Western Digital Corporation (NASDAQ:WDC) Q3 2023 Earnings Call Transcript

Western Digital Corporation (NASDAQ:WDC) Q3 2023 Earnings Call Transcript May 8, 2023

Western Digital Corporation beats earnings expectations. Reported EPS is $-1.37, expectations were $-1.57.

Operator: Good afternoon, and thank you for standing by. Welcome to the Western Digital’s Fiscal Third Quarter 2023 Conference Call. Presently, all participants are in listen-only mode. As a reminder, this call is being recorded. I would now like to turn the call over to Mr. Peter Andrew, Vice President, Financial Planning & Analysis of Investor Relations. You may begin.

Peter Andrew: Thank you, and good afternoon, everyone. Joining me today are David Goeckeler, Chief Executive Officer; and Wissam Jabre, Chief Financial Officer. Before we begin, let me remind everyone that today’s discussion contains forward-looking statements, including expectations for our product portfolio, cost reductions, business plans and performance, demand and market trends, and financial results based on management’s current assumptions and expectations, and as such, does include risks and uncertainties. We assume no obligation to update these statements. Please refer to our most recent financial report on Form 10-K and other filings with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially.

We will also make references to non-GAAP financial measures today. Reconciliations between the non-GAAP and comparable GAAP financial measures are included in the press release and other materials that are being posted in the Investor Relations section of our website. With that, I will now turn the call over to David for introductory remarks.

David Goeckeler: Thank you, Peter. Good afternoon, and thank you for joining the call to discuss our 2023 third quarter results. Western Digital’s third quarter performance exceeded expectations with core metrics at the high-end of our guidance range, demonstrating the company’s resilience in a challenging market environment. We reported third quarter revenue of 2.8 billion non-GAAP gross margin of 11% and a non-GAAP loss per share of $1.37. Over the last several years, our team is focused on enhancing business agility and delivering a range of innovative industry leading products that address the increasing data storage demands of our customers. The groundwork we laid combined with the actions we have taken since the beginning of this fiscal year to right size and refocus our business have enabled us to navigate a dynamic environment.

I am pleased that we delivered non-GAAP gross margin at the higher-end of our guidance range due to strong execution across both our HDD and Flash businesses. In HDD, our early actions to streamline our manufacturing footprint and focus our product offerings on delivering the best value for our data center customers have resulted in gross margin upside and profitable market share gains in HDD. In Flash, our broad go to market strategy anchored on our enviable retail franchise in a strong client SSD portfolio enabled us to optimize bid placement and bolster gross margin. During the fiscal third quarter, we saw signs of demand stabilizing across various end markets. In consumer, Our flash and HD results were consistent with the expectations we shared in January.

In client, demand for each major product area came in better than we expected across PC OEM, channel, mobile and gaming. In cloud, demand for capacity enterprise hard drives improved whereas the demand for flash drives was consistent with our expectations set in January. Before I jump into updates on our HDD and Flash businesses, I would like to reiterate that the strategic review process is ongoing and we will provide updates as we have them. I’ll now turn to the business update starting with HDD. During the fiscal third quarter, our HDD revenue improved sequentially with growth in capacity enterprise offsetting seasonal declines in retail and client. During the quarter, our 22 terabyte CMR drive became the highest volume product among all of our 20 terabyte and above capacity points.

Demonstrating our leadership position at this capacity point. In addition, we expect the complete qualification of our 26 terabyte Ultra SMR technology in the fiscal fourth quarter. These innovative products provide multi-generation benefits to our customers. Turning to Flash, total exabyte shipment came in higher than expected in consumer, mobile, PC OEM, and channel products. Despite the industry experiencing the worst downturn in over a decade, Western Digital delivered positive product gross margin, excluding underutilization charges, driven by our unique combination of premium retail brands, broad go to market channels, and low cost flash supply from our joint venture fab with Kioxia. Furthermore, we continue to see encouraging signs of price elasticity driven content growth in retail flash led by WD Black, SSD optimized for gaming, as well as mobile PC OEMs and channel within client.

On the technology front, BiCS6 achieved its anticipated cost crossover during the quarter. Moreover, on March 30, Western Digital and Kioxia announced our next generation BiCS8 node, a groundbreaking technology that builds upon the success of BiCS5 and BiCS6. This new technology is based on circuit bonded to array architecture, which provides several benefits, including reduced cycle time faster yield ramp, better or lateral scaling, and industry leading IO performance when compared to products based on circuit under array architecture. We continue to aggressively productize BiCS8 for a broad range of applications, which will position Western Digital for success as business conditions improve. As we look to the fiscal fourth quarter, in hard drives, overall demand will be impacted by ongoing inventory digestion at cloud customers and a sustained decline in client.

However, we are beginning to experience improved demand at certain customers in China. In Flash, we are seeing signs of stabilization and content increase per unit. PC OEMs have emerged from inventory digest and are now shipping closer to end demand. Gaming will remain strong, while enterprise SSD for cloud applications will remain soft. We anticipate modest growth in bit shipments into the fiscal fourth quarter. Before I hand the call over to Wissam, I would like to thank the Western Digital team for the response efforts they made in addressing the network security incident we disclosed on April 2nd. Our team took proactive and precautionary measures to secure our operations and successfully executed on our business continuity plans. With that, I’ll turn it over to Wissam.

Wissam Jabre: Thank you, David, and good afternoon, everyone. Fiscal third quarter results reflected the challenging market environment with continued pressure on revenue and profitability. Total revenue for the quarter was $2.8 billion, down 10% sequentially and 36% year-over-year. Non-GAAP loss per share was $1.37. Looking at end markets, cloud represented 43% of total revenue at 1.2 billion, down 2% sequentially, driven by an increase in capacity enterprise drive shipments, which was offset by a decrease in Flash shipments. Nearline bit shipments were 79 exabytes, up 31% sequentially. Year-over-year, revenue declined 32%, primarily due to a decline in shipments of both hard drive and flash products, as well as price decreases in Flash.

Client represented 35% of total revenue at $1 billion, down 10% sequentially and 44% year-over-year. On both a sequential and year-over-year basis, the decrease was driven by price declines across our flash products and lower client SSD and hard drive shipments for PC application. Finally, consumer represented 22% of total revenue at 0.6 billion, down 22% sequentially, and 29% year-over-year. Sequentially, the decrease was due to a seasonal decline in shipments of both retail hard drive and flash products, as well as price declines in retail flash. The year-over-year decrease was driven by lower retail hard drive shipments and price declines in flash. Turning now to revenue by segment. HDD revenue was 1.5 billion, up 3% sequentially and down 30% year-over-year.

Sequentially, total HDD exabyte shipments increased ] and average price per hard drive increased 10% to $109. On a year-over-year basis, total HDD exabyte shipments decreased 23%, and average price per unit increased 9%. Flash revenue was 1.3 billion, down 21% sequentially and 42% year-over-year. Sequentially, Flash ASPs were down 10% on a blended basis and 12% on a like-for-like basis. Flash bit shipments decreased 14% sequentially and 1% year-over-year. Moving to costs and expenses, please note that my comments would be related to non-GAAP results unless stated otherwise. Gross margin for the fiscal third quarter was 10.6%, down 6.8 percentage points sequentially and 21.1 percentage points year-over-year. This includes $275 million of charges for manufacturing underutilization, inventory write-downs and other items.

HDD gross margin was higher than anticipated at 24.3%, up 3.6 percentage points sequentially and down 3.4 percentage points year-over-year. Sequentially, the increase was primarily due to higher capacity enterprise volume, as well as lower manufacturing costs and underutilization related charges. Underutilization charges were less than projected at approximately $40 million or 2.7 percentage points, partially benefiting from the actions to streamline our manufacturing footprint and offsetting other charges of $22 million. Flash gross margin was negative 5%, down 19.5 percentage points sequentially, and 40.6 percentage points year-over-year. Underutilization charges associated with the reduced manufacturing volumes were approximately $160 million or 12.2 percentage points, less than expected as we focused on lowering manufacturing costs.

During the quarter, we incurred $53 million of flash inventory write-down charges resulting from projected selling prices falling below the cost of inventory. We continue to tightly manage our operating expenses, which were at $602 million for the quarter, down 57 million sequentially and 138 million year-over-year. Operating loss in the quarter was $304 million, driven by underutilization charges, inventory write-downs and other items totaling 275 million. Income tax expense was $60 million. Despite a consolidated loss, we continue to have taxable income in certain geographies resulting in taxes payable in those areas. Fiscal third quarter loss per share was $1.37, inclusive of a $9 million dividend cost associated with the convertible preferred equity.

Operating cash flow for the third quarter was an out flow of 381 million and free cash flow was an outflow of 527 million. Cash, capital expenditures which include the purchase of property, plant, and equipment and activity related to our Flash joint ventures on the cash flow statement was $146 million. Gross debt outstanding was 7.1 billion at the end of the fiscal third quarter. Trailing 12 month adjusted EBITDA at the end of the third quarter, as defined in our credit agreement was 2.5 billion, resulting in a gross leverage ratio of 2.8x, compared to 2.1x in the fiscal second quarter. As a reminder, our credit agreement includes $0.7 billion in depreciation addback associated with the Flash joint ventures. This is not reflected in our cash flow statement.

Please refer to the earnings presentation on the Investor Relations website for further details. At the end of the quarter, total liquidity was $5.3 billion, including cash and cash equivalents of 2.2 billion, undrawn revolver capacity of 2.25 billion, and unused delayed draw term loan facility of 875 million. Before I cover guidance for the fiscal fourth quarter, I’ll discuss the business outlook. We expect HDD revenue to decrease sequentially, due to ongoing inventory digestion at cloud customers. We expect Flash revenue to decrease sequentially as modest growth in bit shipments is more than offset by ASP declines. We expect Flash bit shipment growth to accelerate in the first half of fiscal year 2024. In the fiscal fourth quarter, total gross margin will be negatively impacted by underutilization charges and Flash pricing.

We continue to tightly manage our cost structures through this dynamic environment and expect operating expenses to be below $600 million. For fiscal year 2023, we project gross capital expenditures to be approximately $2.2 billion, and cash capital expenditures to be approximately 0.8 billion. The projected cash capital expenditures represent more than a 50% reduction from our forecast as we entered fiscal year 2023 and approximately 35% reduction from fiscal year 2022. I’ll now turn to guidance. For the fiscal fourth quarter, our non-GAAP guidance is as follows: We expect revenue to be in the range of $2.4 billion to $2.6 billion. We expect gross margin to be between 3% and 5%, which includes underutilization charges across Flash and HDD totaling $220 million to $240 million.

We expect operating expenses to be between $580 million to $600 million. Interest and other expenses are expected to be approximately 90 million. We expect income tax expense to be between $60 million and $70 million. We expect loss per share of $2.20 to $1.90, assuming approximately 321 million shares outstanding. I’ll now turn the call back over to David.

David Goeckeler: Thanks, Wissam. Over the past few quarters, we have successfully ramped a series of industry-leading storage products and commercialized innovative technologies, while concurrently rightsizing our cost structure. Our proactive actions have positioned Western Digital favorably for the future as demand gradually returns to normal levels. In closing, I would like to thank our team members for their unwavering commitment in advancing innovative products and driving operational efficiency. Their exceptional efforts have allowed Western Digital to deliver in to the dedication and support of our people worldwide, and we remain committed to upholding the highest ethical standards in all that we do. Okay. I look forward to your questions. Let’s open it up.

Q&A Session

Operator: Our first question comes from C.J. Muse from Evercore ISI. Please go ahead.

C.J. Muse: Yes, good afternoon. Thank you for taking the question. I guess I’d love to get a sense for where you’re seeing demand stabilize versus where you still see pockets of inventory? And as part of that, I guess embedded in your revenue guide, it looks like you’re kind of suggesting HDD down maybe 10% to 15%, SSD down 5% to 10%. So, I guess is that kind of the right way to think about it? And then as part of that, where do you think we’re seeing stabilization and where do you think we need to work down inventory some more?

David Goeckeler: Inventory correction there is mostly behind us. Our channel business performed really well this past quarter, I think, above what our expectation was. The inventory issue is still very much in data center and it’s very lumpy. We have some big cloud customers that are consuming. We have others that are really in a full inventory digestion and aren’t taking anything. So that market is still where we see a lot of inventory digestion going on. And I expect that to be lumpy for the next couple of quarters. We are seeing some signs of stabilization in China. We talked about that. I think it’s setting up for recovery in the second half of the year, a lot more activity around RFPs and discussions about what demand is going to look like the second half.

So, that’s a bit – an overview of where we see the market. I think on your numbers, you’re probably down a little more than we are on HDD. I think that’s probably more a single-digit kind of number on a sequential basis.

C.J. Muse: Very helpful. And as a quick follow-up, can you kind of walk us through what you’re thinking today in terms of underutilization charges beyond the June quarter?

David Goeckeler: Yes. Well, let’s talk about for each business. I mean, I think in HDD and I’m sure Wissam will have a little bit to add here as well. HDD, which is the smaller part of the number, but still significant we’re going to see a drop in volume next quarter. So, we’ll see some underutilization there. On the Flash side, we continue to underutilize the fab. We’re managing it in a very dynamic way, kind of week-to-week month-to-month to make sure we’ve fully understand demand and keep our inventory in a position where we want it. And so – but we will definitely see underutilization on both sides of the business next quarter.

Wissam Jabre: And just to add – C.J., sorry, just to add a bit more color, I think we – in our guide, we’re estimating around , the range of underutilization charges. And by business, this is roughly two-thirds Flash, one-thirds HDD or one-third .

C.J. Muse: Thank you.

David Goeckeler: Thanks, C.J.

Operator: Our next question comes from Joe Moore from Morgan Stanley. Please go ahead.

Joe Moore: Great. Thank you. You mentioned that you’re taking lower cost for market charges on NAND, can you talk about the methodology there? Is that – do you pool that and then take a charge overall or is it anytime any individual product falls below the market price you adjusted down?

David Goeckeler: So, Joe with respect to our LCM charges, we do it at the finished good product level. It is not pulled.

Joe Moore: Got it. Okay. Thank you. And then in terms of the underutilization charges and things like that, do you know how the covenants are going to be defined? Are you going to be able to remove those charges from the EBITDA number as defined in the covenant?

David Goeckeler: Those are typically allowed to be added back per our credit agreement to the EBITDA.

David Goeckeler: Okay, great. Thank you very much.

Wissam Jabre: Thanks Joe.

Operator: The next question comes from Aaron Rakers from Wells Fargo. Please go ahead.

Aaron Rakers: Yes, thank you for taking the questions. Just to build on that last question, just to be safe. Your gross margin expectation in this current quarter, I’m guessing the commentary assumes that you’re not expecting another inventory charge in the flash business? And if so why not?

Wissam Jabre: So Aaron, we typically factor into our guidance all the expectations. And when we exited Q3, like a typical quarter, we do our reserve reviews and we take the – we make sure that the balance sheet properly stated. And so based on our forecast, everything is baked into the guidance. Typically, we have a small amount in the guidance just like we did also in the past quarter.

Aaron Rakers: Okay. And then I guess my follow-up question is on the hard disk drive business, I can appreciate you guys seeing some cloud customers, kind of – it sounds like purchased really no product this last quarter. I’m guessing from a competitive perspective how would you characterize the current environment? Have you seen increased price aggressiveness? How do you guys think about the discussion around HAMR and your roadmap going forward, etcetera?

David Goeckeler: Yes, I mean, I think there’s always price pressure in this market Aaron, but we’ve been very disciplined about the value of our products. I think you – one of the things we feel very good about is, we’ve been investing in our HDD roadmap, things like OptiNAND, ePMR, UltraSMR, these products are really now starting to ship in volume. We talked about the 22-terabyte CMR drive was the highest volume drive at 20 and above. So, we feel very good about where the portfolio is, about where it’s going. We’ve got a number of very large customers qualifying SMR right now. That’s clearly the next step in the data center, our UltraSMR product there, the 2016, we talked about we’ll finish up calls this quarter and start deploying next quarter.

So, we feel like we’ve got a portfolio that is aligned with what the market needs. And that’s showing up in, kind of how we’re able to monetize that portfolio and not have to compete on price. So, future technologies like HAMR will be there. We’re still are ways away before that product is going to be a volume type product. The volume products are the 22s going and then SMR are going to be the big volume products over the next couple of years and after that we’ll get to HAMR. We feel confident about that technology. It’s been in development for a long time. We’re in the final stages of it as an industry and I think everybody is excited that it will be the roadmap for 30 and above when we need it.

Aaron Rakers: Thank you.

Operator: Our next question comes from Sidney Ho from Deutsche Bank. Please go ahead.

Sidney Ho: Thank you. I wanted to ask about the network security breach. Can you give us an update on the recovery there? Looks like your operations are back to normal levels, but have you experienced or do you expect any more issues with productions or your ability to ship products?

David Goeckeler: Yes, we’ve been very transparent about that incident. When we noticed it, we let folks know, we took our – we basically disconnected ourselves from the public Internet to protect ourselves and then restore the environment. We still have capabilities inside the companies and the factories were operational throughout that. Clearly, a tremendous amount of work by the team, but we feel like we’re nearly all the way back now as far as operation. We got to bring the store online in here in another week or so, but it was really, really good to see our business continuity plans, you don’t want to rely on them too often, but when we had two, they were there and they kept the company moving forward.

Sidney Ho: Okay, great. Thanks for that update.

Wissam Jabre: Sorry, Sidney. I just wanted to add that for fiscal Q3, we don’t have any impact in the numbers to the network security.

Sidney Ho: Okay. That’s great. Maybe my follow-up question is, Samsung talk about their cutting production. I’m curious if your competition with the customers have changed since that announcement, and related to that, do you expect the June quarter to be the bottom of – for your margins for your Flash business? Thank you.

David Goeckeler: I would say, we have – I mean obviously we have very robust conversations with our customers all the time. I wouldn’t pin the tone of conversations on to how any one particular player in the market is acting or what they’re doing. We stay very focused on our business. As far as where is the bottom, I mean we expect the market to come into balance as we go through the second half of the year. I think we’re clearly taking a lot of actions in our own business to closely manage it, supply and demand. Keep the utilization of the fab close to where demand is. So, we manage our inventory. Clearly, we’re going through one of the most severe downturns in a while, but we think as we move through the second half of the year the market will come into balance.

Sidney Ho: Great. Thank you.

Operator: Our next question comes from Mehdi Hosseini from SIG. Please go ahead.

Mehdi Hosseini: Yes, thanks for taking my question. One near term and more to with inventory. Your inventories are – absolute dollar value keeps going higher. And I want to understand how the mix is changing between wafers, finished good, and other material? Is there any way you can give us a color how incremental changes are happening for different categories within inventory, and have a follow-up?

Wissam Jabre: Yes, we typically don’t break that out as much on the call. This is a bit too much detail, Mehdi, for me to discuss here. The one comment I would make though, when we think of inventory, our operations team is really focused on minimizing where we can. So, we basically try to stage it in the places that makes the most sense from a demand perspective.

Mehdi Hosseini: Let me rephrase the question. How do you – how should we think about the risk of inventory write-down?

Wissam Jabre: I mean, the inventory write-down typically is, it’s really based – the ones that was, for instance, I called out is based on basically the inventory value relative to where the market price is. And so, if – when prices decline by a lot, then we do have to take a closer look and see if there’s any impact, but that’s what I would say about that.

Mehdi Hosseini: So, would – are you assuming that the rate of price decline is moderating, so maybe that would minimize the downside risk?

Wissam Jabre: What I’m saying is, we – what I’m saying is, at the end of every quarter our balance sheet is properly stated because we do look at where the inventory value is versus where the demand is and the prices are most particularly at the finished good level. And so, where we see differences we have to adjust our inventory value, otherwise it is properly stated. I guess your question is more around trying to predict where the price is going and we typically don’t necessarily do that.

Mehdi Hosseini: Okay. Thank you. And then the question for David, looking at longer-term more than just one quarter. I think there is some confusion or unknown factor how new type of AI would impact demand for HDD versus SSD, do you have any view how this incremental demand created. These are expensive working stations. How is it going to impact SSD versus HDD?

David Goeckeler: We’re doing analysis on that, Mehdi. What I would say is, to me – I’ll even go a little longer-term, bigger picture. This just reinforces the value of stored data. I think that it just seems like there’s this constant ways for people can figure out how to use all the data they’ve stored to do very productive things with it. And I think the latest is training these AI engines. And so, we just think it’s another element of the long-term value of data storage and it’s just a big secular tailwind for the HDD business and the enterprise SSD business. I mean, again, you know that they’re both – they both have big TAMs in the data center, and they’re both growing. And we think this is another reason why people will store more data is because they can monetize it in different ways in the future.

Mehdi Hosseini: But I guess I was hoping you would shed some light as to how the HDD CAGR would change? I don’t think this is going to lift the TAM for each different types of stores at the same rate. Is there any thoughts that you can share with us?

David Goeckeler: I think it will – HDD is the lion’s share of storage in the cloud. So, you would expect that’s where the bigger lift would be across those two technologies.

Mehdi Hosseini: Okay, thank you.

David Goeckeler: Thanks Mehdi. It’s good to talk to you as always.

Operator: The next question comes from Shannon Cross from Credit Suisse. Please go ahead.

Shannon Cross: Thank you very much for taking my questions. My first is, as you look at what you’re doing on OpEx in terms of holding in cost, how do you think about the – how you’re – where you’re investing? And how are you making those decisions? And how should we think about potential impact to future projects at this point? And then I have a follow-up. Thank you.

David Goeckeler: Yes. We’ve been very – obviously, we’ve been – one of the things we’ve been building into the business over the last several years as we’ve restructured the business is more agility and the ability to proactively respond to the market we’re in. I think that’s kind of the hallmark of the organization we’re trying to build is agile and dynamic. But clearly, on top of that, Shannon, we went to a business unit structure for a reason. It’s because we have two very, very focused organizations with very sophisticated leaders in them that is constantly doing the ROI analysis of where we put our OpEx, and we get the most out of it. And I think quite frankly, that’s led to the portfolio we have today. I think we have the best portfolio we’ve ever had.

And that’s an effort that goes on constantly, continuously. And so, as we continue to draw down OpEx to resize the business to the realities of what the market is. We’ve built the capability over the last couple of years to do that in a way where we can make sure we’re going to get – first of all, the OpEx we spend, we get the best ROI out of it, the best return and that we make sure that we’re making – we’re taking actions to the business that don’t harm the long-term value of it, and we make the right decision on a day-by-day, week-by-week, month-by-month basis. So, I think this is really a capability we’ve built in the last three years, and I think it’s serving us well right now to make sure that we’re not cutting in ways that are going to impact the long-term health of the business.

Shannon Cross: Thank you. That was helpful. I’m curious – and maybe I’m trying to make lemonade out of lemons. But I’m just wondering, as you’ve cut capacity on the HDD side, and you’ve had these underutilization charges, are there things that you’ve learned in terms of maybe how you manufactured in the past ways to drive incremental productivity? I’m just thinking it’s kind of – it’s certainly a unique time to maybe take a step back and look how things are – how things have been done and what you can do in the future? Thanks.

David Goeckeler: So, I’ll make a few comments. I suspect Wissam will have a few comments as well. I mean this is – there’s been a lot of focus on this in the last year of how do we become more efficient, how do we automate more. Several of our factories have won World Economic Forum Lighthouse awards for automation. How do we rescale our employees? And how do we just – we’ve been very focused on driving a level of automation, driving productivity, and just lowering our fixed cost asset base in the HDD business. And I think our fixed – I don’t think I know, our fixed costs in that business are now the lowest they’ve been in well over a decade. So, I think that’s paying off in the way we’re able to generate margin in the business at lower volume levels. And then as the volume starts to pick back up, we’ve got capacity to meet what the market needs, and I think we’ll do that at a much lower cost basis.

Wissam Jabre: Yes. I mean the one thing I would add also, in addition to what David said, some of the activities that we drive in terms of the manufacturing side are taken back into the development organizations to think about things that come on platforms and the ability to improve on the way our products are designed for manufacturing efficiency, even increasing manufacturing efficiency going forward. And of course, with that comes a better cost structure.

Shannon Cross: Alright. Thank you very much.

David Goeckeler: Thanks, Shannon. Appreciate it.

Operator: Our next question comes from Krish Sankar from TD Cowen. Please go ahead.

Krish Sankar: Hi, thanks for talking my question. David, first question is on your NAND ASP decline in March quarter, seems to be better than what your competitors had. I’m just kind of curious, any puts and takes if you talk about your specific pricing versus competition in March, how to think about it in June? And along the same path, you mentioned the supply-demand balance later this year and bit shipment for flash growing. Are you baking in some, kind of a mobile recovery that’s going to help you drive that? And then I have a follow-up.

David Goeckeler: Yes. I think on pricing, it’s kind of the same story all the time, right? Whether it’s a down market, upmarket, mid-cycle market, which is really have a diverse portfolio. We’ve talked about this a lot from retail to the channel business, PC OEMs, enterprise SSD gaming has become a very nice part of the portfolio and growing part of the portfolio. And it’s just that – mobile, obviously, is a big part of our portfolio. And it’s just been mixing across that where we get the best return, right, putting our supply and our bits in the places where we can get the best return. I do think that, that is a – that go to – that breadth of go-to-market is in markets that we can reach literally from every single consumer to the largest technology companies in the world and kind of everything in between.

And just the ability to mix across that with a strong portfolio and a strong set of brands as well, SanDisk, SanDisk Professional, WD_BLACK, puts us in a good position to get the best return on our supply. Next quarter, we don’t really want to comment on future pricing. It’s all into the guide. We’ve talked about the individual markets. What I would say is, we’re pricing in or we’re putting in what we think is going to do on an individual market-by-market basis and then how we’ll mix that next quarter.

Krish Sankar: Got it. Got it. Thanks for the dividend. And then as a follow-up on the HDD side, it’s kind of nice to see the 22 terabyte CMR is now bigger than 20 terabytes in terms of volume. How should we expect that to grow? And what is its impact on gross margin?

David Goeckeler: I think that’s our focus – on a CMR drive, that’s our focused capacity point and it’s significantly ahead of other CMR drives above 20. So – or above the 20 terabyte drive. We expect that to be our premier drive for the next – until we have a different CMR product in that part of the business. So, we expect that to be a very good growth engine, and we’ve talked a lot about that drive of – it provides a lot of value. It provides a lot of TCO value for our customers. And we – it contributes an appropriate amount of margin from that perspective as well.

Krish Sankar: Got it. Thanks David.

David Goeckeler : Thank you.

Operator: Our next question comes from Wamsi Mohan from Bank of America. Please go ahead.

Unidentified Analyst: Hi, thanks for taking my questions. It’s filling in for Wamsi today. David, I think maybe another pricing question for you. I think you talked about price elasticity. Could you just elaborate a little bit on what exactly you’re seeing either in Flash or in HDD? And a related question to that is, there’s some worry that maybe a lot of memory inventory might be built again this quarter from the likes of some OEMs like Apple because they want to maximize their favorable component pricing? So, do you think this could lead to a further elongation in the recovery of the market, even though in the near-term it might get a little bit tighter? So, just your thoughts on that? And what exactly are you seeing in price elasticity?

David Goeckeler: I think the elasticity in NAND is mainly what I was talking about. I mean, we’re seeing PC OEM up mid-20s year-over-year on capacity. I think a really interesting number to me is the elasticity across our consumer franchise, which is tens – hundreds of millions of devices we sell a year in that channel up a third year-over-year on capacity per unit. Gaming up more than that, and mobile up even more than that. So, I think we’re seeing the market work. Even in the midst of a great downturn, you expect – well, especially in the midst of a great downturn, you expect to see elasticity start to kick in, and we are starting to see that across the portfolio. What was the second part of the question, again?

Unidentified Analyst: It was about a customer .

David Goeckeler: Prebuying. Yes. I think you do see – I think we are seeing instances of that. I wouldn’t say it’s pervasive, but we see instances of it. And I think it – I think maybe it’s a sign of where the customers think we are in the cycle as well.

Unidentified Analyst: Got it. So, for my follow-up, if I can ask a quick one to Wissam, how are you thinking about free cash flow going forward? I mean is it – what needs to happen to get to positive free cash flow? And is that possible in this calendar year? So, just your thoughts on that? I mean, how are you looking at working capital and thinking about free cash flow? Thank you.

Wissam Jabre: Yes, . So, we are totally focused on free cash flow. As you’ve seen us since the beginning of the year, we’ve been very proactive on OpEx, reducing that quite a bit on CapEx, as well as taking underutilization to manage and preserve our cash and not build inventory. And so, this is very important to us. In fact, we continue to make improvements. I mean, if you look at our CapEx trend, it’s gone down quite a bit. This year, we’ll probably be spending approximately if not even more than 35% below last year. With respect to the next few quarters, we typically do not guide for free cash flow. But what I could say is that this is, as I said, a top priority for us and is a big focus, as you would imagine, as we navigate the dynamic environment.

Unidentified Analyst: Thank you for all the detail. Appreciate.

David Goeckeler: Thank you.

Wissam Jabre: Thank you.

Operator: The next question comes from Tom O’Malley from Barclays. Please go ahead.

Tom O’Malley: Hi, good afternoon guys and thanks for taking my question. My first one is related to the HDD side of the business. Your competitor recently talked about a recovery that initially was expected to be in June and is now pushed out to the December quarter. Could you just frame the way that you’re thinking about the recovery? Is it kind of in-line with that? You’re obviously guiding the HDD business down, but any color you could give on the back half of the calendar year about when you expect that business to recover?

David Goeckeler: Yes. I think, Tom, it’s – I would say as we go through the second half of the year, it will get better. The issue is that these revenue levels and these unit levels, it’s just very lumpy. You have very large customers that if they buy or not buy, it can impact the TAM and the available market in a very significant way. So – and that’s what we’re experiencing next quarter. I mean, this quarter, we saw things were a little better than we thought on capacity enterprise shipments. We’ll see a sequential decline in that, and then we’re expecting to go back up as we go in the second half of the year. But I expect it to be lumpy as we go through this inventory digestion because a lot like we saw in the PC OEM space, a lot of customers are just completely focused on inventory digestion, which is basically new purchases just go to zero.

And customers at this scale with this, kind of business that has an impact. So, I expect to see a lumpiness over the next several quarters. I do have a level of optimism about China in the second half of the year. We’re seeing better activity there. And so, we expect to see that improve in the second half of the year as well, which should also help the business.

Tom O’Malley: Helpful. And then just a follow-up is on the Flash side. You guys talked about a mix of customer behavior, right, where some are still consuming inventory and then others are more aggressively purchasing to various degrees. I don’t want you to speak on specific customers, but we’ve heard this across the ecosystem, particularly through this earnings period here where there is a discrepancy in terms of spend. Could you help maybe just frame where you’re seeing that spend? Is there a certain type of customer that’s spending more than others or is it really just random where guys came in with certain inventory levels and are working through that? Just any color there would be really helpful as we’ve heard that data point from multiple companies here?

David Goeckeler: I guess I would say that customers that are different segments of the market that are through their inventory digestion are now more or less shipping to end demand being lean on inventory. There are instances of people doing strategic buys in that – in some of those cases where they’ve got their inventory to where they want it, but now they’re making their own – they have their own view of the cycle. That’s a very small number, I would say. And then the other one is just – where they’re at in their – the data center customers especially are just in – there’s a variability of the level of inventory at each customer, and they’re so big that it can impact the entire market. So – and like I said, ones that have heavy inventory are basically working that down in an aggressive way. And so, I think it’s going to – like I said, I think it will be lumpy for a couple of quarters until we get through that.

Tom O’Malley: Thank you.

David Goeckeler: Thanks, Tom.

Operator: Our next question comes from Toshiya Hari from Goldman Sachs. Please go ahead.

Toshiya Hari: Hi, good afternoon. Thank you so much for taking the question. David, three months ago, you mentioned that you were cutting production in your NAND business by 30%. I’m curious if the magnitude of the cuts today are, kind of in that ZIP code, if anything has changed materially? And going forward, what would you need to see to start taking up your utilization rates in the Flash business?

David Goeckeler: Yes. We’re kind of at the point where we’re – I think it’s – I think probably the same ZIP Code is probably a fair way to say depending on where you live, ZIP codes can be pretty big if you’re in the country, I guess. But it’s really about managing to where we see the demand and keeping our inventory relatively in check. We know it’s going up somewhat, but we want to make sure it doesn’t get away from us. So, we’ll use the fab in that. I mean, we’re just – we’re going to have to see demand signals for our customers is just as simple as that. We have a very close relationship with a lot of them. We’re in the – obviously, in the market every single day. A lot of these consumer and channel markets are more transactional, where we can see the business across a wide swath.

And then, of course, we’re talking to the biggest customers biggest technology companies in the world. So, we’ll get a – we have a pretty good idea of where their demand is, and we’ll set the fab appropriately to make sure that we keep the right inventory position and we have the product when they’re ready.

Toshiya Hari: Got it. That’s helpful. Thank you. And then one follow-up for Wissam on the balance sheet side of things. I know you don’t guide free cash flow on a quarterly basis or annual basis, but just curious how we should be thinking about inventory, whether it be dollars or days, going into the June quarter and working capital overall. Is that going to be a consumer of cash in the June quarter or do you think you can generate some cash from working capital? Thank you.

Wissam Jabre: Sure, Toshiya. With respect to inventory, the current projection is, I would say, flattish in terms of dollar, but in terms of days, I anticipate we should see a downtick from here. Well, we continue to, as David said, manage it on a very, very regular basis very closely. And so, that’s probably the biggest in terms of the working capital. That’s the number that would be moving the most. Again, we don’t guide the free cash flow, so I wouldn’t want to make any more comments around working capital. But I think the answer on the inventory would be a good indicator to what working capital will look.

Operator: Our next question comes from Harlan Sur from JPMorgan. Please go ahead.

Harlan Sur: Hi, good afternoon. Thanks for taking my question. The market share numbers are out for last year, you guys drove a strong number 2 position in client SSD, strong double-digit sort of percentage share position, right? But in enterprise, you guys drove, sort of low single-digit enterprise SSD market share last year, and it’s sort of hovered in this 4% to 7% range for a while now, like what is the team doing to try and drive its share in this fast-growing market to more of what I would call appropriate, sort of double-digit percentage share profile?

David Goeckeler: Yes. Thanks for the question, Harlan. Always good to hear from you. We’ve talked about this quite a bit over the last year. It’s about qualifying the products at the big players, qualified in the channel. We just qualified this last quarter on BiCS5 enterprise SSD with some of the biggest customers. So, the road map is moving forward as we expected. It’s just a very dynamic market right now. So, it’s difficult to judge share. Obviously, our goal is what we’ve put out there is to drive that higher. And I have every confidence we’ll do that as the market stabilizes and some of these big customers get back to their normal rates of purchasing.

Operator: Our next question comes from Srini Pajjuri from Raymond James. Please go ahead.

Srini Pajjuri: Yes, thank you. I have a question on the cost side, Wissam. So, it’s a little tricky to figure out given all the, I guess, one-time charges. I’m just wondering, you previously talked about NAND cost declines in the mid-teens, I believe, just wondering if you’re tracking to that. And then as we go to BiCS8, how should we think about the cost declines, especially – I guess, historically, we’ve had 30% to 40% bit demand growth. And going forward, if that dynamic changes, if it’s lower than 30%, do you think we can still, kind of get to that mid-teens cost declines or do you need the 30% to get to that level?

Wissam Jabre: Sure. So, thanks for the question. In terms of Q3, we have to think of it basically with and without underutilization. When you factor in the entry underutilization charges, we wouldn’t be – we wouldn’t have reduced cost or cost income down by mid-teens. However, if we exclude that, then we’re close to mid-teens in Q3. Now, to your question on BiCS8. I mean this is – with the way our road map works and the timing of when BiCS8 starts ramping, it is pretty much designed in a way to allow us to continue that mid-teens reduction – cost reduction over time. I wouldn’t want to comment about the exact sort of percentage and so on in terms of the crossover because I think it’s a little bit premature to talk about this. But conceptually, that’s what we’re aiming with ramping BiCS8 slightly earlier than previously anticipated.

Operator: Our next question comes from Karl Ackerman from BNP Paribas. Please go ahead.

Karl Ackerman: Yes. Thank you. I was hoping you could discuss the trajectory of exabyte demand of your cloud customers in the next couple of quarters? And whether there’s a divergence and a recovery across on-prem and public cloud? And I guess as you address that question, how do you assess whether you might be shipping below normalized replacement demand? Thanks.

David Goeckeler: I think we see the enterprise and the cloud market. They’re both soft right now. So, we don’t see a huge difference between the two. Again, the difference is, Karl, that you got this idiosyncratic behavior at really big customers. So, a customer that usually buys a significant amount of hard drives in a quarter, hundreds of millions of dollars goes to zero. You can pretty much assume they’re buying under replacement demand. So, that’s kind of where we’re at. We just – again, other customers are going along more according to plan. So, the inventory level is a bit distributed across big customers. So, we look at this quite a bit to understand like where do we think the exabyte growth is and where are we setting the – our long-term production capabilities and all of that.

But right now, it’s just a little difficult to draw long-term conclusions and some of – a little bit behind some of your question, given just the way the market is – the lumpiness of the market.

Operator: The next question comes from Vijay Rakesh from Mizuho. Please go ahead.

Vijay Rakesh: Hi. Just a quick question. I don’t know if you talked about Elliott strategies, and I think they had filed some – they had some filings, but just wondering how that process is progressing? I don’t know if you can talk to it.

David Goeckeler: It’s progressing. Very active. Everybody in it is under NDA, so I can’t say anything about it, and we look forward to talking about it when we reach a conclusion.

Operator: Our last question comes from Ananda Baruah from Loop Capital. Please go ahead.

Ananda Baruah: Hey, thanks guys. Appreciate it. Maybe for Wissam. I might have missed it, but just wondering if there’s any context you can provide about how you’re thinking about the debt due in February of 2024? How you’re going to handle that, go back handling that? Thanks.

Wissam Jabre: Yes, Ananda. With respect to the 1.1 billion of convert due in February 2024, the plan is to address it over the next couple of quarters.

Peter Andrew: Okay. Jason, is that the last one?

Operator: Yes, that was the last question.

David Goeckeler: All right, everyone. Thanks for joining us today. We look forward to seeing you through the quarter. Take care.

Peter Andrew: Thank you.

Operator: This concludes today’s conference call. Thank you for joining. You may now disconnect.