Western Digital Corp (WDC) — Q4 2022 Earnings Call Transcript

Thank you, and good morning, everyone. Joining me today are David Goeckeler, Chief Executive Officer; and Wissam Jabre, Chief Financial Officer. Before we begin, let me remind everyone that today's discussion contains forward-looking statements, including product portfolio expectations, business plans and performance, demand and market trends and 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-K 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 website. With that, I'll now turn the call over to David for introductory remarks.

Thank you, Peter. Good morning, everyone, and thanks for joining the call to discuss our fourth quarter and fiscal 2022 results. I'm pleased that the Western Digital team executed well and delivered solid results in light of the ongoing macro and geopolitical dynamics. We reported fourth quarter revenue of $4.5 billion, non-GAAP gross margin of 32% and non-GAAP earnings per share of $1.78, all within the guidance ranges we provided in April. Fiscal year 2022 revenue totaled $18.8 billion, and we reported non-GAAP earnings per share of $8.22. This compares to revenue of $16.9 billion and non-GAAP earnings per share of $4.55 in fiscal year 2021. We grew revenue 11% and EPS increased 81%, demonstrating progress in unlocking the earnings potential of our business. In addition to strong financial performance, fiscal year 2022 was a hallmark year for Western Digital from an innovation, product development and execution perspective. In particular, we regained innovation leadership with the introduction of multiple products and technologies for the cloud. In May, we announced a 26-terabyte drive, leveraging our OptiNAND and UltraSMR technologies as well as ePMR. Impressively, this means we've nearly doubled drive capacity relative to when I joined Western Digital just over two years ago. In Flash, we expanded adoption of our NVMe enterprise SSD from one cloud titan to three as well as qualification at several enterprise OEM suppliers. From an organization perspective, we have bolstered the company's executive management team, further strengthening our ability to drive operational excellence, innovation and disciplined financial management. On top of all of these achievements, we reduced debt by $1.7 billion and attained an investment-grade corporate rating, placing Western Digital on a solid financial foundation. Before I jump into additional detail on the quarter, I wanted to provide an update on our strategic review. As you know, two months ago, we announced that we are reviewing potential strategic alternatives aimed at further optimizing long-term value for our shareholders. The Executive Committee of the Board, which I lead, continues to oversee the review and Elliott Management is participating alongside us under a non-disclosure agreement, along with other interested parties. We're evaluating a range of alternatives, including options for separating our market-leading Flash and HDD franchises. We are moving expeditiously, but this work will take time. We will not be answering any questions about the strategic review today given the ongoing nature and confidentiality of the process. We will provide updates in the future as appropriate. Now I'll provide updates on our HDD and Flash businesses. During the fiscal fourth quarter, strong demand from our cloud customers for our latest generation energy-assisted drives drove near-record near-line shipments of 111 exabytes. Total HDD revenue declined sequentially due primarily to consumer and client HDD demand. We commenced commercial shipment of a number of products incorporating our OptiNAND technology. In addition to shipments of our 20-terabyte and 22-terabyte CMR drives, qualifications of our 26-terabyte SMR drive are underway, as we noted at our product launch event in May. This SMR-enabled drive enables 20% higher capacity than our CMR variants, offering significantly better TCO for our cloud customers and further highlighting the performance-driven benefits of the innovation that Western Digital is packing into a hard drive. Finally, we are ramping a second cloud customer with SMR technology this quarter and remain on track to lead the industry's transition to SMR-based drives for the cloud. We are very confident in our multiyear product roadmap for capacity enterprise drives, which combine ePMR, OptiNAND, UltraSMR and triple-stage actuators to deliver a cutting-edge portfolio of drives in commercial volumes at a wide variety of capacity points. We also continue to invest in HAMR and the commercialization of this technology alongside our other HDD technologies that are leading the industry. The breadth and depth of this portfolio strongly positions us to be the provider of choice for the largest and most complex data centers in the world. Building on the expertise cultivated over decades of bringing to market industry-leading technologies, we are committed to leveraging our innovations to continue driving business results in capacity enterprise into the future. Turning to Flash. Revenue grew sequentially on an improving product mix and increased flash supply. Growth in Flash during the quarter came primarily from enterprise SSD, with revenue more than doubling sequentially. Gaming is another key growth market for us, where we continue to demonstrate the strength of our client SSD franchise with exabyte shipment growing nearly 70% year-over-year. We have a leading position in gaming with our WD_BLACK brand being recognized globally for innovation, performance and quality. The latest example of this is our WD_BLACK SN-850 NVMe SSD product certified for Sony PS5 game consoles, which enables players to expand the high-speed storage capacity of their PS5 console and allows them to store and play both PS5 and PS4 games directly from the drive. On the technology front, BiCS5 represented about half of our Flash revenue in the June quarter, up from 46% in the previous quarter. We are preparing to ramp BiCS6 late this calendar year and into 2023. Based on circuit under array architecture, BiCS6 enables many exciting high-performance products for 5G phones, SSDs and QLC flash. Let me now offer a few observations on the demand environment. In the cloud end market, we experienced strength in the fiscal fourth quarter as supply constraints at Western Digital and our end customers started to ease. Overall, demand from our cloud customers has been consistently strong and we expect this strength in cloud to carry into the second half of calendar year 2022. We believe the accelerated digital transformation will continue to drive cloud growth and believe we are on track to generate about half of our revenue from this market by fiscal year 2025. Outside of cloud, our expectations for calendar year 2022 demand growth have moderated since our last earnings call. As the fiscal fourth quarter progressed, we saw consumer spending soften, impacting both retail Flash and HDD demand. This weakness has migrated to the consumer PC end market as we enter the second half of the calendar year. In client, the market generally expects PC shipments to decline approximately 10% in calendar year 2022. We are seeing our PC OEM customers aggressively rightsize their inventory to reflect current demand conditions, which will impact our business in this market in the second half of the calendar year. After going through that correction, we expect a more normal flow of business going forward as we believe PCs will continue to fulfill broader use cases as the foundation of the increasingly common hybrid enterprise, driving unit demand above pre-pandemic levels in richer SSD content. All of these PC market dynamics are accelerating the final phase of the shift of client devices from HDD to flash technology. Consequently, the client HDD market is now declining at an accelerated rate relative to the period before the onset of the pandemic. To reflect this reality, we are now taking aggressive action to restructure our HDD manufacturing footprint to reflect this market dynamic. In mobile, expectations for smartphone units have come down in recent months, led primarily by reduced demand in China. Industry analysts expect the smartphone industry unit volume to decrease by a mid-single-digit percentage year-over-year in calendar 2022. While we are well-positioned in supplying flash memory for 5G smartphones, we are also seeing our largest customers aggressively resetting their inventories for these products. We expect the inventory correction to primarily impact our fiscal first quarter and return to market demand for the remainder of the fiscal year. In consumer, we have a premium brand and a great franchise in the marketplace. In particular, we have developed an enviable position and excellent relationships with major brick-and-mortar retailers and online retailers across the globe, including Best Buy and Target in the US, MSH Group in Europe, JD.com in China and Officeworks in Australia. As a result of these strong relationships, our impressive scale, product breadth and trusted brand, we lead most consumer storage product categories. While macroeconomic factors and COVID measures have impacted consumer demand in the near term, our customers' loyalty and preference for the performance and quality of our solutions are key differentiators, which will position Western Digital well for the upcoming back-to-school and holiday seasons. Before turning the call over to Wissam, I want to leave you with a few takeaways. First, at the Investor Day, we laid out the case, where the world of ever-increasing intelligent devices powered by the cloud is creating an astonishing amount of data, of which only a small percentage is stored. Our conviction remains strong and our view on near double-digit revenue growth remains intact. Over the past several years, the storage market has entered an era of accelerated growth, led by the strength of the cloud market, which drove HDD revenue growth for Western Digital and the industry. In Flash, capital investments for incremental NAND bit growth are becoming more expensive, resulting in a more disciplined investment across the industry. At Western Digital, our long-standing and growing relationships with hyperscale and OEM customers across the world, coupled with our leadership in commercializing innovations for capacity enterprise hard drives and momentum with NVMe enterprise SSD for data center, has made us a trusted partner. This combination of rapid demand growth in storage, technology leadership and product momentum offers Western Digital opportunities for financial outperformance. With that, let me now turn the call over to Wissam, who will discuss our fiscal fourth quarter results and provide an outlook for the fiscal first quarter.

Thanks, David, and good morning, everyone. As David mentioned, overall results for the fiscal fourth quarter were in line with our expectations, reflecting the resilience and agility of our business model against such a dynamic macro environment. Total revenue for the quarter was $4.5 billion, up 3% sequentially and down 8% year-over-year. Non-GAAP earnings per share was $1.78, within the guidance range we provided in April. For the full fiscal year 2022, revenue was $18.8 billion, up 11% from fiscal 2021. Non-GAAP gross margin expanded 4.3 percentage points and non-GAAP operating margin increased 5.7 percentage points, as we proactively managed our expenses, resulting in non-GAAP EPS of $8.22, up 81% from last year. Turning to our end markets. For the fiscal fourth quarter, cloud represented 46% of total revenue at $2.1 billion, up 18% sequentially and 5% from a year ago. Within Cloud, Western Digital's continued success in leading the industry transition to energy-assisted hard drives drove the growth. The continued ramp of our 18-terabyte and 20-terabyte drives drove a 7% year-over-year increase in nearline HDD revenue. Sequentially, nearline bit shipments increased 9% to 111 exabytes. In Flash, enterprise SSD revenue more than doubled sequentially and was up 38% year-over-year. The client end market represented 36% of total revenue at $1.6 billion, down 5% sequentially and 14% year-over-year. On both a sequential and year-over-year basis, client HDD led the revenue decline, while Flash revenue was roughly flat. Consumer represented 18% of revenue at $0.8 billion, down 9% sequentially and 23% year-over-year. On a sequential basis, the revenue decline was due to lower HDD retail shipments. The year-over-year decrease was due to broad-based decline in retail products across HDD and Flash. For the full fiscal year 2022, Cloud revenue increased 40% year-over-year, led by a 38% increase in nearline HDD. Flash product revenue for enterprise SSD applications more than doubled year-over-year. Client revenue decreased 3% year-over-year as growth in Flash was offset by a 30% decrease in client HDD. Client HDD for PCs and Notebooks represents just mid-single-digit percentage of total HDD revenue exiting the fiscal year. Lastly, consumer revenue decreased 6% for the year, all attributed to a decline in retail HDD. Turning now to revenue by segment. In the fiscal fourth quarter, we reported Flash revenue of $2.4 billion, up 7% sequentially and down 1% year-over-year. Sequentially, Flash ASPs were up 2% on a blended basis and up slightly on a like-for-like basis. Flash bit shipments increased 6% sequentially and 11% year-over-year. HDD revenue of $2.1 billion was flat sequentially and down 15% year-over-year. Sequentially, total HDD exabyte shipments increased 1%, while the average price per HDD increased by 19% to $120 as our mix continues to transition towards the cloud. On a year-over-year basis, total HDD exabyte shipments decreased by 10% and average price per unit increased by 24%. As we move to costs and expenses, my comments will be related to non-GAAP results unless stated otherwise. We continue to exert disciplined financial management to drive better results. Gross margin for the fourth quarter was 32.3%, up 60 basis points sequentially and down 60 basis points year-over-year. Our Flash gross margin was 35.9%, up 30 basis points sequentially and 40 basis points year-over-year. On both a sequential and year-over-year basis, growth in enterprise SSD for data center applications led the improvement in gross margin. Our HDD gross margin was 28.2%, up 50 basis points sequentially and down 210 basis points year-over-year. Operating expenses of $760 million were below our guidance range as we continue to prudently manage our expenses. Operating income was $702 million, representing an 8% increase from the prior quarter and a 15% decrease year-over-year. Our tax rate was 11% for both the fiscal fourth quarter and fiscal year 2022. Earnings per share was $1.78, compared to $1.65 in the prior quarter, and $2.16 in the year-ago quarter. Operating cash flow for the fourth quarter was $295 million, and free cash flow was an outflow of $97 million. Operating cash flow was impacted by revenue linearity. The ramp back to normal production output at the flash joint venture, timing of component deliveries to our factories and corporate-related control measures in China contributed to a back-end loaded quarter. Cash, capital expenditures, which include the purchase of property, plant and equipment; and activity related to our Flash joint ventures on our cash flow statement represented a cash outflow of $392 million in the fiscal fourth quarter. We remain disciplined in investing in manufacturing capacity. Gross CapEx and cash CapEx for the fiscal year 2022 were $2.7 billion and $1.2 billion, respectively, below our expectation, as we actively managed our capital investments. We made a $150 million scheduled and discretionary debt repayment. Our gross debt outstanding was $7.1 billion at the end of the fiscal fourth quarter. We ended the quarter with $2.3 billion of total cash and cash equivalents. Our trailing 12 months adjusted EBITDA at the end of the fourth quarter as defined in our credit agreement was $4.8 billion, resulting in a gross leverage ratio of 1.5 times compared to 2.4 times a year ago. As a reminder, our credit agreement includes $0.9 billion in depreciation add-back associated with the Flash Ventures. This amount is not reflected in the cash flow statement. Please refer to our earnings presentation on the Investor Relations website for further details. I'll now provide our view of both HDD and Flash businesses for the fiscal first quarter as well as comments on several key items for fiscal year 2023. For the fiscal first quarter, we expect Flash to lead the sequential revenue decline as our customers right-size their inventory. We expect a relatively modest decline in overall HDD revenue, primarily driven by client and consumer, with gross margin remaining relatively flat. As we look towards fiscal year 2023, we expect cash capital expenditures to be in line with our target model, within the range of 8% to 10% of total revenue. Total gross capital expenditures are expected to be approximately $3.2 billion. Regarding Flash CapEx, we remain excited about our technology roadmap despite what is clearly a volatile period in the memory industry. As we have discussed on prior calls, BiCS6 is a more capital-intensive technology node that will require an increase in capital expenditures. Our CapEx outlook for fiscal year 2023 reflects our commitment to technology leadership and will accelerate our path to leapfrog from BiCS6 to BiCS+ in the next several years. I am also pleased to share that the Flash JV Fab 7 manufacturing facility at the Yokkaichi plant has been approved to receive a subsidy of up to JPY92.9 billion from the Japanese government, further demonstrating the strategic importance of what is the world's largest NAND manufacturing facility. Given the macro environment, we continue to actively manage our capital expenditures and supply. We are in discussion with our joint venture partner to adjust capital investments and align our production growth with demand. In HDD, we will continue to focus our capital spending primarily on heads and media in order to meet the future growth in cloud demand. Offsetting these investments, we are taking aggressive actions to restructure our client HDD manufacturing footprint. We strive to optimize free cash flow generation in response to the macroeconomic dynamics. For our fiscal first quarter, our non-GAAP guidance is as follows. We expect revenue to be in the range of $3.6 billion to $3.8 billion. We expect gross margin to be between 27.5% and 29.5%. We expect operating expenses to be between $760 million and $780 million. Interest and other expenses are expected to be approximately $70 million. Our tax rate is expected to be between 28% and 30% in the first quarter and for fiscal year 2023. This increase is due to the tax law changes that became effective for our fiscal year 2023, requiring the capitalization of certain R&D expenses that were previously eligible for immediate deduction from taxable income. These changes are expected to result in an immediate increase in our tax rate of approximately 12 percentage points, which will then decrease gradually over time. We expect earnings per share to be between $0.35 and $0.65 in the first quarter, assuming approximately 319 million fully diluted shares outstanding. I'll now turn the call back over to David.

Thanks, Wissam. Let me just wrap up, and then we'll open up for questions. In summary, we continue to believe that we have built the right foundation for long-term growth. We have reignited our innovation, established discipline in spending and investment and remain consistent in deleveraging our balance sheet. The innovation engine that drives TCO benefits and value to our customers, the multiple channels to deliver our products to market and the large and growing storage markets put us in a great position to capitalize on the opportunity presented by the proliferation of intelligent devices and rapidly accelerating data creation. While segments of our end markets are now going through an aggressive inventory adjustment as supply chain impacts of the pandemic start to ease and the macro economy softens, secular demand for storage continues to be strong and underpins the digital transformation that continues across all industries. I also want to thank our employees for their hard work during the fiscal year. Despite ongoing geopolitical and macro challenges, our team worked together to deliver strong financial performance for Western Digital. I am proud of what this team has accomplished and excited to see what we can do together in the next fiscal year. All right. Peter, with that, let's open it up for Q&A.

Yeah, good morning. Thank you for taking the question. I guess, first off, just want to clarify here. In terms of what's driving the weakness, is it safe to say that it's entirely consumer client and that on the hyperscale and enterprise side you're not seeing any changes? And as part of that, as you think about this inventory correction on the consumer client side, how long do you think the duration will last? Is this a one-quarter phenomenon? Too early to tell? Would love to hear your thoughts there.

Good morning, C.J. Yes, I agree with your assessment. I would add that we are experiencing some inventory corrections in the China cloud sector. The US hyperscalers are continuing to operate steadily. However, we first noticed a significant inventory adjustment among the PC OEMs, which has drastically reduced their demand this quarter as they try to align their inventory with actual unit sales. We believe this correction will be relatively short-term, but whether it lasts one or two quarters remains to be seen. It is indeed a sharp decline in the current quarter. The smartphone market is experiencing similar trends, and this is even evolving within the quarter. Recently, one of our largest customers significantly lowered their forecast for the quarter by over $150 million. The strong message we receive from our customers indicates that they are simply resetting their inventory, which we anticipate will also be a one-quarter phenomenon. Looking at the broader market, we expect to see improvements over the next couple of quarters. In the consumer and channel space, we are beginning to see some stabilization. Our channel business has performed as expected in the first four weeks of the quarter, and certain regions, like Europe, show signs of strength. The consumer sector appears to be stabilizing as well; while growth is not robust yet, it looks better than it did a couple of months ago. The OEMs, however, are undergoing a significant and rapid correction in their inventory levels, along with some cloud business in China.

Very helpful. And just a follow-up question on the NAND side of the house. You talked about rising cap intensity at BiCS6 and what's next. But at the same time, it sounds like you're talking about tempering investments at the JV. So could you walk through how you're thinking about forward CapEx given the changes you're seeing in the end markets?

Yeah, I'll make a few comments and Wissam can comment as well. But we've always known that BiCS6 was going to be a more capital-intensive node. I mean, again, we're coming off of a BiCS5, which is the most capital-efficient node in the history of our roadmap, so that's not surprising. And we're driving through that transition. We feel very good about the node. It's just it's a more capital-intensive node. Now I will note, as we talked extensively about our Investor Day, our capital intensity in general per bit is the best in the industry, and that's something we really strive for in our roadmap. So when we're talking about a more capital-intensive node, remember, that's a relative issue. We're still in the best position as far as capital per additional bit, and that's a very, very big focus of ours. Now the more macro question is, we're obviously having conversations across the JV about resetting our bit growth in general, independent of node, given the reality of what the demand environment is. Overall, bit demand is coming down. We're in an oversupply environment, it's demand-driven oversupply, it's not a supply-driven oversupply. But we'll reset. We're looking at our CapEx. And we'll make adjustments given what the current situation is. Wissam?

Sure. We are aiming for our cash capital expenditures to be between 8% and 10% of revenue according to our target model. However, as macroeconomic conditions evolve, we will adjust our approach as needed.

Thank you, everyone. Good morning. I have a couple of questions. I’d like to delve deeper into the Flash revenue expectations for this quarter. With hard disk drive revenue remaining relatively flat, it seems you’re indicating a sequential decline of around 20% to 30% in NAND revenue for this quarter. Given this, how do you perceive the balance between bit shipments and pricing in your expectations? I’m trying to grasp whether this is primarily driven by pricing or bit shipped, and do you believe this guidance indicates a bottom in the market?

I believe it's important to view this as a situation driven by demand. Our largest customer, along with others in the PC sector, is currently adjusting their inventory and reducing demand for the quarter to accommodate this reset, which is causing both pricing and volume pressures. As they realign their inventory, I anticipate that we'll see some volume return as we progress through the quarter. From some customers, I am optimistic that this is just a temporary change for one quarter, while for others, it may take a bit longer. We'll have more insights as the quarter unfolds and will share updates during our discussions. It's worth noting that this market is very dynamic and some changes have occurred recently, making it challenging to predict. However, we remain confident in our guidance and are glad we issued it when we did given the rapidly changing environment. Our customers are actively managing their inventory, and I believe they will navigate this situation effectively. As mentioned in our prepared remarks, the supply chain is improving, and both we and our customers are receiving more components, which may be enhancing their confidence in inventory management. Simultaneously, we are entering a softer economic phase, leading to a significant reset across the board, particularly affecting the Flash business. The HDD business, on the other hand, is still experiencing consistent strong growth from hyperscalers in the US, and we are very optimistic about our portfolio in that segment for the fiscal year ahead.

Okay. And as a quick follow-up, just thinking about the Flash business a little bit more. These last couple of quarters, and appreciating that mix is a factor, but these last couple of quarters, it looks like you've seen a little bit of a slowing of your ability to drive cost down in the Flash business. As we think about BiCS6, how are you thinking about the relative cost down structure of BiCS6 relative to BiCS5? Thank you.

Yes, as we've discussed regarding cost reductions, we aim for 15%. We know there will be some quarters where we may fall short and others where we exceed that goal. Ideally, we want more favorable quarters, which has generally been our experience, but we've faced a few quarters that didn't reflect that. Looking at our fiscal year, we achieved right around 15%, possibly slightly above that. Is that correct, Wissam?

Yes, that's correct, David. One thing to keep in mind, Aaron, is that we experienced fab contamination in the third fiscal quarter. This is partly the reason we haven't observed the same rate of cost reduction in the last couple of quarters of fiscal 2022.

So Aaron, we feel really good about the BiCS6 transition and what that's going to bring. And I think you'll see in the upcoming quarters, the costs will get back to where we expect it to be. We explicitly drive our roadmap around this number. We explicitly drive the nodal transition and the roadmap development around making sure we can deliver the 15% year-over-year and we are very pleased that we just delivered it again in the last fiscal year.

Great. Thank you. I wonder if you could address, I mean, I didn't hear a specific answer to volume versus prices in NAND in Q3, but I guess what is your inventory balance going to look like at the end of Q3? And I know in the past, you guys have been willing to take fab utilization adjustments to keep that number under control. Have you thought about that in this environment?

Yeah. I'll make a few comments. I'll let Wissam make a few comments. And we don't guide to that level of specificity, but they're both roughly down about the same.

Yes. That's where the numbers shape up, roughly among the same.

And your inventory balance?

Well, given that this is mostly demand driven, we expect inventory to grow a bit this quarter as the supply is higher than where the demand is. However, as we said in the prepared remarks, we are in discussions with our JV partners to take appropriate action to the extent we can to limit that.

Thank you very much. Maybe just as a follow-up on the HDD side, taking it on the positive end, Dave, maybe if you could give a little color on your confidence level on the sustainability of the US hyperscalers' spending trends. What gives you the confidence that this will at least carry through the second half of this year and maybe into the early parts of 2023?

Yes, there are a couple of points to mention. First, we have a very close relationship with them and communicate daily. The feedback we receive in planning for the second half remains strong and consistent. Our portfolio around 22 and 26 terabytes, as well as SMR, is robust. A significant highlight from the last quarter is that we have a second hyperscaler that has fully qualified SMR. Our UltraSMR technology, which allows us to get 20% more capacity from a drive, positions us well for the transition. Their messaging about product consumption in the second half and into next year has been very consistent. Additionally, we have new qualifications in progress for the 22 terabyte CMR and 26 terabyte SMR models. Throughout the fiscal year, these products will start to ramp up and gain volume adoption.

Great. That's helpful. And maybe as my follow-up question, in terms of following up from your Analyst Day where you did put a big focus on the NAND flash moving to the SSD market for the Cloud segment itself as well. Do you see this shift beginning with BiCS6, or is this more of a BiCS+ type of endeavor where it will be future generations where you see the biggest shift towards SSD NAND?

No. I mean, the shift is happening now. I mean, we just delivered a quarter of 105% sequential growth on our enterprise SSD portfolio. Now that's a particularly strong result. But we're very confident that as we work through the next couple of years, we're going to drive our share of enterprise SSD from the 8% to 16%. We've got a very good plan for that. It's a great market to participate in. Like I said, we broke through with the qualifications and the success has been strong. Now it will be lumpy, not every quarter is going to be up. But the trajectory over the three-year time span is we have a lot of confidence, we're going to drive that to the 16% share in FY 2025.

Yes, thank you. Good morning. You are currently shipping significantly below demand levels due to the inventory correction observed in the September quarter. Could you provide some quantification of that? Additionally, if we assume the digestion you mentioned is completed by September, what would be the appropriate base to consider for driving any sequential growth in the December quarter?

In the PC market, we believe that the initial estimate of around 325 million units will likely be closer to 305 million units. This reflects the significant correction currently taking place. We have also noted that smartphone demand has decreased in the low single digits. Right now, we’re experiencing a sharp decline as companies adjust their inventory. Many are gaining confidence that the supply chain is improving, though there are still some tight areas. Overall, we’re seeing better availability of components that were previously scarce. Everyone is adapting to this new reality as they prepare for a softer consumer environment, which provides context for our current perspective.

Thanks for taking my question. So, looking at your Flash margins, they are still at a pretty decent level in the June quarter, but obviously that will come down in the September quarter. But with margins coming down into, let's say, the next few quarters given where the pricing is heading, do you think your margins will get back to that last trough in 2019 when it was below 20%? Obviously, pricing is out of your control, but are there things in your control that you will make the mix trough be better than the last one? Thanks.

We have made significant improvements to our portfolio over the past couple of years, and these efforts will become evident. Our focus on through-cycle margin, which we discussed during our Investor Day, is about enhancing both the minimums and maximums. We believe we are well positioned to achieve this, particularly with the strengths in enterprise SSD and our robust presence in the gaming market, which has shown substantial growth in the last year and a half. Therefore, we enter this situation with a much stronger and more diverse portfolio, providing us with more opportunities to allocate our supply, which we anticipate will result in better outcomes.

Good morning. Thank you for taking my question. I have several inquiries regarding your HDD business, specifically about utilization rates, capital expenditures, and the restructuring plan you mentioned. Regarding utilization rates, your closest competitor has suggested making some adjustments soon. Is this something you are considering or implementing in your HDD operations? Additionally, what do you anticipate for capital expenditures in your fiscal 2023 outlook, particularly concerning your hard drive business? Lastly, could you provide more details about your restructuring efforts, including how much capacity will be added in the medium to long-term? Thank you.

Thank you, Toshiya. I’d like to provide some context and additional details on our capital expenditure and our perspective on the client hard drive market. As we noted, this market has been quite dynamic over the past couple of years. During the pandemic, we experienced a significant increase in demand for client hard drives due to the surge in PC demand. However, the situation has changed dramatically, and we are now seeing a decline of over 50% year-over-year in this business. It appears to be returning to pre-pandemic levels and is dropping even faster as the transition to flash storage continues. This shift is beneficial for us, as we have a strong portfolio in client SSDs. We've been navigating this transition for several years, but it requires us to reassess our client HDD capacity, which we are actively working on now.

Yes. Regarding the restructuring, as David mentioned, we are reducing our manufacturing footprint on the client side. We expect this to benefit us in a few ways, including slightly on the capital expenditure side and also in terms of the cost of goods sold. Any underutilization that was related to that part of manufacturing capacity is being effectively managed out. This should assist us in achieving a gross margin transition for the HDD business from the fourth quarter to the first quarter, which we anticipate to be approximately flat. Based on this, we should likely see further improvements in the subsequent quarters.

On CapEx.

We typically do not separate CapEx between HDD and Flash, but we plan to remain within our target model of 8% to 10% of revenue. At Investor Day, I mentioned that we aim for the HDD business to target 4% to 6%, possibly higher in the near term, as we are investing in enterprise manufacturing capacity. However, we are closely monitoring the supply-demand situation and do not intend to invest in or create overcapacity in the short term to maintain this balance.

So Toshiya, I want to add a few more comments to give a complete picture. We’re beginning to see what we discussed at our Analyst Day. In terms of heads and media, we still need to invest because these large drives contain many heads, so we are continuing to invest in heads. We are transitioning the media to capacity enterprise. However, we currently have the capability to produce millions of client drives that we no longer need. Therefore, we are adjusting that part to reduce costs in the system.

Hey, good morning, guys, and thanks for taking my question. I just wanted to look at the overall business. Obviously, you've talked about the moving parts into September. But could you talk about when you think you might see the total top line start to recover? I know, there's a lot of moving parts. I know, there's not a ton of visibility right now. But obviously, from a net income pro forma earnings perspective, do you guys see yourselves making losses in the coming quarters? And just if you do, can you talk about the depth in which you're kind of planning for that based on recessionary scenario? Just any color on where you might see this bottom from a total company perspective? Thank you.

We are not anticipating any losses. The situation is very dynamic at the moment. If we look back a few quarters, we began discussing the softening consumer market early this year. This softness started in Europe due to the war and in China because of lockdowns, which continued throughout the first half of the year. Typically, the consumer business is weaker during this period, with April and May being slow months, but we usually see a strong recovery in June. This year, however, that recovery did not materialize; the softness persisted. We noticed a decline in consumer spending on PCs and smartphones, prompting original equipment manufacturers to aggressively adjust their inventory levels. On a positive note, we are beginning to see signs of stability in the consumer and channel businesses. The sell-through was on track in the early part of the quarter, although sell-in remains slightly behind as companies are hesitant to increase their inventory. In some areas, such as Europe, we are even witnessing quarter-over-quarter growth in the channel. The pace of inventory correction among OEMs will determine our next steps. Meanwhile, demand from US hyperscalers in the cloud sector remains consistent, even though we are expecting some adjustments in China’s cloud market. China has been relatively quiet overall, and we will monitor how the situation evolves. Despite the sharp corrections in the PC and OEM sectors, other areas of the market are beginning to stabilize. Wissam, do you want to add anything? We don’t typically forecast the upcoming quarters, but feel free to share your thoughts.

Yes, we do not provide forecasts for upcoming quarters, but we do not anticipate losses. One point I want to emphasize is that, despite the current downturn, we are starting from a much stronger financial position. Over the past couple of years, we have made significant improvements to strengthen our finances. Additionally, we launched an exciting range of products last quarter, and we have a robust product portfolio along with strong additions to our leadership team. This positions us well to navigate through these challenges.

Thank you very much. I have a two-part question regarding HDD gross margin. You're currently operating a couple of hundred basis points lower than your competitors, and I would like you to elaborate on that. Is this linked to the client capacity you're trying to reduce? Additionally, on the NAND side, you previously mentioned that the decline is roughly equal between bits and pricing. I want to confirm if that's what you intended to convey. If so, then both bits and pricing have indeed decreased more than your competitors. I'm curious if you can explain why your NAND business is underperforming compared to your peers. Thank you.

So on HDD, the gap in gross margin is currently 100 basis points. I'm pleased with the progress we made in gross margin this quarter. We were able to increase the gross margins in HDD more quickly than anticipated. Last quarter, we expected sequential growth in the second half, but we managed to achieve some of that in calendar Q2, which is our fiscal Q4. This improvement came from several factors, including favorable pricing, which has remained stable or even improved slightly. The industry has been working towards this, especially with the innovations we are introducing. Additionally, we've made some advancements on the cost side. It's important to remember that each competitor has a different mix. There are certain markets, particularly the performance enterprise markets, from which Western Digital withdrew years ago. This segment is declining but still has significant margins that we don't pursue. Overall, from a margin standpoint in HDD, I emphasize that our innovation and our product portfolio, including the 22-terabyte drive and the 26-terabyte UltraSMR drives, place us in a strong position within the industry. As we progress through FY 2023, these products will become increasingly central to our offerings. This positions us well to have meaningful discussions on total cost of ownership with our customers as we continue to innovate. Regarding Flash, it's a rapidly changing market. Conditions have shifted even in the past couple of weeks. We are currently at a different point in our forecasting process, incorporating feedback from our customers. We have clients with substantial demand that is fluctuating within the quarter. We have provided guidance around this, and while we aim to improve upon it, this reflects the current state of our business.

Thank you. Thanks for squeezing me in. David, I just wanted to follow up to the last comment. You highlighted earlier in the call that you remain comfortable with near-line cloud demand, especially in North America. And then you just said that demand is very volatile. What gives you confidence that the North American cloud service providers go through inventory digestion later this year and into next year? Is there anything that you can share with us? And I have a follow-up.

I think it's just our deep relationship with them and the conversation we have. We also have multi-quarter agreements with a lot of these customers, which gives us more visibility into what their plans are. We're, obviously, in deep conversations with them about our next generation products, which is very exciting. We're able to bring a market-leading capacity points to them across CMR and SMR. So, again, 22-terabyte CMR is a unique product in the industry. And then we have 26-terabyte SMR, which is, again, a unique product in the industry. Nobody else can go to those capacity points. And so, we feel very good about where the portfolio is. Those are being adopted and qualified across our customer base. I think the strength of where we're at in the TCO equation we bring to our customers, as well as the visibility that we see and given the relationship gives us confidence as we move through the second half of the year.

All right. Thanks, everyone. We appreciate you spending time with us here early on a Friday morning. Thanks for all the great questions, and we'll look forward to talking to you throughout the quarter.