up. I just wanted to see if you can provide a little bit more color on that. Thank you..

Yeah, so one of the things that – the first question has to do with HDD capacity, so just to comment on that.

One of the things that Mike said, we have been very aggressive over a period of time of taking capacity out both in the form of brick and mortar as well as in terms of head count to react to the decline that we have seen in the hard drive market. And I want to emphasize those numbers.

We've taken out 20% of our facilities and 25% of our head count over the course of the last two years. We also have, we have additional plans to reduce that further, up to one third and when you look at from two years ago. And so we will continue to be as proactive as we possibly can.

Obviously our margins in terms of what we reported on the hard drive sides shows that we have done a pretty good job of managing the cost side of the equation in terms of our infrastructure and capacity. I have no doubt that we'll continue to do that going forward.

In terms of your comment on OpEx, the one thing that I would like to emphasize is that our guidance for fiscal Q1 assumes a higher level of incentive compensation. So the increase is really a couple of different things.

One, there is a full quarter of SanDisk OpEx, but also a higher level of short-term incentive compensation funding as compared to the prior for fiscal Q4.

Next question?.

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

Thank you. Is there anything you can offer on free cash expectations for 2017 after doing a little over $100 million last quarter? And with that, anything to offer as far as your thoughts behind the projected debt paydown schedule? Even qualitatively would be great. Thanks..

So in terms of free cash flow, we're going to provide updated guidance in December. So I think that's the soonest we'll give you more granularity. But in terms of our debt paydown schedule, I think it's safe to assume we're going to be aggressive where we can be to pay that down as quickly as we can.

Our long-term commitment remains the three to five-year horizon getting to 1.5 times leverage. And as I mentioned, as we can find ways, whether it's our cash conversion cycle or other operational improvements that generate more free cash flow, we will look to use that to delever the balance sheet..

Got it.

And then quickly on the legacy hard drive business, apologize if this was covered already, but the gap up in consumer units during the quarter, what drove that?.

The gap up.

What do you mean by gap up?.

I think it went from 7 million units to 10 million sequentially, big sequential move. I must have the wrong numbers..

I'm not sure what you're referring to..

Consumer HDD is 7.3 million in the March quarter, 10 million in the June quarter..

So that would be gaming..

Gaming. It's all gaming..

Thanks, guys..

Thank you. And our next question comes from the line of Ana Goshko with Bank of America. Your line is now open..

Hi. Thanks very much. First I wanted to clarify, on the CapEx guidance ranges that you gave, that includes incremental contributions into the flash JVs.

Is that true?.

Yes. Yes, it does. That's our cash CapEx range that we provided..

And then in the quarter, it looks like there was a $90 million contribution.

What's the expectation on the SanDisk side for the CapEx that's at SanDisk proper? And how much do you expect to contribute into the JV going forward?.

That would be implied in that 6% to 8%. Beyond that, we won't be providing specifics..

Okay. And then secondly, I think the largest piece of the synergy case between the SanDisk/Western combination was the vertical integration on the NAND supply side. And I wanted to get an update on when you think you'll be able to start realizing that..

Yeah, I think as we stated, we're going to do that through product life cycle adjustments. So we are not going to retroactively go back to existing products shipping to customers. So that's going to happen over the course of time. And really largely sort of 18 months and beyond we'll start to see that take more effect..

Okay. And then this may be mundane, but I don't know if I caught a depreciation and amort projection for this coming quarter..

I don't believe that we provided one..

We did not..

Okay.

Can I get one?.

No..

Okay. Okay. Thank you, then..

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

Anything on the long awaited transition to energy assisted magnetic recording? Is that 2017, or that keeps on getting pushed out?.

Well, I would say it's 2018, 2019 kind of dynamic..

Okay. So it's fallen out. Okay. Thank you..

Thank you. And our next question comes from the line of Vijay Rakesh with Mizuho. Your line is now open. Please check your mute button, Vijay..

Yeah, hey. Sorry about that. Just on the OpEx level, where do you see the long-term OpEx level? I know it's $875 million here.

Where do you see it longer term?.

That's an additional item that we'll be providing more color on in December. We're still scrubbing through the details..

Okay.

And on the gross margin line, what are the puts and takes as you look out? What drives it? Where do you see upside coming from as we look out couple of quarters here?.

Well that's a very general question. And so, again, we'll be providing more information in December in terms of our gross margin range. But obviously the puts and takes, it's going to be dependent upon the usual things, what happens with mix, what happens with pricing, what happens with demand.

Obviously right now in terms of what Mike was alluding to, we've got a favorable supply/demand situation in terms of NAND. That's helping our margin profile from an overall perspective. And hard drive market is relatively stable, certainly from a demand perspective.

But as Mike alluded to, we continue to see some share-based pricing behavior in certain parts of the market that's kind of offsetting maybe some of the more positive things that we're seeing in terms of mix and demand on the hard drive side. So there's various different puts and takes.

But on balance, we see at least in the near term an upward trajectory from 31% to 32% in terms of our gross margin percentage..

All right. And just last question here on the yen.

I might have missed the first part of that, but were you mentioning the unrealized hedging gains in the yen? Do you expect that to – does that flow through the EPS line in coming quarters or how do you see that $35 million (sic) [$26 million] (56:01) and $17 million in [indiscernible] (56:07)?.

So first of all, let me clarify. That is just purchase accounting. So it will not flow through the P&L for Q1 and Q2 and beyond for the instruments that we had at the time of the closing of the transaction. So all our new hedging instruments will flow through in the customary manner.

Now, we still get the cash benefit of those instruments, but you will see effectively it's what would otherwise have been a decrease in the next few quarters as a result of that purchase accounting requirement..

Got it. Best of luck. Thank you..

Sure..

Thank you. And our next question comes from the line of David Phipps with Citigroup. Your line is now open..

Thanks for taking my question. Can I ask you about the operating expenses in the fourth quarter? Because combined, those were about $484 million. In the coming quarter, you've guided to $875 million. So what were the unusual charges or if any, within those two line items..

Nothing unusual. And again, the complexity with the guide is you compare a full quarter with a quarter not including obviously SanDisk for the full period. And as we indicated earlier, the incentive compensation now will be fully funded, which wasn't the case before. So the reconciliation is a bit tricky. But nothing out of the ordinary..

So the current quarter was $484 million of op expenses including $70 million of stock comp. And so the next quarter will be $875 million, and I guess we'll have a lower component of stock comp..

So stock-based compensation is excluded from all the numbers we are communicated..

It's included. You'll have a full quarter, so it will actually be higher stock comp. We'll repeat the answer. The primary difference between F Q4 and F Q1 OpEx is having a full quarter of SanDisk OpEx plus a higher level of incentive compensation funding. That's the primary difference..

But wouldn't that be – so that should be a bigger number than a smaller number.

Isn't that? What am I missing?.

We'll have to take this offline, okay?.

Okay. Thank you..

Thank you. And our next question is from Nehal Chokshi from Maxim Group. Your line is now open..

Thank you.

The exabytes shipped, does that include the NAND flash component now?.

Repeat that. I'm sorry..

The exabytes shipped, the 66.1 in the June quarter, does that include the NAND flash shipments as well?.

Yes..

It does. Okay.

So there was an acceleration on a year over year growth, so is that primarily attributable to the inclusion of NAND flash?.

No. It would be primarily driven by capacity enterprise shipments..

Got it. Okay. And then my follow-up is that you had about $100 million upside relative to the original midpoint guidance. And given the ASP uptick, which I think is due to the mix shift to the capacity enterprise, it sounds like it was largely capacity enterprise that drove all this.

And could you give some additional color as far as where that demand from capacity enterprise was? It sounds like it's hyperscale, but just want to make sure it's just hyperscale and there's no upside from the enterprise storage OEMs as well..

Well, just to make an overall comment, because remember we provided guidance prior to the acquisition of the SanDisk, which SanDisk which was obviously legacy WDC. Our financial results for F Q4 for legacy WDC came in largely consistent with our expectations.

So primarily the upside that we saw was driven by if you want to call it legacy SanDisk or our new flash-based business over that stub period..

I see. Thank you..

Sure. All right. So I want to thank you for joining us today. In closing, I want to thank Olivier Leonetti for his contributions as our Chief Financial Officer over the last two years. We greatly appreciate Olivier's dedication during this transformative time and wish him the best in the future.

We look forward to staying in touch with our investors in the analyst community in the weeks and months ahead. Thank you..