Western Digital Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 30, 2023

Key Takeaways

  • Spinoff announcement: Western Digital will form two independent public companies—HDD retaining the Western Digital name and Flash spun off tax-free to shareholders in H2 2024—to unlock shareholder value through focused management and capital allocation.
  • Q1 results: Revenue fell 26% YoY to $2.75 billion and non-GAAP loss per share was $1.76, with $225 million in underutilization charges weighing on gross margin.
  • HDD innovation: The 26 TB Ultra SMR drive became the highest-volume nearline runner in just two quarters, and WD expects sequential HDD revenue growth as cloud demand recovers.
  • Flash recovery: Flash revenue rose 13% sequentially on record bit shipments (up 26%) and signs of price inflection, setting the stage for gross margin improvement as inventory normalizes.
  • Q2 outlook: Management guides Q2 revenue of $2.85–3.05 billion and gross margin of 10–12%, expecting lower underutilization charges and continued pricing gains in both HDD and Flash.
AI Generated. May Contain Errors.
Earnings Conference Call
Western Digital Q1 2024
00:00 / 00:00

There are 17 speakers on the call.

Operator

Morning, ladies and gentlemen, and welcome to the Western Digital First Quarter Fiscal 20 24 Earnings Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Peter Andrews, VP of FP P and A and Investor Relations.

Operator

Sir, please go ahead.

Speaker 1

Thank you, and good morning, everyone. Joining me today are David Geckler, Chief Executive Officer and Wissam Jabre, Chief Financial Officer. Before I begin, we have a lot of exciting items to discuss today. In addition to the earnings press release and slides, we also have a press release and slides regarding the conclusion of our strategic review. All of these materials will be posted in the Investor Relations section of our website shortly.

Speaker 1

Let me remind everyone that today's discussion contains forward looking statements based on management's current assumptions and expectations and as such This does include risks and uncertainties. These forward looking statements include expectations for our product portfolio, Spending and cost reductions, business plans and performance, market trends, financial results, the outcome of Our ability to complete the transaction, the future performance of our separated businesses and the creation of shareholder value by separating our businesses. We assume no obligation to update these statements. Please refer to our most recent financial report on Form 10 ks and other filings with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially. We will also make references to non GAAP financial measures today.

Speaker 1

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

Speaker 2

Thank you, Peter. Good morning and thank you for joining our call. I will first discuss the completion of the strategic review and then turn to our Q1 results. We're thrilled to announce the completion of our strategic review and Plans to form 2 independent public companies focused on capitalizing on the data storage industry's growth in HDD and Flash. After evaluating a comprehensive range of alternatives, the Western Digital management team and Board determine that spinning off its Flash business is the best executable alternative at this time to fully realize value for shareholders.

Speaker 2

This transaction will allow each franchise to execute on its product and innovation roadmap and capitalize on the unique growth opportunities in their respective end markets. Each company will benefit from streamlined management focus, operational flexibility in the ability to set its own distinct capital allocation and shareholder return policies. We are excited for the opportunities this transaction and unlock significant value for our shareholders. Before discussing the details, let me walk you through the journey that brought us to this point. In March 2020, I joined Western Digital with a strong conviction in the company's unique position to accelerate and benefit from the digital transformation that is reshaping every industry, every company and how all of us live our daily lives.

Speaker 2

And importantly, I saw an opportunity to create value for a leader in both NAND flash and hard drives. During my early days at the company, I spent considerable energy into rebuilding and refocusing the company, including the formation of the HDD and Flash business units. It soon became clear that our focus on driving 2 distinct technology portfolios was the right strategy And the new management team that I brought in worked together to transform Western Digital by bolstering business agility and reinvigorating innovation. In addition, we promptly focused on strengthening our balance sheet. We made the tough decision to suspend our dividend, which allowed Western Digital to speed up debt reduction and paid down $2,700,000,000 of debt over a couple of years following the suspension.

Speaker 2

We further enhanced our liquidity by bringing in $900,000,000 of strategic investment from Apollo Global management and amenadart credit agreements. We also settled a long standing tax dispute to increase strategic optionality. The groundwork we laid over the past several years, including the additional actions taken in fiscal year 'twenty three to right size the business, have enabled us to navigate a dynamic environment, all while staying focused on delivering a range of industry leading products. Each business is now in a strong operational position to succeed on its own and the actions we are announcing today We'll further enable each company to drive long term success in the years to come. The Western Digital team and Board completed the strategic review after evaluating a comprehensive range of alternatives and determine that spinning off its Flash business is the best Executable alternative at this time to fully realize value for shareholders.

Speaker 2

During our strategic review process, We evaluated material opportunities for each of our businesses. However, given current constraints, It has become clear to the Board in recent weeks that delivering a standalone separation is the right next step in the evolution of Western Digital and puts the company in the best position to unlock value for our shareholders, while providing strategic optionality for both businesses. Given the confidential nature of the strategic review, We will not be discussing any of the other alternatives that were considered during the process. On Page 6 of the presentation, We present a separation transaction summary. The HDD business will retain the Western Digital name and become an independent Publicly traded company.

Speaker 2

The Flash business is expected to be spun off in a tax free transaction to Western Digital shareholders and the name of the publicly traded company will be determined at a later time. We target to complete these plans in the second half of calendar year twenty twenty four subject to the principal closing conditions described in the slide. Page 7 provides a bit more visibility into some of the end market exposure for our flash and HDD businesses on a trailing 12 month basis. Moving to the individual businesses on Page 8. In HDD, Western Digital is a well known leader in the mass storage market with an ability to generate consistent cash flow on a standalone basis.

Speaker 2

Our ability to lead the industry in bringing new innovations to the hard drive market To enable higher capacity points for mass market adoption has established Western Digital as a key strategic supplier to the world's global cloud service providers, storage OEM and distributors. The massive opportunity is driven by the ongoing expansion of the cloud infrastructure connected to intelligent endpoints and powered by high speed networks. Industry analyst to $25,000,000,000 over the next 3 years with cloud representing over 90% of the total addressable market. The cloud represents an incredibly large and growing end market for Western Digital and we are well positioned to address customer storage needs. Moving to our Flash business on Page 10.

Speaker 2

The Western Digital Flash business is well known for its broad go to market channels, Enviable premium brand retail franchise and strong client SSD portfolio. Industry analysts forecast the flash market to grow at approximately 15% compounded annual growth rate over the next 3 years to $89,000,000,000 in calendar year 2025. We believe content increases in the consumer and client end markets as well as explosive growth of data created in the cloud by emerging applications such as generative AI, Virtual reality and autonomous driving are driving a faster growth in flash versus HDD. The highlight of our consumer end market is the strength of our SanDisk brand of retail products and our suite of high performance SSDs For gaming enthusiasts, the brand recognition in Affinity combined with our unmatched presence across the world It's a great setup for the business on a standalone basis. Our successful 23 year partnership with Kioxia continues to provide us a reliable Together, we have successfully brought to market numerous generations of flash technology with the industry's lowest cost and best capital efficiency.

Speaker 2

The joint venture fabs produce over 30% of the world's bits and our joint memory technology roadmap remains incredibly well positioned, especially as we lead the industry's transition to wafer bonding. We will likely host an Investor Day closer to the time of the spin off of our Flash business to give investors greater clarity into the historical and future outlook for each of our businesses along with the intended capital structures for each business. With that, I'd like to turn to Q1 fiscal 'twenty four earnings review and business update. Western Digital's 1st quarter and right size the business have enabled us to capitalize on enhanced earning power in an improving environment. We reported 1st quarter revenue of $2,750,000,000 and a non GAAP loss per share of $1.76 Our ability to develop differentiated and innovative products across a broad range of end markets has resulted in sequential margin improvement across both flash and HDD businesses.

Speaker 2

In flash, healthy inventory levels on our balance sheet and signs that flash pricing is beginning to inflect have laid the groundwork for further gross margin improvements. Our broad go to market channels, enviable retail franchise and strong client SSD portfolio have enabled us to shift bits to the most attractive end market categories and achieve 26% sequential bit growth as well as upside in gross margin. In HDD, our industry leading 26 terabyte Ultra SMR drive became the highest Nearline volume runner in just two quarters, which demonstrates Western Digital's aerial density leadership and ability to deliver high volume innovative technologies to data center customers worldwide. During the quarter, demand in Consumer and Client continued to improve, exceeding our expectations. In Consumer, Flash revenue has returned to growth on a year over year basis, led by strong content increases and unit growth.

Speaker 2

In client, PC and component demand also exceeded our expectations and demand for gaming consoles and mobile remained resilient. In cloud, demand for both hard drive and flash products remain subdued. I'll now turn to the business updates starting with Flash. During the quarter, Flash revenue increased sequentially, led by record exabyte shipments and continued content growth in consumer and client end markets, including PCs and all retail products as we continue to optimize bid placement in an improving environment. WDBLACK, which is optimized for gaming, continued to perform well with bit shipments more than doubling and content per unit increasing over 50% year over year.

Speaker 2

We are in an excellent position from both The Flash technology and capital efficiency perspective, today a majority of products we are shipping are based on BiCS5, the most capital efficient node in the 3 d era that continues to provide an amazing cost structure and efficient capital spending. As we look into calendar year 2024, we are ramping an array of QLC based client SSDs based on BiCS6 technology to lead the expected industry transition to QLC. After BiCS6, we remain on track to introduce a broad range of high performance products based on BiCS8 technology with its unique chip bonded on array architecture. Turning to HDD, revenue declined due to lower nearline exabyte shipments driven by subdued demand from our cloud customers and slower than expected recovery in China. However, demand for consumer and client hard drives was stable.

Speaker 2

Western Digital has continued to lead the industry in driving innovation within the nearline market. Our ability to bring innovation into mass market The drives that are quickly deployed into cloud data centers is reflected in our results as we successfully led the industry's transition to SMR based nearline drives. Specifically, our 26 terabyte Ultra SMR drive, which we first announced at our Investor Day accounted for nearly half of our nearline exabyte shipments with total SMR shipments exceeding the 40% goal we laid out in the same quarter a year prior. We are on track with our 28 terabyte ultra SMR drive qualification and have a clear roadmap of EPMR and Ultra SMR based innovations into the 40 terabyte range. These developments a result of the choices we have made in the past few years through a combination of product R and D and manufacturing capabilities, and we are proud of how we have been executing against our strategy.

Speaker 2

Looking ahead to the fiscal second quarter. In Flash, we expect both modest bit and ASP improvement and a decline in underutilization charges to drive continued In HDD, we expect higher nearline shipments and seasonal demand in consumer end market to drive sequential revenue growth. We anticipate our value based pricing efforts and lower underutilization charges will lead to sequential revenue and gross margin improvement in the quarter and through the rest of fiscal year 2024. As we continue to execute against our HDD product roadmap, We are setting the stage for profitable growth for years to come. With that, I'll turn it over to Hessam.

Speaker 3

Thank you, and good morning, everyone. As David mentioned, fiscal first quarter results exceeded the guidance ranges provided in July. Total revenue for the quarter was $2,750,000,000 up 3% sequentially and down 26% year over year. Non GAAP loss per share was $1.76 Looking at end markets For the fiscal Q1, cloud represented 32% of total revenue at $900,000,000 down 12% sequentially and 52% year over year. Sequentially, the decline was primarily due to lower nearline hard drive shipments to data center customers.

Speaker 3

The year over year decrease was primarily due to declines in shipments for both hard drive and flash products. Clients represented 42% of total revenue at $1,100,000,000 up 11% sequentially and down 7% year over year. Sequentially, the increase was due to growth in flash bit shipments. The year over year decrease was primarily due to declines in flash pricing. Consumer represented 26% of revenue at $700,000,000 up 14% sequentially and 8% year over year.

Speaker 3

On both a sequential and year over year basis, the increase was driven by both higher content per unit and increased unit shipments in Flash. Turning now to revenue by segment. In the fiscal Q1, flash revenue was $1,600,000,000 up 13% sequentially and down 10% year over year. This marks the 2nd consecutive quarter of sequential increase. Sequentially, flash ASPs decreased 10% on a blended basis and 4% on a like for like basis.

Speaker 3

We shipped a record amount of flash bits in the quarter with shipments increasing 26% sequentially and 49% year over year. HDD revenue was $1,200,000,000 down 8% sequentially and 41% year over year. Sequentially, total HDD exabyte shipments decreased 5% and average price per unit increased 13% to $112 On a year over year basis, total HDD exabyte shipments decreased 42% and average price per unit decreased 10%. Moving to gross margin and expenses, Please note that my comments will be related to non GAAP results unless stated otherwise. Gross margin for the Q1 was 4.1%, which was at the higher end of the guidance range provided in July and included $225,000,000 in underutilization expenses and $9,000,000 in other one time charges.

Speaker 3

In total, these charges represented an 8.5 percentage point headwind to gross margin. Flash gross margin was negative 10.3%, Underutilization charges due to reduced manufacturing volumes were $142,000,000 and flash inventory write downs were $9,000,000 resulting in a combined 9.7 percentage points headwind to gross margin. HDD gross margin was 22.9%. Underutilization charges were higher than expected at $83,000,000 or a 7 percentage point headwind to gross margin. We continue to tightly manage our operating expenses, which were down 19% year over year to $555,000,000 well below our guidance range.

Speaker 3

Operating loss was $443,000,000 which included underutilization charges and inventory write downs totaling 2 and $34,000,000 Income tax expense in the fiscal Q1 was 25,000,000 Net loss per share was $1.76 inclusive of a $15,000,000 dividend associated with the convertible preferred equity. Operating cash flow for the Q1 was an outflow of $626,000,000 and free cash Flow was an outflow of $544,000,000 Free cash flow included a payment of $523,000,000 for the IRS settlement and $191,000,000 cash receipt from the sale and leaseback of our facility in Milpitas, California. Inventory declined $201,000,000 sequentially to $3,500,000,000 Days of inventory declined 10 days to 120 days. Flash inventory declined by nearly $400,000,000 driven by record bit shipments in the quarter and proactive actions taken to reduce wafer starts. Days of inventory for flash have reached the lowest level in nearly 4 years.

Speaker 3

HDD inventory grew by nearly 200,000,000 due to the timing of certain purchases and lower than expected shipments. Cash capital expenditures, which include the purchase and sale of property, plant and equipment, including the proceeds from our sale leaseback of our Milpitas facility and activity related to our flash joint ventures on the cash flow statement represented a net cash inflow of $82,000,000 In the fiscal Q1, we fully drew the $600,000,000 delayed draw term loan facility. Gross debt outstanding was $7,700,000,000 at the end of the fiscal quarter. At the end of the quarter, total liquidity was $4,300,000,000 including cash and cash equivalents of $2,000,000,000 and undrawn Revolver capacity of $2,250,000,000 Before I cover guidance for the fiscal Q2, I'll discuss the business outlook. For fiscal Q2, we expect total revenue growth to be led by higher nearline HDD shipments and improved pricing in flash.

Speaker 3

We continue to adjust production into the Q2 to better align supply with demand and anticipate lower underutilization charges in both flash and HDD. For our fiscal Q2, our non GAAP guidance is as follows. We expect revenue to be in the range of $2,850,000,000 to $3,050,000,000 We expect gross margin to be between 10% 12%, which includes underutilization charges across flash and HDD totaling $110,000,000 to $130,000,000 We expect operating expenses to be between 560 and $580,000,000 Interest and other expenses are expected to be approximately 105,000,000 We expect income tax expenses to be between $20,000,000 $30,000,000 for fiscal 2nd quarter and $80,000,000 to $120,000,000 for fiscal year 2024. We expect a preferred dividend of 15,000,000 We expect a loss per share of $1.35 to $1.05 assuming approximately 325,000,000 shares outstanding. I'll now turn the call back over to David.

Speaker 2

Thanks, Wissam. Let me wrap up and then we'll open up for questions. We are now emerging from a historic storage cyclical downturn where all of the changes made in the past several years were evident in how well each business performed relative to peers. The Q1 of fiscal 2024 builds upon the improvements we made in fiscal year 2023 around disciplined supply and capital expenditure While executing on our product innovation roadmap, we continue to tightly manage our operating expenses and are closely monitoring demand in our end markets to appropriately manage our inventory in both flash and HDD, all to improve sequential and year over year upside in our results. Moving forward, as we progress through fiscal year 2024, We see an improving market environment in both businesses.

Speaker 2

With an improved position, the separation of the company unlocks value by creating 2 independent public companies with market specific strategic focus, better positions each franchise to execute Innovative technology and product development, capitalize on unique growth opportunities, extend respective leadership positions and operate more efficiently with distinct capital structures. Okay, Peter, let's open up for Q and A.

Operator

Ladies and gentlemen, we will now begin the question and answer portion of today's conference. And our first question today comes from Joe Moore from Morgan Stanley. Please go ahead with your question.

Speaker 4

Great. Thank you and congratulations on the decision here. Can you talk through a little bit anything preliminary in terms of How the OpEx might be apportioned between the two businesses? And you mentioned maybe you'll give us the capital structure at a later date, but just anything Early on, unlike what you think the right amount of debt is to a portion of the 2 businesses.

Speaker 3

Hey, Joe, good morning. Thanks for the question. Look, it's a little bit too premature to talk about details with respect to each As we get closer to the separation, we'll be in a better position to talk But much more details with respect to OpEx apportionment as well as capital structures, Leverage targets and capital return policies, etcetera.

Speaker 2

Hey, Joe. This is David. Thanks for the question. Good to hear from you this morning. One thing I will say is we're very happy with the level of efficiency we've driven into the business over the last Year, especially during this downturn and we think has put us in a very good position to go through this transaction.

Speaker 2

I think OpEx over 2 years is down over the last 2 years is down over 200,000,000 So, we put ourselves in a position where we've got very efficient business and some flexibility to go through a transaction like this. So as Bassam said, we'll have more to say as we get closer.

Speaker 4

Okay. Great. And then I wonder if I could just ask more tactically, in terms of The need to pay down the convert early next year, how you're thinking about that and whether this The strategic change here changes anything in terms of your ability to do convert issuance or things like that, weigh that down?

Speaker 3

Yes, Joe. The current announcement does not affect our ability to address the convert. As we've said before, our plan is to address the convert that's maturing in Feb 24 by the end of this calendar year.

Speaker 4

Thank you very much.

Speaker 5

You're welcome.

Operator

Our next question comes from Aaron Rakers from Wells Fargo. Please go ahead with your question.

Speaker 6

Yes. Thank you for taking the question. 2 if I can as well real quick. I guess the first question is Thinking about the separation, appreciating that you're not going to give anything at this point around the capital structure. I'm just curious though, the relationship with Sia, I know in the past there's been certain attributes of rights as part of the JV.

Speaker 6

Any kind of context about the dialogue Moving to the separation as it relates to that JV rights or should we be thinking about any approval processes that are involved in that?

Speaker 2

No. So first off, the relationship with Keyokshi is outstanding and it has It's been for a very, very long time. So we expect that to continue on. Absolutely, it provides a tremendous foundation for our NAND business with both very capital efficient NAND and a tremendous roadmap as we're going into BiCS8 here. But we can execute this transaction without any other approvals.

Speaker 6

Okay. And then as a quick follow-up, I'm just curious on the hard Stride business, I know the cloud revenue and total was down consistently, again, quarter over quarter. Just how would you characterize what you're seeing from a nearline Perspective from the cloud, have you started to see demand pull again? Just any kind of context of how you're thinking about The shaping of kind of a recovery here as we move forward.

Speaker 2

Yes. We think this past quarter was the bottom, Aaron, and we See improving demand as we move throughout the fiscal year on a quarter over quarter basis. We've had certain customers that have been on the sidelines for a while and they're starting to come back and give us visibility into ordering. So We expect the market to recover from here going forward.

Speaker 6

Okay. Thank you.

Operator

Our next question comes from Krish Sankar from TD Cowen. Please go ahead with your question.

Speaker 7

Yes. Hi. Thanks for taking my question. I have 2 of them too. First one, Again, sorry to harp on the separation.

Speaker 7

It makes a lot of sense. I'm just kind of curious, in the past, David, you've spoken about some of the synergies In R and D and how the HDD product line uses some of the BOM from OptiNAND etcetera, I'm just kind of curious, would that change post the separation or There's going to be no strategic shift on that. And then I had a follow-up.

Speaker 2

So there's no the separation doesn't To imply any change in strategy for either business. So both of them will continue to go forward. No change in our product roadmaps. So we feel very good about what's been built over the last 3, 4 years. We feel like we're in a market leading position in both franchises, both from a product point of view.

Speaker 2

If you look at what's happened in the hard drive business, it's very, very clear now the adoption of SMR is the next Big step in the cloud data center and that's progressing very well. Our 26T drive just became the highest shipping drive in the quarter. And we announced the next generation of that with the 28T as well. So no change there. OptiNAND is still a big part of that And the team will be able to procure that and continue to drive that part of the strategy.

Speaker 2

And on the flash side of the business, the portfolio It is also in great shape with both from a product strategy and also the branding strategy. SanDisk, WD Black, these brands continue to perform Extremely well. So we think it's a great setup for both businesses going forward.

Speaker 7

Got it. Thanks for the data. And then a quick follow-up. Your peers spoke about the HAMR technology getting like adopted next year and your road map shows EPMR to extending to 32 plus terabyte. I'm kind of curious How you think about HAMIL and your roadmap in case that catch up with Seagate?

Speaker 2

Look, we put a lot of optionality in our roadmap a number of years ago, so that we could extend The capacity points with things like OptiNAND, SMR, Ultra SMR, EPMR, So that strategy is working very, very well. We're leading the industry in capacity points. We expect to be able to drive this strategy into the 40 terabyte range on our drives. HAMR is in development. It's going well and we'll be able to fold that into our roadmap at the appropriate time.

Speaker 2

But for now, we've got a great roadmap. We've got a market leading roadmap. We're leading the adoption of SMR into the cloud data center and we expect, we have many more generations to go on our And then we'll move to HAMR at the appropriate time when it's mature and we can build it at scale and it'll be the next leg of growth into the future.

Speaker 7

Thanks, Steve.

Speaker 2

Thank you, Krish.

Operator

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

Speaker 8

Hi. Yes. Thank you so much. Good morning. Back to the transaction, I guess, can you maybe talk a little bit about all the actions that you have taken that might Preventing some of the dis synergies that typically occur in terms of stranded costs when there is separation of the business.

Speaker 8

Can you maybe address that? And on your comments on the roadmap, UltraSMR, PPMR, you have a lot of options. You've noted scaling up to 40 TB. Can you just talk about what the cost of that, How that would compare to your own future, HAMR roadmap and give us some sense of How cost competitive you think these products would be? Thank you.

Speaker 2

Okay. So on the first one, yes, I mean, Wamsi, I think you Kind of laid it out there. We've been going through a whole series of actions that have set us up for this announcement. It was really about So as I talked about in the prepared remarks, we've we separated ourselves into business units on the product side that allows us to really get very focused on the portfolio and all the OpEx we And on building our products, make sure it's we get the best return for it. I think that's worked out well.

Speaker 2

We then did the same thing in operations. We've now divided those organizations around HDD and Flash. So we've And then we've optimized, taken out cost everywhere we can, so that we can operate them independently and also have just the most efficient business Possible, as I said, we've focused on our balance sheet. So I think we've put ourselves in a very good position where We can go through this separation and the organization is as prepared as we possibly can be for it. We've also, as I said earlier, we've taken a lot of OpEx So we've driven the OpEx down to a very efficient number.

Speaker 2

So we believe We can go through the separation and end up with 2 very well structured companies that can execute very well and they come out of the gate with market leading portfolios on each side and into a recovering market. So we feel good about that. Cost of the portfolio, look, I mean, As you continue, we feel the roadmap we have in place, we can produce ultra SMR, EPMR, Opti NAND drives very high scale, very quickly, very high yields on all the products. So we think the cost position is very Advantageous, you see that in our results. So when HAMR comes, we'll Fold that in and we want to get to the point where we have the same level of yields, we have the same level of confidence as we do something like a 26 T Drive that we just launched and now it's the nearly half of our exabytes a quarter or 2 in and that's how we think about launching new products.

Speaker 2

So when we get there, I think that we'll have that same kind of cost structure on HAMR and we have a great very, very strong position to drive very efficient, Very high scale, very quickly, new drives for many generations on the Technology that we've put in place over the last 3 or 4 years.

Speaker 8

Thanks, Dave.

Speaker 2

Thank you.

Operator

Our next question comes from Sidney Ho from Deutsche Bank. Please go ahead with your question.

Speaker 9

Thank you. Congrats on the announcement today. Understanding you have amended the debt covenants Given the announced transaction, how are you thinking about the covenants over the next few quarters, specifically related to free cash flow before the transaction is closed and does that limit the amount of CapEx you could spend in the meantime? And I'll have a follow-up.

Speaker 3

Hey, good morning, Sidney. Thanks for the question. The current announcement does not affect the amended Credit agreements. And so from a free cash flow, from a covenants perspective, we're comfortable that we can operate effectively. We have ample liquidity.

Speaker 3

We do have ample operational flexibility to operate. So I don't see the current announcement as impacting us in any way.

Speaker 9

Okay. My follow-up is, if you look at the fiscal Q2 guidance, if you can walk us through your assumptions that drive 7 points of increase in gross margin, That will be great. It looks like underutilization charge is coming down. Are there benefits from sales of previously written down inventory? And what are you expecting in terms of Price increases in both flash and hot disk drive on a like for like basis.

Speaker 9

Thank you.

Speaker 3

Okay. Maybe I'll start a little bit on the cost side and then David could chime in on the top line side. Look, the when One of the bigger, obviously, levers is the underutilization. We did in Q1 around 225,000,000 In total, we had around $234,000,000 to $235,000,000 of other charges. And our guide has a Underutilization at a much lower level, and so that's one element.

Speaker 3

In addition, obviously, we continue to focus on cost reduction. We do have Still we're still if you exclude the underutilization aspect, we're still taking cost out of the system on both the flash side and the HDD side. And so that's a key lever to improve the gross margin. And then if I take it back up To the top line, we see obviously improvement in the on the revenue side and the improvement is coming from both Size of the house on both businesses. So that also contributes quite well with respect to the Gross margin and within that revenue also, we do have a bit of mix that's helping us as well.

Speaker 2

Yes. Sydney, I guess what I would add is, if you look at the HDD business, we're ramping new products, Right. The 26T drive is ramping rapidly. And we also have an improving price environment pricing environment And drives, which is a nice tailwind. And then in flash, we have an improving pricing environment as well as we saw him set a better mix.

Speaker 2

And we expect that business to inflect a positive gross margin next quarter, which is a great milestone for us as we continue the recovery of the business. Thank

Speaker 10

you.

Operator

Our next question comes from Tom O'Malley from Barclays. Please go ahead with your

Speaker 11

Good morning and thanks for taking my question. I just wanted to ask on your expectations for both market Demand on the NAND exabyte side for fiscal year 2024, as well as your view of supply. I mean, you're starting the year up almost 50% year over year, obviously, off a very low base and sequentially up mid-20s.

Speaker 2

Some of

Speaker 11

your peers have talked about really strong demand here To begin the fiscal year or to begin the recovery in those for those other guys, but kind of some slowing as Sky saw the bottom, ordered a bunch and have kind of slowed down. Can you just give me your comments on if you're seeing any of that and then your expectations for the exabyte shipments for you for the fiscal year?

Speaker 2

Yes. So, we did we have seen an acceleration here at the end of 'twenty three. We've raised our demand number quite a bit into the low mid teens for 2023. We'll get to 24. Some of that, There has been some strategic buys as part of that.

Speaker 2

I know that's been a big discussion in the industry, but we also just see the markets returning to normal inventory level. So for us, that's been more of what's been happening and a good mix across the businesses. For 2024, we see high teens kind of demand and we continue to see production significantly below that.

Speaker 11

Helpful. And then on the other side of the business, you talked about the kind of varied inventory positions you have Flash going down, HDD actually going up a bit. If you compare your results with Seagate at least for the last couple of quarters, results have been relatively similar. Could you just talk about when we should start to see that divergence Just given the fact that you're addressing a higher capacity point in the market today and theoretically you should see some outsized benefit. When do you think you'll start to see

Speaker 5

that divergence in the market?

Speaker 11

Thank you. The

Speaker 2

Divergence in what aspect, Tom?

Speaker 11

In terms of revenue, Different.

Speaker 2

So we're managing the business for profitability on HDD. I mean, I think it's we and I think we are driving So, that's the way we think about the business and driving back to our model, which we expect to get back to here over the next several

Speaker 1

Jamie?

Operator

Our next question comes from Serena Pajjuri from Raymond James. Please go ahead with your question.

Speaker 12

Yes. Thank you. Good morning, guys. David, on the HDD comments that you see growth throughout the fiscal year, Just looking for some additional color, just kind of listening to some of your customers and the big hyperscalers, I think the CapEx comments have been fairly mixed. And I'm just curious as to how broad based this recovery that you're seeing is?

Speaker 12

Is it primarily driven by the inventory work downs or anything else that's And also if you can comment on by geography, I think you said China was weak in the quarter. If you could talk about how your expectation for China business is going forward?

Speaker 2

Yes, I think you got it there in your question. I think you have more broad based Participation in the market by the big hyperscalers as they get to the end of their inventory corrections. So that's been Remember, we're coming off a very, very, very low numbers. So, we expect improvement throughout the year by More people participating in the market and more consistent participation by the ones that have been in it on a quarter over quarter basis. China has been it's been better, but not as it hasn't recovered as fast as we expected.

Speaker 2

So it's still a little bit lumpy and weaker than we would like. So the smart video market has been pretty consistent and we've seen Some good results there. But in the cloud space, it still has a little ways to go.

Speaker 12

Thank you. And then cash flow question for Wissam. I guess, I'm just curious, you had an IRS Payment due during the quarter, did you make that payment? I see like a $300,000,000 impact from the tax. And then if you could walk us through Some of the puts and takes in terms of free cash flow for next quarter, I think that will be helpful.

Speaker 12

Thank you.

Speaker 3

Yes, sure. So on the Tax payment, in Q1, we made a $523,000,000 payment with The IRS settlement discovers the years 2008 to 2012. And so this is why you see when you look at our free cash flow that we reported for fiscal Q1 at a negative $5.44 and that we had that $523,000,000 payment. On the it was partially offset by the sale and leaseback of the Milpitas facilities of around 191,000,000 So all in all, we were around the negative $200,000,000 for the quarter. As we look forward, obviously, the key It's the continuous improvement of the profitability and of the business, working capital management.

Speaker 3

You've seen our Very, very closely on both flash and HDD. So I expect that inventory to continue to decline gradually in this coming quarter and the next. And then the continued focus on CapEx For the fiscal year, we did say that for fiscal 2024, we expect our cash CapEx to be significantly lower than fiscal 2023. So free cash flow is and cash flow is very important to us, big focus and we'll continue to focus on it. And as we look into the second half of fiscal twenty twenty four, we're projecting to be Cash flow positive on a quarterly basis in the second half of this fiscal year.

Speaker 12

Thank you.

Operator

Our next question comes from Karl Ackerman from BNP Paribas. Please go ahead with your question.

Speaker 13

Yes, thank you. Good morning.

Speaker 2

Good morning, Carl.

Speaker 13

Hey, good morning. When do you anticipate NAND underutilization charges to abate? And then second, you indicated that NAND and HDD bit shipments will recover in December. I guess for NAND, will that be primarily tied to consumer applications or do you expect enterprise to be the larger driver over the next couple of quarters. Thank you.

Speaker 2

Yes, I'll take the second part of that and Hessam can comment on the underutilization charges. Look, we expect bids to be up slightly in the December quarter. It's a strong consumer quarter for us. We don't really break out by mix, but, I mean, I think that's one way to think about it. We expect an improving price environment and bits To be slightly up.

Speaker 3

Yes. And with respect to underutilization, Karl, we do manage our supply very dynamically. And so We guided this quarter based on what we see today. We do expect underutilization to Continue in the 3rd fiscal quarter, maybe a little bit lower than here, but it's a bit too early to cover quarters beyond the next one.

Speaker 13

Thank you.

Speaker 2

2nd fiscal quarter.

Operator

Our next question comes from Vijay Rakesh from Mizuho. Please go ahead with your question. Actually, the next question comes from Timothy Acheri from UBS. Please go ahead with your Thanks a lot. David, at

Speaker 5

the bottom of Slide 4, you did say that the Board remains open to considering other alternatives should they become available. So since you put that in the presentation, can you talk about what other options could be available? Is this a reference to the collapse of the JV that Hynix commented about or was asked about on its call, is this in reference to an outright sale of the NAND business? Can you just talk about that a little more?

Speaker 2

No, it's not in reference to any particular thing. It just says that we think this is the best next step for the business to unlock value. We think that We put the business in a position to go through this right now. So all the reasons we talked about from the portfolio to where we are on an Efficiency point of view to where we are on the work we've done to retire debt and also going into an improving market. But I think any company is always open to other strategic options should they become available and we'll consider them at that time.

Speaker 2

Although I do want to be very clear that the strategic review is completed and any conversations that were going on as a part of that have ended. And we're very excited about this step forward. We think it's the best next step for the business. But I think in any business, you're always going to be open. If there's other Strategic options that become available, we will thoroughly consider those at the time.

Speaker 5

Got it. And then Wissam for you. So the underutilization charges of $120,000,000 at the midpoint, How do they split for December? I would think that more of it's now in the HDD business, but how does that split? Thanks.

Speaker 3

Yes. The split of the underutilization is 2 thirds flash and 1 third HDD.

Speaker 5

Great. Thank you, Hassan.

Speaker 3

You're welcome.

Operator

And our next question does come from Vijay Rakesh from Mizuho. Please go ahead with your question.

Speaker 14

Yes. Hi. Just a quick question, if you went to it already. When you look at the hard disk drive side, wondering if you had what the exabyte growth was for the last 2 years and what you're seeing as you look forward with this seems like a little bit of a bounce coming through. What do you expect for fiscal 2024, fiscal 2025 Okay, under 'twenty four, let's say.

Speaker 14

Yes.

Speaker 2

So yes, we I mean coming off such a high On 2022, 2023 will be down, but then we expect to get back to we expect a consistent exabyte growth in this business in the mid to high 20 range On an ongoing basis.

Speaker 14

Got it. And the same on the NAND side, with the spin off, Do you see any change in the technology roadmap? How do you see the 218, the BICS next generation BICS coming? And if you can also give us your expectation on NAND bit growth for 2023 2024?

Speaker 2

Yes. No, we don't expect any change in the technology roadmap. The JV is very strong, very solid, very productive. Teams work together on a day by day basis. We've talked a lot about that.

Speaker 2

We're very happy with where it's at. The relationship is very Strong, the technology roadmap, we think, as we talked about last time with BiCS8 and wafer bonding, we've made a huge step forward there. We've always been able to produce NAND at a better capital intensity than the rest of the industry. Our measures over the last Several years are up to a third less capital intensity for the business. So the JV has been strong for 23 plus years and we expect it to be strong for very, very far into the future.

Speaker 2

So we feel very good about that.

Speaker 14

Got it. And any thought around the bit growth, I guess, for 2024 and 2020 as that As the next generation as the next big stage starts to ramp, I guess?

Speaker 2

Thanks. Yes. We expect demand in 2024 in the NAND business to be High teens, if it gets really strong, maybe it will creep over the 20s, in the low 20s. But we're thinking about those High teens numbers and like I said production will be significantly below that.

Speaker 4

All right. Thank you.

Operator

Our next question comes from Harlan Sur from JPMorgan. Please go ahead with your question.

Speaker 15

Hi, good morning. Congratulations on the strategic actions announced today. On the flash technology side, the JV brings strong synergies in flash manufacturing development and manufacturing scale. Excluding the underutilization charges, you guys have been driving down the underlying cost per bit at around a mid Teams type CAGR and in line with your prior targets and that's even with the rising capital intensity, right. As you look ahead, Big 6 transition moves to bonded architecture on Big 8.

Speaker 15

Does the team believe it can sustain its mid teens cost on profile?

Speaker 2

Yes, we do. We feel very good about that. I mean, I've spoken about this in the past. It's an explicit goal of the technology team to continue to drive those cost downs and we feel good about our ability to do that. It's been one of the strengths of the JV and the JV technology team for a very long time.

Speaker 15

Well, thank you for that. And then on the flash portfolio side within SSD particularly, the team has been in a very, very strong number 2 market Your position in client SSD, very strong portfolio. In enterprise and cloud, however, You've been consistently in the sort of number 5, number 6 global market share position. So as you think about spinning out the Flash business, What is the team doing to improve its competitiveness in its enterprise and cloud SSD portfolio?

Speaker 2

Well, we like the portfolio we have. We qualified our NVMe based enterprise SSD at multiple cloud providers. And unfortunately, we qualified right into a Significant downturn in cloud consumption of enterprise SSDs. So, as that starts to come back over the next several quarters. And as we go through 2024, we expect our position to improve as we as those vendors start consuming again.

Speaker 2

I mean, the reality is, is there's just not a lot of buying in that market going on right

Speaker 13

now. Perfect. Thank you.

Speaker 2

Thank you.

Operator

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

Speaker 10

Yes, sir. Thank you. David, I just want to go back to your I'll just make regarding Enterprise SSD. When I look at the slides from The results of a strategic review, you're highlighting strength in client SSD and also retail, but I don't see any mention of enterprise SSD. How should I reconcile that with the comment you just made?

Speaker 2

Well, I mean, that's because those are 2 very, very strong strengths of the portfolio. I think they're very unique. Look, our retail franchise is a real gem. I mean, it's a big part of the portfolio. It provides better through cycle Profitability, we've done a lot of work on building brands over the last several years and we've already had very, very Strong brands in SanDisk.

Speaker 2

I mean, I think everybody knows SanDisk is a premier brand in the industry. We've built the Black brand around gaming now. That's a significant part of I think we're the preferred provider in gaming. We talked about it this quarter where 50% year over year content increases in devices and doubling the number of bits in that. So It's been it's a very, very key part of the portfolio.

Speaker 2

We look forward to highlighting it more. The client portfolio has always been a Strength of the business is something that's been built over the last several years. We've driven several innovations in that like the DRAM less client SSD. That's always been a very strong part of the portfolio. I guess, Mehdi, we could have put a whole bunch of stuff on the slide that we're proud of in the portfolio, but we pick The strongest ones, but we're very bullish on the enterprise SSD market.

Speaker 2

It's just a market that's depressed right now. We talked a lot about that last year. We had qualifications at multiple hyperscalers. Those products are still active. We're migrating them forward to future nodes and we expect those to ramp as that market recovers.

Speaker 10

Okay, great. And just a question, a follow-up question for Bassam, and I'm not asking you for a guide on 2024, but if I just look at your cost decline, if I just assume 10% bit cost decline And assume the current ASP trend, your NAND or Flash business should become profitable maybe by mid year or sooner than later. The trajectory is very supportive of reaching profitability in the next couple of quarters. Is that a fair assumption?

Speaker 3

Well, look, what in the current guide for this quarter, It does imply that NAND should be gross margin positive. And in terms of the outer Quarter is a little bit too early for us to comment on them.

Speaker 10

Okay. Thank you.

Speaker 2

Thanks.

Operator

And our final question today comes from Toshiya Hari from Goldman Sachs. Please go ahead with your question.

Speaker 16

Hi, good morning and congrats on the announcement.

Speaker 2

Thanks, Ashish. Yes,

Speaker 16

Dave. So on the NAND side, I think based on A response to a prior question, it looks like you're assuming underutilization charges declined by about $60,000,000 from September to December. Are you guys taking up wafer starts or what's driving the sequential decline in charges in NAND?

Speaker 2

Yes. I guess what I Wissam will comment a little bit as well. But I guess what I would say, Toshi is We're not putting a broad statement out there about that. What we're doing is just being very dynamic with how we manage wafer starts so that we can keep supply and demand matched as best we can without letting inventory get up too high. So as you saw, I mean, our NAND inventory This is the best level since I've been here in the company.

Speaker 2

I mean, Wissam's team has done a great job and the operations team just done an unbelievable job of managing that. We'll stay very close to where our markets are and how we're seeing demand and then we'll adjust wafer starts appropriately.

Speaker 3

Yes. Thanks, Dave. The only thing I would add, Toshiya, is that when you think of underutilization, just I know there was an earlier question on this. Yes, we do expect underutilization further in the second half of the fiscal year. The way to think of it is we were Expecting underutilization to be slightly lower from these levels in the 3rd fiscal quarter.

Speaker 3

And as David said, this is very dynamic. We continue to manage the business on a day to day, week to week basis. And so obviously depending on business conditions this could still change.

Speaker 16

Yes, that's very helpful. Thank you. And then as a quick follow-up, David, you talked about value based pricing on the hard disk drive side and how that's driving better Gross margins into the December quarter. Can you speak to any kind of specific end markets where you're seeing traction? Is it mostly Client and consumer, are you able to push through some price increases in the cloud segment as well?

Speaker 16

Thank you.

Speaker 2

I think it's so first of all, on the channel, we're seeing good response to value based pricing. And then as we bring out new products, So as I said in the past, I think innovation is what the first part of value based pricing is bringing a better value proposition To our customers and as we continue to bring out unique products, 26 terabyte ultra SMR ramped very fast, nearly half of our Our near line exabytes this quarter and we're now bringing out 28. And I think as we continue to do that, we'll have the opportunity have a better conversation with our customers because we're bringing more value to them. So I would say it's we're looking at it across all of our markets.

Speaker 12

Got it. Thank you.

Speaker 2

All right. Thank you, Toshi. We appreciate that. Everybody, we appreciate the time today. Thanks Thanks for the discussion and we look forward to talking to you as we progress throughout the quarter.

Operator

And ladies and gentlemen, with that, we'll conclude today's conference call. We thank you for joining. You may now disconnect your lines.

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