Western Digital Corporation

Good afternoon, and thank you for standing by. Welcome to Western Digital's fiscal third quarter 2023 conference call. Presently, all participants are in 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 one on your phone. 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 and Analysis of Investor Relations. You may begin.

Thank you, and good afternoon, everyone. Joining me today are David Geckler, Chief Executive Officer, and Wasam 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.

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 has 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 bit placement and bolster gross margins. 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 PCoEM, 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 updates, starting with HDD. During the fiscal third quarter, our HED 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 a 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 Kyoksha. 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, Bix 6 achieved its anticipated cost crossover during the quarter. Moreover, on March 30th, Western Digital in Keoksha announced our next-generation Bix 8 node, a groundbreaking technology that builds upon the success of Bix 5 and Bix 6. This new technology is based on circuit-bonded-to-array architecture, which provides several benefits, including reduced cycle time, faster yield ramp, better lateral scaling, and industry-leading IO performance when compared to products based on circuit under-array architecture. We continue to aggressively productize BIX 8 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 digestion 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 Usam, 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 Usam.

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 bid 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 15%, 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 will 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 outflow 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 2.8 times compared to 2.1 times in the fiscal second quarter. As a reminder, our credit agreement includes $0.7 billion in depreciation add-back 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 bid shipments is more than offset by ASP declines. We expect flash bid 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 an 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 to $2.6 billion. We expect gross margin to be between 3% and 5%, which includes underutilization charges across FLASH and HDD, totaling $220 to $240 million. We expect operating expenses to be between $580 to $600 million. Interest and other expenses are expected to be approximately $90 million. We expect income tax expense to be between $60 and $70 million. We expect plus per share of $2.20 to $1.90. assuming approximately 321 million shares outstanding. I'll now turn the call back over to David.

Thanks, Roussam. Over the past few quarters, we have successfully ramped a series of industry-leading storage products and commercialized innovative technologies while concurrently right-sizing 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 industry-leading gross margins across our HDD and flash businesses, despite the challenging and rapidly changing landscape. Additionally, I am immensely proud to share that Western Digital has been honored for the fifth consecutive year as one of the world's most ethical companies by the Ethisphere Institute. This recognition is a testament 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.

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'd like to withdraw your question, please press star 2. One moment, please, for the first question. Our first question comes from CJ Muse from Evercore. Please go ahead.

Yeah, 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, you know, 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, you know, where do you think, you know, we're seeing stabilization and where do you think we need to – to work down inventory some more.

Hey, CJ, thanks for the question. Good to hear from you, as always. Yeah, I think in, you know, as we talked about in consumer, we're seeing some stabilization there as far as demand. You know, PCOEM we've been talking about now for three plus quarters, and I think we see them mainly shipping to true demand. I mean, nobody's building inventory right now, but we think the 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 quarters. We are seeing some signs of stabilization in China. We talked about that. I think it's setting up for a recovery in the second half of the year, a lot more activity around RFPs and discussions about what demand is going to look like in the second half. So that's 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.

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?

Yeah, well, let's talk about it for each business. I mean, I think in HDD, and I'm sure Wisam 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 fully understand demand and keep our inventory in a position where we want it. But we will definitely see underutilization on both sides of the business next quarter.

And just to add, CJ, sorry, just to add a bit more color, I think in our guide we're estimating around 220 to 240, the range of underutilization charges. And by business, this is roughly two-thirds flash, one-third HDD. Or one-third HDD. Thank you.

Thanks, CJ.

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

Great. Thank you. You mentioned that you're taking lower-cost-per-market charges on NAND. Can you talk about the methodology there? Do you pool that and then take a charge overall, or is it any time any individual product falls below the market price, you adjust it down?

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

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 covenants?

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

Okay, great. Thank you very much. Thanks, Joe. You're welcome.

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

Yeah, thank you for taking the questions. Just to build on that last question, just to be succinct, 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?

So, Aaron, we typically factor into our guidance all the expectations. And when we exited Q3, just like a typical quarter, we do our reserve reviews and we make sure that the balance sheet is properly stated. And so based on our forecast, everything is baked into the

uh guidance typically we have a small amount in the guidance just like we did also in the past quarter okay and then i guess my follow-up question is on the hard disk drive business i could appreciate you guys seeing you know some cloud customers kind of it sounds like purchase really no product this last quarter i'm guessing you know from a competitive perspective how would you characterize the current environment have you seen increased price aggressiveness How do you guys think about, you know, the discussion around Hammer and your roadmap going forward, et cetera?

Yeah, I mean, I think there's always price pressure in this market, Aaron. But, you know, we've been very disciplined about the value of our products. I think, you know, one of the things we feel very good about is we've been investing in our ACD roadmap, things like OptiNAN, 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. You know, we've got a number of very large customers qualifying SMR right now. That's clearly the next step in the data center. Our ultra-SMR product there, the 26T, we talked about will finish up quals 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, you know, that's showing up in kind of how we're able to monetize that portfolio and not have to compete on price. So, you know, future technologies like Hammer will be there. We're still a ways away before that product's going to be a volume-type product. The volume products or the 22s going in an SMR are going to be the big volume products for the next couple of years, and after that we'll get to Hammer. 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's excited that it will be the roadmap for 30 and above when we need it.

Thank you.

Yep.

Our next question comes from Sydney Ho from Deutsche Bank. Please go ahead.

Thank you. I want 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 production or your ability to ship products?

Yeah, we've been very transparent about that incident. When we noticed it, we let folks know. 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, you know, we feel like we're nearly all the way back now as far as operation. We've got to bring the store online here in another week or so. But it was really, really good to see our business continuity plans. You know, you don't want to rely on them too often, but when we had to, they were there, and they kept the company moving forward.

Okay, great. Thanks for that update.

Sorry, Sidney, I just wanted to – I'd add that for fiscal Q3, we don't have any impact in the numbers to the network security. Okay.

That's great. Maybe my follow-up question is, Samsung in early April talked about their cutting production. I'm curious if your conversation with your customers have changed since that announcement. And related to that, do you expect the June quarter to be the bottom for your bargains for your Flash business? Thank you.

You know, 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 those 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's the bottom, I mean, we expect the market to come into balance as we go through the second half of the year. I think, you know, 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 our 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.

Great. Thank you.

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

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

Yeah, we typically don't break that out as much on the call. This is a bit too much detail, Maddy, 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.

Let me rephrase the question. How should we think about the risk of an inventory write-down?

I mean, the inventory write-down typically is really based on The one that was, for instance, I called out is based on basically the inventory value relative to where the market price is. And so 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.

So would Are you assuming that the rate of price decline is moderating, so maybe that would minimize the downside risk?

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.

Okay, thank you. And the question for David, looking at longer term, more than just one quarter, I think there is some confusion or unknown factor of 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?

We're doing analysis on that, Maddie. 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. Again, you know that 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.

Well, I guess I was hoping you would shed some light as to how the HDD Kegel would change. I don't think this is going to lift the time for each different types of storage the same rate. Is there any thoughts that you can share with us?

I think it'll, you know, 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. Okay, thank you. Thanks, Mehdi. It's good to talk to you, as always.

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

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 costs, how do you think about where you're investing, and how are you making those decisions, and how should we think about potential impact of future projects at this point? I'm going to have a follow-up. Thank you.

Yeah, 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, Shanna, 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 you know, constantly doing the ROI analysis of where we put our OPEX and we get the most out of it. And quite frankly, that's led to the portfolio we have today. I think we have the best portfolio we've ever had. And, you know, 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 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 we're not uh we're not cutting in ways that are going to impact the long-term health of the business thank you that was helpful um i'm curious maybe i'm trying to make lemonade out of lemons but i'm just wondering as you've cut capacity on the hdd side you know and you've had these under utilization charges

Are there things that you've learned in terms of maybe how you manufacture in the past, ways to drive incremental productivity? I'm just thinking it's kind of a, it's certainly a unique time to maybe take a step back and look how things have been done and what you could do in the future. Thanks.

I'll make a few comments. I suspect Sam 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? You know, several of our factories have won World Economic Forum, Lighthouse Awards for automation. How do we rescale our employees? And how do we just, you know, we've been very focused on driving a level of automation, driving productivity, and just lowering our fixed cost asset base in the HGD 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 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.

Yeah, and I mean, the one thing I would add also in addition to what David said, 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 like common 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. Great.

Thank you very much.

Thanks, Shannon. Appreciate it.

Our next question comes from Chris Sankar from TD Cowen. Please go ahead.

Hi, thanks for taking my question. David, first question is on your non-ASP decline in March quarter. It seems to be better than what your competitors had. So I'm just kind of curious, any push and peeks you can talk about your specific pricing versus competition in March, how to think about it in June. And along the same path, you mentioned supply-demand balance later this year and bid shifting for flash growing. Are you baking in some kind of a mobile recovery that's going to help you drive that? And then add a follow-up.

Yeah, I think on pricing, it's kind of the same story all the time, right? Whether it's a down market, up market, mid-cycle market, which is, you know, really have a diverse portfolio. You know, we've talked about this a lot from retail to the channel business, PCOEMs, enterprise SSDs. 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. And I do think that that is a, you know, that breadth of go-to-market and 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. You know, we've talked about the individual markets. You know, 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.

Got it. Got it. Thanks for that, David. 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 volumes. How should we expect that to grow, and what is its impact on gross margins?

You know, I think that's our focus. On a CMR drive, that's our focus capacity point, and, you know, it's significantly ahead of other CMR drives above 20, or above the 20-terabyte drive. We expect that to be our premier drive for the next, you know, 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, you know, we've talked a lot about that drive of, you know, it provides a lot of value. It provides a lot of TCO value for our customers. And, you know, it contributes an appropriate amount of margin from that perspective as well.

Thanks, David.

Thank you.

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

Hi, thanks for taking my questions. It's Rupal filling in for Wamsi today. Hey 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, you know, 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, you know, their favorable component pricing. 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?

I think elasticity and NAND is mainly what I was talking about. I mean, we're seeing PCOEM 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 to 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.

Second part of the question again?

It was about a casino.

Oh, pre-buying, yeah.

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, you know, I think maybe it's a sign of where the customers think we are in the cycle as well.

Got it. For my follow-up, if I can ask a quick one to Issam. 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.

Yeah, Rupalu, so we're 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 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 can say is that this is, as I said, top priority for us and it's a big focus, as you would imagine, as we navigate the dynamic environment.

Thank you for all the details. Appreciate it.

Thank you. Thank you.

The next question comes from Tom O'Malley from Barclays. Please go ahead.

Hey, good afternoon, guys, and thanks for taking my question. My first one's 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 HGD business down, but any color you could give on the back half of the calendar year about when you expect that business to recover.

Yeah, I think, Tom, it's, I would say as we go through the second half of the year, it'll 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 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 that 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.

Helpful. And then just a follow-up is on the – 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, you know, 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.

I guess I would say that customers that are different segments of the market that are through their inventory digestion are now – you know, more or less shipping to end to man, being lean on inventory. There are instances of people doing strategic buys in some of those cases where they've got their inventory to where they want it, but now they, you know, 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 ones is just inventory, 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, you know, 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'll be lumpy for a couple quarters until we get through that.

Thank you.

Thanks, Tom.

Our next question comes from Toshi Ahari from Goldman Sachs. Please go ahead.

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?

Yeah, we're kind of at the point where we're, you know, I think probably the same zip code is probably a fair way to say it, depending on where you live. Zip codes can be pretty big if you're in the country, I guess. But, you know, 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 going to have to see... you know, demand signals for our customers. It's just as simple as that. We have a very, very close relationship with a lot of them. We're obviously in the market every single day. A lot of these, you know, 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 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.

Got it. That's helpful. Thank you. And then one follow-up for WESOM 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.

Sure, Toshia. 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 many more comments around working capital, but I think the answer on the inventory would be a good indicator to what working capital would do.

Our next question comes from Harlan Sir from JP Morgan. Please go ahead. Hi, good afternoon.

Thanks for taking my question. You know, the market share numbers are out for last year. You guys drove a strong number two position in client SSD, strong double-digit percentage share position, right? But in enterprise, you guys drove sort of low single-digit enterprise SSD market share last year, and it 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?

Yeah, thanks for the question, Arlan. Always good to hear from you. It's, you know, 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 channels. You know, we just qualified this last quarter on Bix 5 Enterprise SSD with some of the biggest customers. So the roadmap 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 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.

Our next question comes from Serini Pajuri from Raymond James. Please go ahead.

Yeah, thank you. I have a question on the COTS side, Winston. 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 Big State, how should we think about the cost declines? Especially, I guess, historically, we've had, you know, 30 to 40 percent demand growth. And going forward, if that dynamic changes, if it's lower than 30 percent, do you think we can still kind of get to that mid-teens cost decline? So do we need that 30 percent to, you know, get to that level?

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 underutilization charges, we wouldn't have reduced the 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 BICS-8, I mean, this is with the way our roadmap works and the timing of when BICS-8 starts ramping, it is pretty much designed in a way to allow us to continue that mid-teens 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, with ramping VIX8 slightly earlier than previously anticipated.

Our next question comes from Carl Ackerman from BNP Paribus. Please go ahead.

Yes, thank you.

I was hoping you could discuss the trajectory of Exabyte demand of your cloud customers the next couple 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. You know, it's... 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, Carl, that you've got this idiosyncratic behavior and really big customers. So, customer that usually buys, you know, 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, you know, 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, what do we think the Exabyte growth is and where are we setting our long-term expectations. production capabilities and all that, but right now it's just a little difficult to draw long-term conclusions and some of it, you know, a little bit behind some of your question given just the way the market is, the lumpiness of the market.

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

Yeah, 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.

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 exclusions.

Our last question comes from Ananda Barua from Loop Capital. Please go ahead.

Hey, thanks, guys. Appreciate it. Maybe for Wisdom, I may 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 24, how you're going to handle that, go about handling that. Thanks.

Yeah, Ananda, with respect to the $1.1 billion of convert due in February 24, the plan is to address it over the next couple of quarters.

Okay, Jason, is that the last one? Yep, that was the last question. Okay.

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

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