Western Digital Corp (WDC) — Q3 2024 Earnings Call Transcript

Thank you, and good afternoon, everyone. Joining me today are David Goeckeler, Chief Executive Officer; and Wissam Jabre, Chief Financial Officer. Before we begin, let me remind everyone that today's discussion contains forward-looking statements based upon management's current assumptions and expectations, and as such, does include risks and uncertainties. These forward-looking statements include expectations for our product portfolio, our business plan and performance, the separation of our flash and HDD businesses, ongoing market trends and our future financial results. We assume no obligation to update these statements. Please refer to our most recent financial report on Form 10-K and our other filings with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially from expectations. 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.

Thank you, Peter. Good afternoon everyone and thanks for joining the call to discuss our third quarter of fiscal year 2024 performance. Western Digital delivered excellent results in the quarter with revenue of $3.5 billion, non-GAAP gross margin of 29.3% and non-GAAP earnings per share of $0.63, all of which exceeded expectations. Our strategy of developing a diversified portfolio of industry-leading products across a broad range of end markets, coupled with structural changes we have made to both of our businesses, is unlocking our true earnings potential and allowing us to continue improving through-cycle profitability and dampening business cycles. This strategy enables us to generate higher earnings per share even in a constrained supply environment. In addition, our commitment to achieving operational efficiency and enhancing our agility has allowed us to run our flash and HDD businesses more efficiently and further drive innovation to take advantage of new opportunities. In particular, as the technology landscape continues to evolve, the demand for AI solutions is becoming increasingly apparent across our end markets. The uptick in AI adoption is highlighting the incredible value of data and will drive increased storage demand across both HDD and flash at the edge and in the core, providing greater long-term growth and margin expansion opportunities for Western Digital. We are in the early innings of unlocking the full potential of this company, and our team remains focused on improving the profitability of our business to drive long-term margin expansion and shareholder value as these new demand opportunities present themselves. Before I dive further into the demand environment, I want to briefly comment on the status of the separation of our flash and HDD businesses. I am proud of the team's ongoing efforts as we drive towards completion of the separation in the second half of the calendar year. We remain focused on achieving the separation as soon as possible, and we'll continue to provide further updates on our progress as appropriate. Moving on to end market commentary. I am pleased to report that during the quarter, revenue in all of our major end markets returned to year-over-year growth. In cloud, we experienced 29% growth in revenue from a year ago, highlighting the incredible success of our industry-leading HDD product line. In addition, we began to experience an increase in demand for our flash-based solutions, signaling a long-awaited recovery in this end market. In client, 20% revenue growth from a year ago was driven by increased bit demand for our flash-based solutions, coupled with an increase in ASPs. In consumer, we experienced 17% revenue growth from a year ago, highlighting the power of the SanDisk premium brand. Higher flash bit sales, combined with a better pricing environment more than offset the continued decline in consumer HDD demand. I'll now turn to business updates, starting with flash. Our sequential revenue growth in the quarter reflects the continuing commitment to disciplined capital spending and carefully optimizing bit shipments into our most profitable end markets to take advantage of the improved pricing environment. This approach, combined with the strength of our product portfolio, has enabled us to drive significantly higher profitability while strategically managing our inventory. On the technology front, we achieved a significant milestone by initiating mass production of our QLC-based client SSD, leveraging BiCS 6 technology. This is yet another significant milestone demonstrating our continued commitment to innovation and market leadership. These advancements pave the way to spearhead the market's transition to QLC-based flash solutions in calendar year 2024. Additionally, our progress with BiCS 8 is on track. While this technology is ready to be productized as market conditions warrant, our innovative offerings will remain at the forefront of the market, further strengthening our competitive position and bolstering our growth prospects. As noted earlier, in the third quarter, we began to experience an increase in demand for our enterprise SSD solutions. We are seeing demand returning for NVMe SSDs that we qualified before the downturn. We are also experiencing significant interest in providing these products in dramatically higher capacities for AI-related applications which we expect to ship in the second half of the year. In addition, we are also sampling our newest high-performance PCIe Gen 5, BiCS 6-based enterprise SSD. We are preparing for qualification at a hyperscaler and the product is generating significant interest in the enterprise market. We expect to ramp in the second half of the calendar year. Turning to HDD. The sequential revenue increase was driven by improved nearline demand and higher pricing as we focused on optimizing profitability per exabyte sold. In particular, nearline revenue reached a fixed quarter high, reflecting the successful strategy we put in place to bring the most innovative, high-capacity and high-performance drives to market. We have the right products at the right cost structure, which are reflected in our financial performance. Our cloud customers continue to transition to SMR with our 26-terabyte and 28-terabyte UltraSMR drives, quickly becoming a significant portion of our capacity enterprise exabyte shipments. SMR-based drives represented approximately 50% of nearline exabyte shipments in the quarter. Our portfolio strategy to commercialize ePMR, OptiNAND and UltraSMR technologies in advance of our transition to HAMR has proven to be the winning strategy and enables us to deliver to customers the industry's highest capacity and leading TCO drives, all of which can be produced at scale with controlled costs. We are confident that our product strategy, which combines UltraSMR technology with upcoming advancements in nearline drives, is enabling Western Digital to deliver best-in-class gross margin in HDDs, all at a time when AI is emerging as another growth engine for the industry. As we move toward a new supply and demand environment, characterized by higher demand, supply tightness and product shortages, we are leveraging our proven technology we've already introduced to the market to meet the demands of our customers with the right portfolio at the right time, while also operating with a lean cost structure for continued profitability improvement in our HDD business. Although the actions we are taking have improved profitability, we remain focused on driving higher margins to appropriately value the incredible amount of innovation and TCO improvements we continue to deliver to our customers. Before I turn it over to Wissam, I wanted to share some perspectives on our outlook. Within Flash, in addition to growth opportunities at the edge, which is Western Digital's strength, we are encouraged by the returning demand within the enterprise SSD market and expect growth throughout this calendar year. AI-related workloads are driving increasing demand for enterprise SSDs, and our portfolio is well positioned to support those use cases. Looking ahead, we anticipate bit shipments to remain flat into the fiscal fourth quarter and look to Flash ASP increases to be the primary revenue growth driver led by our focus on allocating bits to the most high-value end markets amidst the tightening supply environment. While we're pleased to see pricing trends moving in a positive direction, it's crucial to acknowledge the importance of maintaining capital discipline and only reinvesting capital back into the business once profitability improves further, and we see sustained demand. Overall, our continued focus on improving profitability through our innovation roadmap, disciplined capital spending, and strategic pricing initiatives position us well for continued success in calendar year 2024 and into 2025 by offering the most capital and cost-efficient bits in the industry. In HDD, the success of our portfolio of leading capacity enterprise products, combined with the restructuring efforts we've implemented in recent years are yielding improved unit economics and greater visibility. As cloud demand is recovering, we anticipate continued growth driven by higher nearline demand and better pricing as we are now in a supply-constrained environment. We're optimistic about aligning the pricing of our products to better mirror the innovation we are integrating into them, supporting long-term margin expansion in our HDD business. As we reap the rewards of the innovation and operational efficiencies that we've implemented, we will look for opportunities to reinvest in the business when the conditions are ripe for expansion. We will approach every capital allocation decision with a focus on discipline. Let me now turn the call over to Wissam, who will discuss our financial third-quarter results.

Thank you, and good afternoon, everyone. Following on David's comments, Western Digital returned to profitability and free cash flow generation, and delivered great results in the quarter, which exceeded expectations. Total revenue for the quarter was $3.5 billion, up 40% sequentially and 23% year-over-year. Non-GAAP earnings per share was $0.63. Looking at end markets, cloud represented 45% of total revenue at $1.6 billion, up 45% sequentially and 29% year-over-year. The growth was primarily attributed to higher nearline shipments and improved nearline per unit pricing with Flash revenue up both sequentially and year-over-year. Nearline bit shipments of 108 exabytes were up 60% sequentially. Client represented 34% of total revenue at $1.2 billion, up 5% sequentially and 20% year-over-year. Sequentially, the increase in Flash ASP more than offset a decline in Flash bit shipments, while HDD revenue decreased. Year-over-year, the increase was driven by growth in both Flash and HDD ASPs and Flash bit shipments. Consumer represented 21% of total revenue at $0.7 billion, down 13% sequentially and up 7% year-over-year. Sequentially, both Flash and HDD were down at approximately similar rates and in line with seasonality. On a year-over-year basis, the increase was driven by growth in flash bit shipments and ASP. Turning now to revenue by business segment for the fiscal third quarter. Flash revenue was $1.7 billion, up 2% sequentially as ASP increased 18% on both blended and like-for-like basis. Bit shipments decreased 15% from last quarter as we proactively focused our flash bit placement to maximize profitability. Flash revenue grew 30% from fiscal third quarter of 2023 on higher bits and ASP. HDD revenue was $1.8 billion, up 28% from last quarter, as exabyte shipments increased 41% and average price per unit increased 19% to $145. Compared to the fiscal third quarter of 2023, HDD revenue grew 17%, while total exabyte shipments and average price per unit were up 25% and 33%, respectively. Moving to gross margin and expenses. Please note, my comments will be related to non-GAAP results unless stated otherwise. Gross margin was 29.3%, well above the guidance range. Gross margin improved 13.8 percentage points sequentially and 18.7 percentage points year-over-year due to better pricing, our continued focus on cost reduction, and lower underutilization charges. Flash gross margin was higher than expected at 27.4%, up 19.5 percentage points sequentially and 32.4 points year-over-year. There were no underutilization charges in the quarter. HDD gross margin was 31.1%, up 6.3 percentage points sequentially and 6.8 percentage points year-over-year. This includes underutilization charges of $17 million or 1 percentage point headwind. HDD gross margin is within our long-term target range, including underutilization charges. This underscores the team's focus on cost reduction and profitability as previously, this level of gross margin was achieved with higher revenue. Operating expenses were $632 million for the quarter, up 13% sequentially and 5% year-over-year. The sequential increase was mainly driven by higher variable compensation associated with better-than-expected financial results. Operating income was $380 million, which included HDD underutilization charges of $17 million. Tax expenses in the quarter was $51 million, reflecting the improved financial outlook for the fiscal year. Fiscal third-quarter earnings per share was $0.63. Operating cash flow was $58 million, and free cash flow was $91 million. Cash capital expenditures, which include the purchase of property, plant and equipment and activity related to flash joint ventures on the cash flow statement represented a cash inflow of $33 million. Third-quarter inventory was flat from the prior quarter at $3.2 billion, with days of inventory increasing 4 days to 119 days. A decline in HDD inventory offset an increase in Flash inventory. Gross debt outstanding was $7.8 billion at the end of the fiscal third quarter. Cash and cash equivalents were $1.9 billion, and total liquidity was $4.1 billion, including revolver capacity of $2.2 billion. For the fiscal fourth quarter, our non-GAAP guidance is as follows. We expect revenue to be in the range of $3.6 billion to $3.8 billion and project sequential revenue growth in both HDD and Flash. In HDD, we expect continued momentum with our industry-leading SMR product portfolio aimed at the cloud. In Flash, we anticipate bits will be flat and ASP is up as we continue optimizing our bit placement to maximize profitability. Gross margin is expected to be between 32% and 34%. We expect operating expenses to be between $670 million and $690 million with the increase mainly related to certain project-driven investments, coupled with higher variable compensation as the financial outlook has continued to strengthen. Interest and other expenses are expected to be approximately $105 million. We expect income tax expense to be between $30 million and $40 million for the fiscal fourth quarter and $130 million to $140 million for fiscal year 2024 as the financial outlook improved. We expect earnings per share to be $1.05, plus or minus $0.15, based on approximately 342 million shares outstanding. The financial outlook has strengthened, and we will remain disciplined in executing the business, controlling our capital spending and improving our profitability. I will now turn the call back over to David.

Thanks, Wissam. Let me wrap up, and then we'll open up for questions. I'm pleased with the team's performance in developing a diversified portfolio of industry-leading products across a broad range of end markets. As industry supply and demand dynamics continue to improve, we will remain disciplined around our capital spending and focused on driving innovation and efficiency across our business. Coupled with the structural changes we have made to our businesses, we are confident in our ability to drive greater through-cycle profitability and dampen business cycles. As we move forward, we remain uniquely positioned to capitalize on the promising growth prospects that lie ahead, solidifying our leadership position in the industry, particularly as AI continues to drive new storage solution opportunities and growth. Okay. Peter, let's start the Q&A.

Yes. Good afternoon. Thank you for taking the question. I guess first question on the HDD side, the gross margins are spectacular and if we take out the underutilization you're north of 32%. So, curious from here as you think about ongoing tightness, ongoing growth in demand led by the cloud and a pricing strategy where I think you and your main competitor are being extraordinarily rational. How do you think the progression for that part of your business will look through the remainder of calendar '24 and into '25?

Hi, C.J., thanks for the question. We're really pleased with the HDD business portfolio. It all starts with introducing great products that provide the highest capacity and the best total cost of ownership for our customers. When we achieve that, we can capture more of the advantage we offer. This has been our strategy for a while, and we are satisfied with the portfolio's performance, which resonates well with customers. Additionally, we are focused on controlling costs to ensure we offer the lowest-cost products, which contributes to margin expansion. We also observe a returning demand environment as HDD spending recovers from previous lows. Moving forward, as mentioned in the prepared remarks, we plan to continue introducing excellent products and improving total cost of ownership for our customers. We're in a balanced supply and demand environment and have restructured our business during the downturn, adjusting our capacity to align with market needs as demand increases. We see better alignment in supply and demand, with market tightness giving us increased visibility from customers regarding their future orders. Therefore, we are optimistic about improving profitability in this business.

Very helpful. And as a quick follow-up, on the NAND side, I think you guided last kind of high-teens bit growth and I'm just curious, is that still a number in play or given your prioritization of highest profitable areas of NAND, should we be thinking about a different number? And you're not talking about production, but actual revenue bits?

Could you clarify the time period you're referring to in your question?

My apologies, for calendar '24.

For calendar '24, we still see demand in the mid to high teens for the market. We estimate supply to be around 8% of bits in production, indicating we are still facing an undersupplied market. In this quarter, our bit production decreased, and we expect it to drop further in double digits. While we anticipated a more stable outlook as we optimize our supply throughout the year, we aim to identify areas for the best profitability.

Thank you.

Thank you C.J.

Great, thank you and congratulations on the results. In terms of the outlook, looking for 4 points of gross margin improvement, it seems like the like-for-like pricing, certainly in NAND is a lot better than that. HDD seems pretty good as well. What are the offsets that you only would see sort of 4 points of gross margin expansion given the improvement that we're seeing in absolute pricing?

Hey Joe, thanks for the question. Look, our guide comprehends a balanced view of what we have in terms of information today with the outlook; yes, we see improvement in margins in both of the businesses. So on the flash side, we still anticipate improvement in pricing that will help gross margin move a bit higher from here. And on the HDD side, as David mentioned, we continue to focus on the obviously, the great technology that we deliver, but also the cost discipline and pricing of the products. So, all of these are comprehended in our guide.

Great and then as a follow-up, you sort of talked about these higher density SSDs in the second half of the calendar year for AI purposes. Can you talk about what has to happen to sort of get those drives out? Like is it you need new capacity points that you don't currently serve and then can you talk generally, it seems like AI is having some positive effects on both sides of your guys' business. Can you talk about that a little bit?

Yes. So what I would say about the AI demand as it's coming into focus. I don't think it's so much in the results just yet, but we're seeing where it's going to impact both businesses. And clearly, one of them you just outlined, which is we're seeing enterprise SSD demand return, we saw some increase in the last quarter. We expect some increase in this quarter. But really, as we look to the second half, we have customers coming to us wanting the kind of SSDs we built and qualified before the downturn. They just want them in much bigger capacity points, 30 and 60 terabyte capacity points. So it's the same product just taking it and increasing capacity and going through a qualification on that so we're in that process with customers. We also introduced a new SSD that's more compute-focused, which is PCIe Gen 5 product based on BiCS 6, very high performance that plays a little bit different role in the AI training stack and we're getting very good feedback on that product. It's being qualified by our starting qualification, we samples. We're kind of getting rid of the qualification of the hyperscaler and we're seeing good demand in the enterprise market as well. So we feel like the portfolio set up well as we go into the second half, and we're seeing a lot of demand show up for people that are very building large amount of infrastructure for model training.

Thank you.

Thanks, Joe.

Thank you for taking my question. I have two as well. First, I want to discuss the gross margin dynamics concerning the hardware business. David, if you reflect back a couple of years, your capacity peaked at around 150 to 155 exabytes. With the current industry constraints, how would you describe your capacity footprint today? Is it reasonable to expect that you need to achieve a gross margin at or above the upper end of the 31% to 34% target model you've established in order to increase capacity?

Yes, that’s how we’re approaching it. I've discussed this before, and I believe the industry has been oversupplied during the transition from client to cloud. This shift has been ongoing for 15 years. The recent downturn was marked by a notable change in demand, prompting us to reduce capacity to better align supply and demand. As we begin to enter this market, I think we will start to see how it unfolds, and as the dynamics develop towards a sustainable business model, we'll gain better visibility into the future. This will enable us to confidently consider investments to expand capacity if necessary, as everything comes into clearer focus, which is beginning to happen. We're noticing better dynamics, and as our confidence grows—though we’re not there yet—we will explore how to increase capacity in the market. However, we are still just at the starting point.

Yes, that's helpful. And then as a quick follow-up, just on the enterprise SSD topic. I think prior to the downturn you had talked about, I want to say it was 2 or 3 cloud OEMs that you had designed in with the NVMe drive, can you just talk about the breadth of what you're expecting? It just sounds like you're kind of getting back into the market, optimizing displacement there. So how do we think about the breadth of the customer base in that enterprise SSD space?

What we're currently experiencing is that as the market begins to recover, our customers are returning after a prolonged period of adjustment. This is something we have anticipated for quite a while. Every segment, from consumer to PC to near-line HDD, has undergone this substantial adjustment phase, and enterprise SSD was the last area we were waiting to see a turnaround. We are now starting to witness that shift. We're observing two main trends in this market: first, we are receiving orders for the enterprise SSDs we previously qualified as the adjustment phase concludes and customers begin to increase their orders again. Second, we're noticing the influence of AI on various capacity needs and use cases for model training, which is driving additional demand. Both of these developments are occurring simultaneously. We believe our product portfolio is well-equipped to serve these markets, and we expect this trend to continue for the remainder of the year, which excites us.

Thank you.

Thanks.

Yes. Thank you so much. On the HDD side, you had a very outsized exabyte quarter-on-quarter growth in the quarter relative to your nearest competitor. How are you thinking about the continued trajectory here in terms of exabyte growth perhaps both quarter-on-quarter basis, but also maybe calendar '24 versus calendar '23?

Yes. We are observing a significant return in demand. In fact, this quarter showed the largest sequential exabyte growth we've experienced in a long time. While I hesitate to say this is the highest ever, as the business has existed for many years, it's certainly the biggest sequential increase we have on record. This success is largely due to our products strongly resonating with customers. We have great confidence in our technology roadmap surrounding ePMR and UltraSMR, which is proving very popular. Almost 50% of the exabytes shipped this quarter were SMR, and we are well positioned for our earlier projections, expecting more than half of our exabytes in FY '25 to be SMR-based. As we mentioned at the start of the fiscal year, we anticipated sequential growth throughout this period, and we have extended that outlook to the calendar year, which continues to hold true. Therefore, we foresee ongoing sequential exabyte growth for the remainder of this calendar year.

Okay. Thanks for that. And as a follow-up, on sort of reinvesting on the capacity side, on the HDD side. I think you said when conditions are ripe for reinvesting, and I know to Aaron's question earlier you commented on certain gross margin ranges, but this cycle, your gross margin is much higher at lower revenue levels than past cycles. So clearly it feels as though at least you have the capability to drive peak margins much higher than your established long-term range. So why should 33 be maybe the level at which you reinvest? Why wouldn't it be 34, 35 or higher than that?

We haven't established a specific benchmark for that. Our focus is on a comprehensive marketing approach. I understand everyone's eager to know when we will reinvest, but that’s not our immediate concern. We are concentrating on achieving a balanced market in terms of supply and demand while providing exceptional products to our customers that align with the growth of the cloud. I believe the business is developing in line with our expectations and reflects the hard work invested over the past couple of years, leading us to a much healthier position that will enable us to enhance profitability. We are just returning to the lower end of the range we set a couple of years ago. We're not claiming victory; rather, we feel we are just at the starting point of where we need to take the business. Nonetheless, we are optimistic about our ability to boost profitability. Success begins with offering excellent products to our customers, and we must continue to improve total cost of ownership. We have a solid architecture to achieve this while managing our product development costs. We need to remain focused on both aspects: maintaining the lowest costs while ensuring the best total cost of ownership to enable us to adjust pricing and enhance margins. We're addressing the entire equation, and I think our strategy is proving effective. This is evident as we have witnessed demand return and margins increase. However, we believe we are only just beginning in this journey.

Thank you so much.

I'm curious your thoughts on the decision to prioritize the transition to BiCS 8 for the mobile market rather than SSDs because AI demand appears concentrated in high-capacity enterprise SSDs. And I guess as you address that question, could you discuss your opportunity to provide QLC enterprise SSD to address these inference applications that appear to be supporting 30 and 60-terabyte units.

Thank you, Karl. We haven't specified the direction for BiCS 8 yet; it's something in our future plans. One aspect we are confident about is that the technology is ready, and we will launch it when the timing is right, ensuring we meet the appropriate profitability and supply-demand criteria for focusing on that node. The technology itself is performing excellently. However, we have not detailed which products will transition to BiCS 8 first, second, or third. Regarding QLC, we are currently transitioning to BiCS 6. We have several products based on BiCS 6, including our client SSD, which has received outstanding feedback. The performance is remarkable. Our internal controller team has done an exceptional job creating a high-performance QLC client SSD, which we anticipate will lead the market during this transition. We are also introducing BiCS 6 in our enterprise SSDs, which will be advantageous in enhancing capacity and performance. We are optimistic about this transition, which has begun, and the products are now in the hands of customers, receiving very positive responses.

Thank you.

Thanks, Karl.

Thanks a lot. Good afternoon. I have two questions as well, I guess. First on the HDD side, I'm wondering, do you think given some of the challenges on Hammer qualifications that Seagate's having, if you potentially saw a bigger uplift in market on the near line side and you think that market share could potentially sustain or does some of that kind of flow back as those qualifications get done. So I'd love to understand if the share gains you think you're seeing are sustainable or not. And then on the flash side, I would like to just maybe get your perspective. I know you folks are talking about bit growth being flat in June. But as some of these qualifications ramp up in the back half how do you think about bit growth ramping up into the back half of this calendar year?

Yes. Regarding the first question, our business with customers is planned well in advance, so there won't be a situation where something occurs mid-quarter that would lead to a significant share shift. The reality is we have excellent products that are resonating with our customers, and we can deliver them at scale. They offer best-in-class total cost of ownership, and customers are adopting these solutions at a significant rate. As for sustainability, we are committed to introducing great products to the market. We are very confident in our roadmap for hard disk drives and will keep providing the best total cost of ownership solutions for our customers. Concerning bit growth, we anticipate flat growth in the second quarter of the calendar year, but we expect to see an increase in bit growth during the second half of the year.

Got it. Thank you.

Thank you.

Good afternoon. Nice job on the quarterly execution. Another question on enterprise is so you guys have been really smart on how you are allocating flash bits, right, with a strong focus on profitability. So as you reallocate more bits towards eSSD in the second half, is the profitability profile of enterprise SSD portfolio expected to be accretive to the overall flash business and your shares peaked previously sort of in that sort of high single-digit percentage range in enterprise. Just given a more competitive portfolio, like what type of share is the team targeting kind of mid- to longer term?

Thank you, Harlan, your questions are quite relevant. We observed an increase in enterprise SSD sales in the March quarter. Honestly, the numbers are still relatively small, but they are improving. We would not have supplied those components if it wasn't aligned with our portfolio strategy. As we approach the second half of the year, we will assess pricing and other options we have before deciding on supply levels for those products. This ties into our portfolio strategy, which aims to maintain various options. We have a diverse range across client SSD, gaming, enterprise SSD, mobile, and consumer markets, which is significant for us. Our decisions will depend on what we observe as we enter the quarter and, importantly, what unfolds during it, enabling us to allocate supply to achieve the best return. Currently, the environment has improved as the quarter progressed, allowing us to identify more opportunities for mixing and enhancing profitability, as reflected in the results from the March quarter. Therefore, I prefer not to specify a market share number, as it can misrepresent our objectives; our primary goal is to maximize profitability rather than market share in a specific segment. We focus on where we can achieve the highest returns for our supply.

I appreciate that. And then maybe a question on BiCS 8. I know you're not calling out any timing yet, but you have had it sort of in preproduction for quite some time. How are the early yields on this technology? And I guess, more importantly, like can the team still drive mid-teens percentage annualized type cost down with the new bonded the raise technology?

Yes. I am very confident in the yields and the technology. We have a strong belief in it, viewing it as a significant advancement in the OptiNAND architecture when compared to the CBA architecture. The development process has been smooth, and we are prepared to bring it to market when necessary. This ties into a broader discussion about market dynamics and the timing for supply needs. We plan to be disciplined in any transition or capital expenditures until we achieve the desired profitability. We feel optimistic about BiCS 8. You mentioned a second part to your question.

On the cost downs.

Yes, maybe I'll take that, Harlan. Yes. On the cost down, we're still anticipating the mid-teens percentage year-on-year cost downs. So there's no change there.

Perfect. Thank you.

Thanks, Harlan.

Thank you for taking my question. My first inquiry is about nearline. You are significantly outpacing your competitors. What do you believe are the underlying reasons for this? Can we expect this to normalize over time, and do you think it can be sustained? I have a follow-up as well. Thank you.

Yes, the performance of the HDD business is driven by the product. It's pretty straightforward. These are great products. The architecture we built on ePMR, OptiNAND, and UltraSMR has led to strong customer commitment to SMR. They provide the best total cost of ownership in the market. We can produce them at scale, and that's what drives the performance.

Thanks for your insight. You mentioned that AI has an impact on SSD sales. Given your unique perspective, are you seeing AI influence applications that were traditionally associated with HDDs and are now moving to SSDs? Or is it simply a matter of the classic concern about one technology cannibalizing the other? Is AI affecting this situation? Thank you.

We do not see any cannibalization clearly. HDD plays a big role in the AI storage lifecycle as well as the whole ingest phase because all of the big data lakes and all of the raw data sets, those are all going to be stored on HDD. It's just the economics of where you store that data and how do you access that data. It's all that part of the AI pipeline, if you will, is going to be HDD. Now you have all of these other new use cases around training and inference, and those are all going to be SSDs. So it's really about growth as opposed to substitution. And that's what's so exciting about this. And obviously, once you get the models trained, then the models are going to turn out more data, which is going to be stored on HDD. So you got this virtuous cycle going. So it's kind of literally rising tide lifts all boats. It's not a substitution game. Clearly, there's a lot of new use cases being developed around AI, like the whole training infrastructures that are being built, that's what's driving these very high-capacity storage-based enterprise SSDs that we're seeing demand for. So hopefully, that helps.

Thanks for taking my question. I have two of them. First one on flash for Dave. You spoke about the BiCS 6 hyperscale qualifying it. My understanding was a BiCS 6 was kind of more like a sub node and BiCS 8 is going to be the bigger one. I'm just kind of curious to get to your enterprise SSD market share target. Do you really need BiCS 8, or can you achieve it with BiCS 6? And then I have a follow-up.

You're right. BiCS 6 is when we say stub node, it's we're not going to take the whole portfolio to BiCS 6. So we have a big portfolio, and we're choosing which products to take the BiCS 6. And clearly, we're taking the products that require QLC and the kind of things you're talking about. So we feel good about our node a plan in the fab being able to supply what we need in these markets.

Got it. And then, Dave, regarding the hard drive side, you mentioned before that ePMR technology could reach 40 terabytes. I'm curious about your competitor's efforts to ramp up HAMR, which has taken them several years to achieve 3 terabytes per disk in their research and development. Can you provide an update on your HAMR roadmap or the status of your HAMR technology, and how we should view the potential for 30, 40 terabytes or more?

We have been focusing on HAMR for a significant period. Our understanding of HAMR is extensive, and we are aware of all the challenges involved in getting it qualified. We are making progress in this area behind the scenes because we offer a product portfolio with the best total cost of ownership available in the market today, which extends up to 40 terabytes. At 40 terabytes, the economics shift, allowing us to achieve 4 terabytes per platter, leading to a situation where the capacity gain offsets the cost increases necessary to maintain margin profitability. This is a complex concept to convey. However, our portfolio is strategically aligned with the right products, costs, and timing, particularly for HAMR at the 40 terabyte level. We are actively developing this product and have been for a long time. We don't necessarily need to publicize this because our existing portfolio is performing exceptionally well, as we've discussed during this call. We are confident in our HAMR development, and our customers are well informed about our progress and plans, and they feel secure with our direction.

Thanks, David.

Thanks for taking my question. I'm going to do one on the CFO side real quick on OpEx. So big step up in the June quarter, and you're talking about some special projects. How should we think about that progressing? Is that investments that are going to stick around for the next couple of quarters? Or should that reset back to kind of the lower base you've been running out? You've just seen OpEx move from kind of the 550 to 660 over the past year, obviously, revenue increasing as well, but any color there on what that investment is for and if you see a step down after that?

Yes, Tom. Let me start by saying that we do not expect our operating expenses to rise faster than our revenue. We remain committed to maintaining cost discipline. For this quarter, we anticipate an increase, driven almost equally by variable compensation due to a better-than-expected financial outlook. Additionally, there are specific R&D investments linked to projects that align closely with projected revenue. For the next couple of quarters, the guidance we've provided for Q4 seems reasonable. While it's premature to discuss fiscal year '25, we can initially use similar figures for modeling purposes.

Helpful. And if I look at your cost guidance for the year, a couple kind of with what you're looking at for June of '24, when I'm looking at gross margins, it seems like you need to have a pretty significant step-up in HDD gross margins. Are you planning for all of that the underutilization to come out of the model in the June quarter? And if any remains, can you let us know how much you're expecting?

For the most recent third quarter, we had a slight update which we disclosed. However, the numbers are becoming increasingly less significant. For the June quarter, there is still a bit of information, but it's not substantial enough to discuss in detail during this call.

Thank you.

Thanks, Tom.

Thanks, Tom.

Yes, hi. David, Wissam. I have a quick question regarding Flash. Dave, in terms of profitability, how does BiCS 6 measure up against some of the competitive NAND on the market, particularly in relation to die size or cost per gig when compared to peers?

That's a very complicated question. We can discuss it in detail offline. We obviously do a lot of work, and I appreciate that it's a multifaceted issue. It's about die size, memory hole density, and various complex factors involved in producing a NAND product. We believe the product compares extremely well and leads the market. Over the past several years, we have managed to produce bits at one-third less capital expenditure than the industry average, and we expect BiCS 8 to maintain that leadership. We are very confident about the product and its performance. One of the advantages of wafer bonding is that you can create the CMOS separately from the NAND stack, making the CMOS pristine, which results in very fast interfaces. There are many benefits to this architecture that contribute to a top-tier product, and we are prepared to move forward when market conditions support that level of investment.

Yes. Most of the good questions have been asked. But David, I just have a longer-term question, and I think it will help many investors let's say, prices were to go sideways in '25, and you're just focusing on that 15% cost down and higher mix of higher-value SSD products. Can you help us understand how your flash margins would evolve from here? And then I'm not trying to ask you for pricing. But I'm just wondering how we could gauge your execution first, on the product mix and be on the cost down and how they both would manifest into higher margins.

Yes, let me start by answering your question, Mehdi. Our target model remains unchanged. We are still aiming for the flush business to have a gross margin of 35% through the cycle, which means we have some distance to cover from our current position to reach that through-cycle margin. We plan to achieve these gross margins by focusing on our product portfolio, the placement of bits, and managing costs, where we expect to maintain similar ranges for cost reductions.

Okay. That's reasonable. Let me just move on to the second question. And this is something I always ask, focusing on HDD. Is there any update how you see exabyte shipment evolving like over the next couple of years? Is the target now 25% to 30% or less or more?

We are still in the 20% to 25% range, possibly around 25%. We are clearly experiencing a cyclical recovery, moving back to that through-cycle number. The question regarding how much AI contributes to that is still somewhat uncertain. We definitely see an increase in the value of data, leading to a desire to store more data for training additional models, which will generate even more data. Therefore, we believe the bias is increasing. However, I cannot yet specify how much this will alter the trajectory. We will continue to focus on this over the next several quarters, staying close to our customers as these models and AI are deployed and adopted more widely, allowing us to refine our expectations regarding HDD storage demand. We are optimistic that we have a favorable long-term trend for the business.

Hi. I have two quick questions. First, regarding the HDD side, your major competitors mentioned needing to support the supply chain moving forward. How do you view that option or need? Second, since cash flows have turned positive again, could you provide some guidance on how to think about cash flow in relation to net income or EBITDA in the upcoming quarters? Thanks.

I'll comment on the supply chain. We have maintained a close relationship with our suppliers throughout the downturn and continue to do so as we plan for the future. We believe in supporting our supply chain, and Irwin Tan, who leads operations, is based in Singapore where many of our suppliers are located, allowing him to stay closely connected with them. We have consistently supported our supply chain during this period, and as conditions improve, it benefits us all. Would you like to discuss cash flow?

Yes, let me take that. So on the cash flow, yes, thanks. Obviously, we returned to free cash flow positive in Q3. And as the revenue and the business continues to recover, we're completely focused on profitability and cash flow generation. So we should expect that to improve from here.

Yes, thanks guys for taking the question. Just one for me. David, really, I think, piggybacking off the part of Mehdi's question. So just a TAM question on both sides of the business, HDD and Flash, is really the spirit of it that you see some near-term demand from AI coming and TBD on the impact to the TAM over time and also TBD on impact to the normalized growth rate off of whatever the new TAM looks like. And that's really the question. And TBD is the financing, but I just wanted to make sure we get all of your current opinions there. Thanks.

I believe that's a reasonable way to put it. It’s becoming clearer where the impacts will be felt on both sides of the business. However, as you mentioned, we are not yet ready to estimate the effect on the total addressable market, though we do see it as a positive factor for both. In the NAND sector, there are very specific use cases for model training that are significantly increasing. It’s evident across the entire technology industry, and we are witnessing demand for such products in the second half of the year. For HDDs, all the data necessary for that process will be stored on HDDs. Once these models are trained, a significant majority of the resulting data will be kept on HDDs. We see a very promising outlook, but we are closely monitoring our customers in these markets. It is still too early to assign a number regarding its impact on the growth rate or the size of the total addressable market.

Hi, good afternoon. A quick follow-up on this, which is how critical is it to have U.S. manufacturing for SSDs in relation to AI? And how do you look at partnership with hyperscalers as opposed to more kind of a general purpose business?

You mean U.S. manufacturing of the NAND itself or the SSD. Our NAND is manufactured in Japan. So we feel really good about our manufacturing footprint. We haven't discussed the joint venture on this call, but it positions us well in terms of scale and contributes to our low-cost production, capital efficiency, and strong product roadmap. This is all done in partnership with Kioxia, allowing us to invest as the largest supplier in the market, which is advantageous. Our manufacturing setup has not hindered our ability to serve the entire market. Regarding our collaboration with hyperscalers, we maintain a close relationship with them, as they are significant customers and we supply them across both sides of the business. We engage with them to understand their diverse use cases and product requirements, particularly in the enterprise SSD market, where each entity has specific interface needs and varying data center architectures. We ensure we develop the right products for the markets we aim to serve.

All right. Thanks, everyone. We appreciate all of the questions, and we look forward to talking to everybody throughout the quarter. Thanks again.