Western Digital Corporation

Good afternoon, and thank you for standing by. Welcome to Western Digital's second quarter of fiscal 2020 conference call. Presently, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. At that time, if you would like to ask a question, you may press star 1 on your phone. As a reminder, this call is being recorded. Now we will turn the call over to Mr. Peter Andrew. You may begin.

Okay, thank you, and good afternoon, everyone. Joining me today are Steve Milligan, Chief Executive Officer, Mike Cordano, President and Chief Operating Officer, and Bob Ulau, Chief Financial Officer. Before we begin, let me remind everyone that today's discussion contains forward-looking statements, including product development expectations, business plans, trends in financial outlook 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-Q filed 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 websites. With that, I'll now turn the call over to Steve.

Thank you, Peter, and good afternoon. Western Digital delivered solid results in the second quarter as revenue came in at the midpoint of the guidance range and non-GAAP EPS was at the upper end of the range. Our performance reflects strong execution in our product roadmap, success in increasing our hard drive gross margin, and an improving flash environment. Notably, these results reinforce our prior comments that the June quarter marked the bottom of this flash cycle. We extended our capacity enterprise product leadership as we started sampling 18 and 16 terabyte CMR and 20 terabyte SMR drives in December. These drives feature our energy assisted magnetic recording technology providing unrivaled aerial density and TCO benefits. We expect to commence revenue shipments of the CMR drives in the March quarter and ramp shipments through the rest of calendar 2020. Our 14 terabyte platform is performing well, and customer interest in our air-based 10 terabyte drive is quite high. The strength of our capacity enterprise product portfolio will continue to allow us to maintain our leading market share position. We achieved our goal of high single-digit enterprise SSD market share and secured additional NVMe design wins, including at another major hyperscale customer, positioning us for continued revenue growth and share gains. We made an important announcement this afternoon of our next generation 3D NAND technology, FIX5, with 112 layers of vertical storage. FIX5 joins a full portfolio of 3D NAND technologies as our highest density and most advanced 3D NAND today, delivering exceptional performance and reliability. Our team executed well in the quarter, increasing our hard drive non-GAAP gross margins to approximately 31 percent from 28.5 percent in the prior quarter. We now expect an accelerated recovery in our flash gross margins in the first half of calendar 2020, with continued improvement through the end of the year. I will now ask Mike to share our business highlights.

Thank you, and good afternoon. Our December results reflect solid product execution, an increase in hard drive gross margin, and an improving flash market environment. Data center devices and solutions, we executed well in delivering new products, positioning us for continued share gains and profitable growth in calendar year 2020. In capacity enterprise drive, close collaboration between our heads, media, and mechanical design teams allowed us to simultaneously introduce energy-assisted magnetic recording technology and a triple-stage actuator in our new 16-, 18-, and 20-terabyte drives. These innovations provide us with continued aerodensity leadership and a greater design margin, resulting in best-in-class product quality and reliability. Our focus on introducing the right technology at the right time while delivering the best TCO and highest product quality to hyperscale and OEM customers makes us their trusted partner. In calendar year 2019, the success of our capacity enterprise product line, led by our 14 terabyte drive, drove over 40% year-over-year exabyte growth. We also started sampling our 18 and 16 terabyte CMR and 20 terabyte SMR drives and plan to commence revenue shipments of the CMR drives in the current quarter. As these drives ramp along with our 10 terabyte air-based drives, we're well positioned for continued leadership. In FLASH, we achieved our goal of high single-digit enterprise SSD market share as our MVME-based enterprise SSD revenue grew over 50% sequentially. Supply constraints limited our upside as demand was better than expected. I am encouraged to see the significant investments we have made in expanding our product portfolio over the past several years are enabling us to increase participation in higher margin, higher growth, and lower volatility parts of the flash market. We have secured additional design wins, including another major hyperscale customer. which demonstrates our success in broadening our product portfolio and diversifying our customer base. In calendar year 2020, we expect to double our enterprise SSD revenue as we move towards our goal of 20% market share. Our competitive position within the data center is unrivaled. Built on the breadth of our product portfolio, strong customer relationships, technology leadership, and superior product quality, We look forward to another year of strong growth in the data center market. Client devices, strong growth in client SSD, and smart video, along with growth in mobility and desktop hard drives drove the sequential revenue growth in the December quarter. As we enter the March quarter, Flash pricing continues to improve. Furthermore, starting in the June quarter, we expect to begin shipments into a new gaming platform. the gaming console market is expected to be a multi-exabyte opportunity this calendar year. Within client solutions, strong holiday demand for both our flash and hard drive solutions enabled revenue to grow on a sequential basis. At CES 2020, we demonstrated a range of innovative products, including the world's highest capacity pocket-sized portable SSDs, and the world's first USB 3.2 SSD, exclusively for gaming. This afternoon, we announced our fifth generation 3D NAND technology, FIX5. Utilizing a wide range of new technology and manufacturing innovation, FIX5 has significantly increased cell array density horizontally across the wafer. These lateral scaling advancements in combination with 112 layers of vertical memory capability enables VIX5 to offer up to 40% more bits of storage capacity per wafer compared to Western Digital's 96-layer VIX4 technology. We have commenced shipping initial consumer products built on VIX5, with mass production expected to begin later this calendar year. We believe inventory in the flash supply chain has returned to normal levels, and with strong demand for our products, we are experiencing pockets of tightness. These dynamics, combined with continued product execution in both flash and hard drives, position us well for continued profitable growth. I will now turn the call over to Bob for details on our financial performance.

Thanks, Mike, and good afternoon, everyone. Revenue for the December quarter was $4.2 billion, up 5% sequentially and flat from a year ago. Please recall that the September quarter was a 14-week quarter. By end markets, Data center devices and solutions revenue of $1.5 billion was down 3% sequentially and up nearly 40% year over year. On a sequential basis, growth in enterprise SSD was offset by a decline in capacity enterprise drives and the impact of our exit from the storage system business. Client devices revenue of $1.8 billion was up 11% on a sequential basis and decreased nearly 20% year-over-year. As Mike noted earlier, the sequential growth was driven by client SSD, smart video, mobility, and desktop HDD. The year-over-year decline was primarily due to pricing in Flash, our decision to limit our participation in mobility, and a decreased TAM for notebook and desktop hard drives. Client solutions revenue was $948 million. up 6% sequentially and flat year-over-year. Sequential growth was driven by strength in hard drives. By product category, flash revenue was $1.8 billion, up 13% sequentially and down 15% year-over-year. Flash ASPs were down 8% sequentially, primarily related to our increased participation in mobility. Bit shipments were up 24 percent sequentially. Hard drive revenue was $2.4 billion, roughly flat sequentially, and up 16 percent year over year. Average price for hard drive was flat sequentially at $81, and exabyte shipments were down 1 percent sequentially. As we move on to costs and expenses, please note all of my comments will be related to non-GAAP results unless stated otherwise. Gross margin for the December quarter was up 1.1 percentage point, sequentially to 25.9%. Our flash gross margin was 19.5%, up slightly from last quarter, as a better pricing environment was offset by our increased participation in mobile. The hard drive gross margin grew more than expected to almost 31%, from 28.5% the prior quarter. This improvement was due to the full realization of the cost benefits of the KL closure and a stable pricing environment as overall ASP per drive sequentially flat at $81. Operating expenses were $765 million. Operating expenses with normal incentive compensation expense would have been closer to $720 million. Operating cash flow for the December quarter was $257 million. and free cash flow was $377 million. Capital expenditures, which include the purchase of property, plants, and equipment, and activity related to flash ventures on our cash flow statement, were an inflow of $120 million. As previously noted, we are benefiting from the timing of the funds going back and forth between us and the joint venture. For the full fiscal year, we expect cash capital expenditures to be close to zero. Gross capital expenditures, which includes our portion of joint venture leasing and self-operating funding, is expected to be between $2 and $2.5 billion. In an effort to provide greater transparency and clarity into our capital expenditures, we've added a few new slides to our earnings presentation available on our investor relations website. In the December quarter, we distributed $149 million in dividends to our shareholders. We reduced debt by $388 million, which included an optional $325 million debt pay down. From a capital allocation perspective, our first priority is to reinvest in the business to maximize long-term shareholder value. After that, Paying our dividend and reducing our debt are the next priorities. At the end of the quarter, we had $3.1 billion in cash and cash equivalents. Our $2.25 billion revolver remained unused, and our gross debt outstanding was just under $10 billion. Total inventory dollars were down $165 million on a sequential basis as both hard drive and flash inventory decreased. Moving on, our non-GAAP guidance for the third fiscal quarter is as follows. We expect revenue to be in the range of $4.1 to $4.3 billion. We expect gross margin to be approximately 28.5 to 29.5 percent. Please note that this range includes approximately $70 million in costs associated with the K-1 FAB. Operating expenses are expected to be between $740 and $760 million. The midpoint of the guidance range assumes a return to normal variable compensation expense and selective new R&D investments. We expect interest and other expense of $80 to $85 million, and we expect the tax rate to be between 25 and 27%. As a result of this detailed guidance, we expect earnings per share between $0.85 and $1.05, assuming approximately $305 million in fully diluted shares. With that, I will now turn the call over to the operator to begin the Q&A session. Operator, we'll now take our first question.

Ladies and gentlemen, we will now begin the question and answer portion of today's call. If you have a question, please press star 1 on your phone. If you would like to withdraw your question, please press the pound key. One moment, please, for the first question. Our first question comes from Wamsi Mohan with Bank of America.

Yes, thank you, and congrats on the strong guidance. When you speak of an accelerated recovery here in flash gross margins, can you lay out the key drivers of that through 2020 and how you're thinking about the velocity of that recovery and any thoughts on where you might exit the calendar year?

Yeah, Wamsi, this is Steve. I'll take that question. So there's really a couple of different things that I would say are going on in terms of the flash market. One, the first thing is, as we indicated in our prepared remarks, we believe that inventory levels from an industry perspective to the best of our estimation have returned into balance or call it normal levels. So that's one thing that I've heard. The other thing is, is obviously we have been working very hard on improving our our product lineup, which is allowing us to sell into markets that carry higher gross margin profiles as well as their stickier business. And we believe that that will help us over time to manage the volatility that is associated with the flash business. The other thing is, is that, you know, as part of all that is, is that there's an increasing awareness on behalf of our customer base that that inventory supply and demand is tightening up. In other words, demand is going to exceed supply this year. And so, we're seeing customers recognizing that. Prices are improving. Right now, that tightness is kind of in pockets. It's not necessarily across the board. So, we're seeing pockets of tightness in the market. And as we move through the balance of the year, we expect that that tightness will increase. And so what that means from a gross margin perspective, last quarter we said that we thought we would see modest improvement in our gross margins in the flash area. Now we're saying that our margin profile will accelerate in terms of that improvement. And I would expect as we move into the back half of the year, we'll see an increasing more of that as the market tightens up even more in the back half of calendar 2020. What that means from a numeric perspective is that we would say that we have the opportunity for our flash gross margins to get into the 35% to 40% range as we get into the back half of the calendar year.

Okay, great. That's great, Steve. Thanks. I appreciate the color. And can you maybe just – you guys obviously executed pretty well in the quarter on the HDD side as you had guided to sort of have those margins step up as well. Can you talk about the path of the HDD growth margins from here as well? Thank you.

Yeah, I think the way to think about those is we're in a range where we're comfortable going forward, so we will continue to operate around the range that we were afforded.

With a bias for those margins improving over time as an increasing amount of our hard drive volume shifts to capacity enterprise. So what we've talked about is, you know, something in the mid-30% range. We're not necessarily saying that that will happen in this calendar year, but that should be the bias over a period of time.

Okay, great. Thank you.

Thank you. Our next question comes from Aaron Rakers with Wells Fargo.

Yeah, thanks for taking the questions. You know, first kind of keeping on the hard disk drive business, I know you talked about in the press release or the slide deck 100% plus growth year-over-year in near-line HDD capacity shipments. But, you know, given the competitive landscape and the questions, I'm curious, you know, what did that – how did that perform on a sequential basis? And how are you currently seeing the competitive environments?

Yeah, so I think in general, we maintain our leading market share position, call it in the kind of low to mid 50s. We'll see where this all settles out once everybody reports. We expect that to continue right through the first half of this calendar year. And then in the back half, we obviously think we have some opportunity to continue to grow slightly. So from a product positioning standpoint, we feel very good about not only our 14, which continues to be the highest volume shipper, but the expected ramp of our 16, 18, and 20, which will occur throughout the year. And as we noted in the prepared remarks, we will begin initial revenue shipments in the current quarter.

Okay. And then on the gross margin on the flash side, you know, mix can be a meaningful driver to gross margin. But I'm curious, as you continue to execute on BICS, I guess it would be BICS 4, and now we start to talk about BICS 5, can you just update us on how we think about the cost curve relative to that mixed shift effect to kind of take you back to that, as you said, 35% to 40% gross margin? And just where are we at currently in the mix of BICS4 in terms of BICS shift right now?

Yeah, BICS4 is the overwhelming majority of BICS. We're just starting the initial BICS5 ramp. The way to think about, Aaron, though, is really in this kind of 15% plus or minus annualized cost takedown. and certainly we would expect that to continue as we move through this next product transition. Relative to mix, I would say both product and market segment exposure and then, of course, the broader ASP pricing environment are going to be the drivers of the margin enhancement through the calendar year 2020. Thank you.

Thank you. Our next question comes from Mehdi Hosseini with SIG.

Yes, Ed. Thanks for taking my question. Two follow-ups for Mike and Steve. First, on the NAND side and on a game console, or rather a new game console, this is incremental, as I imagine the prior generations are hard disk drive based and now is migrating to SSDs. And there are some figures out there. I just want to see what is your assumption for the kind of an end supply that the new game console is going to consume, given the fact that this is incremental, and I have a follow-up.

Yeah, I think you're right. It is all incremental, and from an industry standpoint, and certainly from our standpoint, because we were not participating in the gaming market in 2019 calendar year on the hard drive side. I don't think we want to go any farther than what we said in our prepared remarks. This is going to be a large, multi-exabyte market, and we wouldn't want to comment any more specifically.

Okay, fair. Moving on to hard disk drive, obviously, you're introducing a new 18 terabyte. Can you help me understand how your cost competitive? I understand your product has a fewer number of plates. And as we migrate from 16 to 18, how that cost competitiveness is going to be used to increase market share?

Yeah. So I think from our standpoint, we think we have a significant time to market lead on 18 and 20. And so the platter count, to our understanding, is consistent with next generation. So our benefit relative to market share is always about bringing the right product to the market in a leading way, getting smoothly through customer qualification, and ramping quickly. We've been doing that generation over generation for several years. We will do that again on the 18-, 16-, and 20-terabyte product that we'll be ramping this year.

Yeah, and, Mehdi, we do have a cost advantage, and we would think that, I mean, that's represented in our underlying hard drive gross profit performance. And one of the things that you're alluding to is that our capacity enterprise drive, and this continues for the 16, 18, and 20 terabyte drives, that we are using aluminum media versus glass media, and that is at a lower cost.

Got it. Thank you.

Thank you. Our next question comes from Carl Ackerman with Cowen.

Hi, good afternoon, gentlemen. I have two, if I may. The first question is regarding your NAN supply outlook. You know, we're calling for 30 percent growth for the industry in calendar 2020. Is most of that coming from process conversions and what's sitting in inventory, or is it going to be dictated by adding substantial greenfield capacity at the K1 facility? And in addition to that, your South Korean peer last night spoke about industry NAND demand growing kind of high 20s for 2020. How does that play in your capital planning process?

Yeah, okay, Carl, one thing I want to comment on is when they were talking about high 20%, I believe that was supply growth, not demand growth. So, but anyway, I'll let Mike comment on the specifics.

Yeah, so all the growth, both ours and the industry, is technology transition. So our K1 expansion is all about technology, room for technology transition. There is no way for capacity in our plans going in, and that's really, I think, a consistent theme across the industry. And just to comment further on where we think, we talked about low 30s in terms of supply growth. Steve commented on what Samsung's comments were. We believe demand growth will be in the 35% plus range this year, hence the shortage.

Very helpful. Last one, if I may. Your enterprise has esteemed market share opportunity is quite significant and I think impressive, but When we think about that, how much of that is driven by a new server architecture launch this year versus retrofitting existing servers? And I ask because a Tier 1 US-based hyperscaler just announced after the close that depreciation will be lower for them in March due to an increase in useful life of their servers. So if I could just kind of talk about that a little bit, that would be great. Thank you.

Yeah. So, no, we're not dependent on any specific server transition. So what we're – able to do with our NVMe products is win both new server and existing socket design wins in the NVMe space. And then, of course, similarly in SAS, there'll be a series of new products announced where we will be designed in. So we're not dependent on any particular server transition, and it's really the power of and strength of the product portfolio as well as the customer's view of us as a preferred supplier that's driving that share growth.

Thank you.

Thank you.

Thank you. Our next question comes from Tim Long with Barclays.

Thank you. Just going back two for me as well, on the HDD side, Could you talk a little bit about as 16, 18, and 20 ramp through the year just for your near-line business, what do you think the gross margin and ASP impacts will be there? And then on the NAND side, there was an earlier comment. You talked a little bit about mix. Could you just give us a sense as to the dilution from mobile and should we expect – more or less participation in that market as we move through calendar 20. Thank you.

So the first one on the hard drives, and we have not been giving specifics on capacity enterprise margins, but they are better than average. And as we've said before, as our mix trends towards more and more capacity enterprise, we do expect a hard drive. Gross margins can get up into the mid-30% range. So that will be a benefit to us. And on the mix question, I mean, we're also not able to get specific in terms of exactly what the numerical implication was of mobile, but it obviously was dilutive to us this quarter. And over time, you know, we'll always participate some in the mobile market, but we'll continue to manage that.

Yeah, and as the flash supply-demand situation tightens up, we will see the mobile market become more attractive for us from a gross margin perspective.

Okay, good point. Thank you.

Thank you. Our next question comes from Joe Moore with Morgan Stanley.

Great. Thank you. I wonder if you could talk about the planning process behind the CapEx at the JV level on NAND to the extent that you guys are feeling better about the business and where profitability is going, you know, do you feel the need to change CapEx at the JV? And then I guess sort of second half of that question, you said earlier in the year that you can sort of get the industry big growth without a lot of CapEx because you won't have the fab shutdown, you won't have the power outage. You know, can you just update us on your thinking of, you know, how that impacts your supply growth for the calendar year?

Yeah, I'll comment overall on the CapEx in terms of bit growth and that sort of thing. I mean, you know, from an overall philosophical perspective, I mean, you know, we want to be adding bit supply to the market that is consistent largely with the overall growth from a demand perspective. So we're not, you know, as a result of the improving environment, we're not looking at accelerating or decelerating our plans. But, you know, over a longer period of time, we would want to try to manage our growth from a supply perspective to growth and demand. And so that hasn't changed.

Great. Thank you.

Thank you. And our next question comes from Mitch Thieves with RBC Capital Markets.

Hey, guys, just two questions for me. I just want to try to clarify or at least get some numbers around this or any way to think about it. So when you look at the SSD opportunities, you're trying to double your share there, or the NVMe, the statement you guys made in the slide deck, and you combine that with the gaming platforms coming in, how much of that is adding to kind of the overall demand? You guys gave out a 35% number. I'm just trying to understand how much of this you guys have clean visibility on so we can get an understanding of how much that demand is gaming plus your share gains on the enterprise side?

The broader industry demand number we gave you is independent of our own share growth and any one of these particular segments. Our view of 35% demand side growth on the year is an aggregate across the industry per bit. When we talk about segment share gains in enterprise SSD and in gaming, that's obviously... product segment related gains. So we're not going to talk specifically about that. I think you can kind of calculate where we think we're going on the enterprise SSD side, given my comments.

Yeah, and add kind of further context to that. I mean, what we're trying to do is we're trying to place our bids in those markets that characterize, I'll call it one or two elements. One, opportunities for us to add more value from a product perspective, thereby driving higher gross margins, refer to that as let's call it enterprise market. And then also those areas of the market that are either stickier, less volatile, so that we can manage the ups and downs that tend to occur in this kind of market. Gaming, yes, it's incremental from a flash perspective, but it also tends to be stickier business, more predictable, and so it has some of those characteristics that are attractive to us as we look to place our bids in more attractive parts of the market, as opposed to, let's call it, more transactional or price-driven areas of the market.

Got it. I understand. And then just last one, you guys have mentioned like 40% kind of NAN gross margins, kind of the goal you guys want to get to. I'm just trying to get a better understanding for how that ramps. Is that something you guys think you can exit at in calendar year, or is it going to take a lot longer than that, just looking for any sort of hell, but when do you guys think you can get to the kind of 40% number you've talked to in the past?

Well, what I commented on is that given the trajectory of our business and where we see it playing out in calendar year, we expect that our flash gross margin rate will move into the 35% to 40% range as we get into the back half of the year. Now, that's not being specific as that calendar Q3 or calendar Q4 wants to see exactly how the market evolves, but we clearly continue to believe that 40% range is the right level for us, and we believe that we'll begin to approach that in the back half of the calendar year.

Perfect. Thank you.

Thank you. Our next question comes from CJ Muse with Evercore.

Yeah, good afternoon. Thank you for taking the question. I guess first question, you talked about industry bit supply growth in the low 30s, and you would be in line with that. Can you share with us what you expect to revenue on a bit basis? And as part of your thinking there, how are you contemplating bits for mobility versus elsewhere?

Well, the one thing I'll say, we don't comment specifically, but we would expect to have our own inventory positions to be in quite balanced state. We are entering the year, and we expect to be exiting the calendar year. To the extent you want to calculate that, that will give you a feel for it.

Okay, and you're thinking on the mobility side, is that something that you're thinking maybe will stick more to enterprise and consoles?

No, the mobility side is not all created equal, and part of our effort over the last several years is getting more product diversification, as Steve talked about, some of the newer areas. But we will continue to maintain exposure to mobility. We will just manage that exposure and make sure we're making or we're able to make good choices as the market continues to evolve. So we see it as a long-term area of investment. We see there are some very attractive parts within the mobile marketplace. So we'll continue to be investing there. We'll just be able to manage our bid allocation more broadly through this calendar year and into the future.

Excellent. And as my follow-up, another question on NAN gross margins. Shocking. I'm curious if you could, I guess, speak to the K-1 charges when you think they might roll off and how accretive that might be. And also, given kind of the state of the industry today, Are you running 100% utilization? What kind of tailwind do you see there? Thank you.

Yeah, so in terms of K1, I mean, we're now having real production runs, and we'll continue to have more production as we progress through the year. This last quarter, we didn't have quite as large a charge as we thought we were going to. I think it came in around $65 million, and I think we had said on this call last quarter it would be around $75 million. In the current quarter, in the March quarter, we're expecting around $70 million in terms of a period expense charge. And that should start to go down after this quarter. And it's really a function of how we ran production and our, you know, obviously ability to absorb those costs. But it'll start to get better, I think, from here.

Yeah, and one thing just to comment on. When I talked about 35% to 40% flash gross margins in the back half of the calendar year, that is – inclusive of any potential startup costs that still remain in the back half of the year.

Thank you. Our next question comes from Munjal Shah with UBS.

Yes, hi. Thank you for taking my question. Two questions. One, could you just update us on the CEO search? And then secondly, on HDD exabyte, they were down 1% sequentially, but then you talk about 100 percent growth on an exabyte basis year-on-year. So, if you could tie those two as to why, on a sequential basis, the exabytes could be down. And related to NEARLINE, what's the visibility into 2020?

David Chambers- Yeah, so I'll take the CEA search comment or question, and then Mike can comment on Capacity Enterprise. So, regarding the search, the search process is ongoing. And one of the things that I will add to that is the Board is very pleased with the progress that they're making today. And so that's all the update we have for now.

And relative to the capacity enterprise marketplace, our fiscal quarter one was a record shipment for us. Our X by share was around 57%. We were operating to optimize both profit and maintain our kind of leading share position in the space. So some of that would be a little bit of a share drop. I talked about that 53% to 55% depending on on where things settle out. But as we look into the first half of this calendar year, we see demand across the breadth of the market remaining fairly strong, and we think we're in a good position to maintain this leading market share position that I just talked about. So visibility is good. Obviously, different customers have different plans, but when we aggregate it, we feel pretty comfortable with continued strength of demand through the first half of the calendar year.

Yeah, thanks a lot.

Thank you. Our next question comes from Stephen Fox with Cross Research.

Hi, good afternoon. Just a couple quick questions from me. First of all, you mentioned that you became supply constrained on the NVME SSDs during the quarter. Can you just sort of talk about how you work that through and what it implies for future growth, maybe this quarter, next quarter? And then secondly, I was wondering if you could expand on You commented about the pockets of tightness you're currently seeing. What exactly would you call out, I guess, besides enterprise? But anything you can elaborate on there and where maybe those pockets expand to in the coming quarter? Thank you.

Yeah, so I'll take the question on the NVMe supply constraint. It was not a flash supply constraint issue. Basically what happened is demand was better than we had expected, and it was some of the components that we use in our NVMe system SSD product. We've worked to resolve those, and it should not be an issue as we move forward through calendar 2020. And then the other question.

Yeah, so I think what we're seeing is, in general, demand has been very strong across client SSD, particularly in the performance categories. So in some parts of the world, there's constraints there, and that's being reflected in the movement on pricing in a positive direction.

Great. Thank you. Thank you. Our next question comes from Harlan Sir with JP Morgan.

Hi, good afternoon. Thanks for taking my question. Good to see the sharp growth in the enterprise and VME SSD platforms. Given the strong momentum on these products and the strong cloud spending environment, do you think that you guys actually exited the calendar year tracking that low double digits percentage market share or were you still somewhat constrained on the supply exiting the year?

Yeah, to Steve's comment, we actually saw demand in excess of our availability of the actual other components. So had we been able to fully realize that, frankly, we would have been in the low double digits on share. That remedies itself as we're now inside lead time. We continue to see strong demand for those products. And as I talked about, we expect a double revenue in that category year over year.

Great. Thanks, Min. On the HCD side, on the outlook for capacity enterprise exabyte shipments up kind of 35% year-over-year this year, seems a bit conservative. I mean, we're hearing that it's more likely in the mid-40% range with 60% type year-over-year growth in the first half of this year, just given the continued strong cloud spending trend. So, wondering if you can kind of lay out your assumptions, maybe here in the first half of the year for exabyte consumption, just given that cloud and hyperscale spending still seems to be quite strong.

Yeah, we haven't been too specific on that. I will say, I will give you a comment that we do see at this time a bias up in demand, so I think that's reflected in your comments. So, you know, relative to a 35% or so annual expectation, I think our current view is a bias up from there.

Great. Thank you.

Ladies and gentlemen, Due to time restraints, we ask that you please limit yourself to one question. Our next question comes from Ananda Barua with Loop Capital.

Hi. Thanks, guys, for taking the question. Congratulations on a solid performance, and it's good to see the guide really amplifying here. I'll just stick with Nearline. Steve, could you just give us a little more context about how you see the aesthetic, and then Mike as well, of the cloud cycle through the year. Mike, it sounds like you're saying you expect it through the balance of calendar year 20 now to some extent. Steve and Mike, do you see it potentially continuing? Is it the potential? I'm not asking for a guy, but the potential to continue X-Rite demand going up sort of into the back half of the year? Is this sort of one where it gets up to a A peak sooner, but then maybe sort of an extended kind of cycle. Any context there would be great. Appreciate it.

Let me try to clarify a little bit. We certainly see the first half of the calendar year remaining strong. I'll reference back the comments I just made. On an annualized basis, we've been talking about 35% annualized growth. We do see on an annualized basis a bias up from there. I wouldn't want to comment kind of any further on, you know, the way the full year or the shape of each of the individual quarters look.

Okay, that's helpful. I appreciate that clarification. Thank you, guys.

Thank you. Our next question comes from Srini Pajuri with SMBC NECO Security.

Thank you. Just to follow up on the previous question, Steve, I guess, you know, We have had pretty strong two quarters from the cloud and market here, and there is some concern that there may be a digestion period as we head into the first half, and I think Intel did say that they expect somewhat of a digestion period. I'm just wondering, you tend to have pretty long visibility, especially on the drive side. I'm just wondering if you're seeing any signs of slowdown out there that causes you to kind of believe that there's gonna be a digestion period.

Yeah, so again, all customers not created equal. There are some that are doing that, but when we aggregate it, the demand remains quite strong through the first half of the calendar year.

Thank you. Our next question comes from Vijay Rakesh with Mizuho.

Yeah, hi, guys. I'm just wondering, I saw your CapEx was down for fiscal 20, keeping that discipline. I was just wondering, as you look at the rest of the ecosystem, are you seeing Any aggressive CapEx or how do you use that? And also on the China side with YMTC as it continues to expand, what are your thoughts in terms of supply coming in with increased or aggressive CapEx given how NAND pricing has been trending? Thanks.

Yeah, you know, I'd comment in terms of, you know, overall industry to the extent that there's public information. But, you know, as Samsung indicated and others have indicated, we're all circling at a bid supply growth rate that's kind of in a similar neighborhood, you know, with Samsung talking about high 20%, you know, 20% growth rate, and we're talking low or mid, low 30s. And so we're kind of all aggregating, and we're not seeing anybody adding capacity from a NAND supply perspective that would concern us Certainly not in the short term because it would take up to 18 months for that to become productive capacity. And so we're not seeing anybody behave in a way that we think that would upset the balance from a supply-demand perspective. So we feel pretty good about that. YMTC, no real change in terms of our expectations there. We do not see them having any material impact in terms of the market for the next several years. And we'll continue to evaluate that. depending upon their ability to ramp not only from a pure production standpoint but from a technology perspective. But certainly no concerns, I would say, over the next two to three years in that regard. And that's kind of within the planning cycle that we would have visibility to.

Thank you. Our next question comes from Sydney Ho with Deutsche Bank.

Great. Thank you. The question is, if you can look at your calendar Q1 guide being roughly flat quarter-by-quarter, which seems to be better than seasonal, especially on the NAND side, can you talk about your expectations made by products, hard drives, solid-state drives, or by segments? Just curious how much of that above seasonal guide is a function of ASP improvements for NAND.

Yes. I'll comment at a really high level, and then Mike or Bob can add a little bit more specifics. But, I mean, if you look at first thing, I'm going to answer it in kind of a backdoor sort of way. If you look at our gross margin improvement quarter on quarter, which is, you know, which is pretty significant in terms of, you know, 25.9 to 28.5 to 29.5 in terms of the range, almost all of that is driven by improving flash environment. So, namely pricing. All right. And so, and yes, there's mixed improvements and that sort of thing. And so, that directly impacts revenue. So, when you look at an improving pricing, environment that's helping us to keep our revenues let's call it flattish on a quarter-on-quarter basis and then beyond that we continue to see the overall demand environment to be solid I mean just kind of solid not great not necessarily but not bad and so it's just kind of there and and that's both a flash and a hard drive statement and so that's allowing us to kind of work against what would be normal seasonality drop in revenue in calendar Q1. So those are really kind of the two big factors.

Thank you. Our next question comes from Nihal Chokshki with Maxim Group.

Yeah, thank you, and great to see the accelerated NAND flash recovery in the gross margins. I did want to make sure I understand the dynamic that is going on there. Do you expect your own NAND flash inventory to decline Q2 for the March quarter, which I think, as Micron has commented, they were expecting their NAND flash inventory to accumulate, but for NAND flash prices to increase. So I'm just wondering if you had some color there as far as your expectations on that.

Yes, this is Bob. I can make a couple of comments, and I don't want to start giving guidance for inventory by quarter. But we're still not satisfied with where we are on inventory in spite of the reduction that we saw this quarter. And our goal over the next few quarters is to get to at least five turns, and that's what we're focused on internally as a company. So it won't be strictly linear getting there, but we think we can achieve that fairly soon.

Thank you. Our next question will come from Patrick Ho with Stiefel.

Thank you very much. Maybe as they follow up to some of the questions about your 18 and 20 gigabit drive, I mean, terabyte drives that have been released, can you discuss how the gross margin acceleration or the path to your target gross margin is impacted by your ability to get those out sooner in terms of the development of those drives? You talked about, I think, last quarter, the nine-platter problem. was pulled in somewhat in terms of development. How does that help in the acceleration of the gross margin progression?

Yes, this is Bob. I guess the first thing I would say is our gross margins are already very good in terms of capacity enterprise. And as I said earlier, as our mix tends more and more toward capacity enterprise, that'll pull up our overall hard drive mix. Our mix was not as good as prior quarters this past quarter, but you still saw the margin improvement. You saw that ASPs stayed flat in spite of a tougher mix. So overall, I think margins are very solid on capacity enterprise, and I think as we introduce a new product, that trend will continue.

Thank you. And our final question will come from Mark Miller with Benchmark before we end with a short statement by our CEO.

Thank you, but I believe the questions I wanted to address about the second half strength and data center and also near line have been posed, so I don't need to pose those again.

Hey, Mark, good to hear your voice. All right, so thank you all for joining us today, and we look forward to seeing you at the upcoming Goldman Sachs Technology Conference in San Francisco. Have a good rest of the day.

This concludes today's conference call. Thank you for joining. You may now disconnect.