Western Digital Q2 2024 Earnings Call Transcript

Participants

Corporate Executives

• Peter Andrew, Vice President, Financial Planning and Analysis and Investor Relations
• David Goeckeler, Chief Executive Officer
• Wissam Jabre, Executive Vice President and Chief Financial Officer

Analysts

• Joseph Moore, Morgan Stanley & Co, LLC
• Aaron Rakers, Wells Fargo & Company
• CJ Muse, Cantor Fitzgerald
• Karl Ackerman, BNP Paribas
• Thomas O'Malley, Barclays PLC
• Krish Sankar, TD Cowen
• Wamsi Mohan, Bank of America Co.
• Mehdi Hosseini, Signal Hill
• Steven Fox, Fox Advisors
• Mark Miller, Benchmark Co.
• Ananda Baruah, Loop Capital

Presentation

[Operator]

Good afternoon, and thank you for standing by. Welcome to Western Digital's Second Quarter Fiscal 2024 Analyst Call. Presently all participants are in listen-only mode. We will open the lines up for questions shortly. [Operator Instructions]

Now, I will turn the call over to Mr. Peter Andrew, VP of FP&A and IR, you may begin.

[Peter Andrew, Vice President, Financial Planning and Analysis and Investor Relations at Western Digital]

Well, 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 on management's current assumptions and expectations. And as such does include risks and uncertainties. These forward-looking statements include expectations for our product portfolio, Business plans and performance, Market trends and dynamics, and 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 will now turn the call over to David for introductory remarks.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thank you, Peter. Good afternoon, everyone, and thanks for joining the call to discuss our second quarter of fiscal year 2024 results. Western Digital's second quarter results demonstrate that the structural changes we have put in place over the last few years and the strategy we've been executing are producing significant outperformance across our flash and HDD businesses. I am confident that building leading products across a broad range of end markets closely controlling our product cost through focused R&D and manufacturing and bolstering the agility of our business will allow us to improve through-cycle profitability and dampen business cycles.

As a result, we reported revenue of $3 billion. Non-GAAP gross margin of 15.5% and a non-GAAP loss per share of $0.69, all of which met or exceeded the non-GAAP guidance ranges we provided in October.

Before discussing the business details, I want to provide some comments on the emerging trends we are seeing and how the changes we have made position our flash and HDD businesses to benefit. In Flash, we've been able to navigate business cycles by managing inventory proactively offering a broad range of products, and optimizing capital efficiency through our joint-venture partnership with Kioxia. These successful efforts are reflected in our best-in-class gross margin throughout the cycle.

During the quarter, our portfolio strategy to dynamically allocate bit shipments drove upside in ASPs and gross margin. Looking ahead, we will continue to take a disciplined approach to our supply and capital investments. Consequently, we continue to proactively manage our bit shipments to structurally align our supply and inventory with customer demand and improve through cycle profitability into the future.

In addition to the recovery in both flash and HDD markets, we believe storage is entering a multi-year growth period. Generative AI has quickly emerged as yet another growth driver in transformative technology that is reshaping all industries, all companies, and our daily lives. Importantly, industry analysts estimate that the edge now represents approximately 80% of total NAND bit shipments, an increase from approximately 75% in calendar year 2022, which is another indication that cloud demand was significantly pulled in during the pandemic.

In addition, we believe the second wave of generative AI-driven storage deployments will spark a client and consumer device refresh cycle and reaccelerate content growth in PC, smartphone, gaming, and consumer in the coming years. Our flash portfolio is extremely well-positioned to benefit from this emerging secular tailwind.

In HDD, Western Digitals' leading EPMR platform and enhanced ultra-SMR technology allow us to provide the highest capacity drives for mass-market deployment. We believe this innovative technology and portfolio strategy enable us to offer the best TCO to our cloud customers and outperform our peers throughout the cycle.

We are confident that the multi-quarter nearline demand headwinds have subsided as our major cloud customers have re-engaged with us. We anticipate our financial outperformance resulting from profitable share gains to become more evident as nearline demand accelerates into the second half of fiscal year 2024 and beyond.

Moving on to-end market commentary. During the quarter, Revenue in the cloud end-market returned to sequential growth for the first time in six quarters. The sequential revenue growth was led by an increase in nearline shipments. In client, sequentially, revenue declined slightly as the increase in flash ASPs was offset by a decline in bit shipments as we proactively optimized product mix. In consumer, the sequential revenue growth was led by seasonal strength in flash bit shipments into retail and an increase in Flash ASPs.

I'll now turn to business updates starting with Flash. During the quarter, the sequential revenue increase was due to stronger execution in driving price inflection by optimizing bit shipment across our broad go-to-market channels into the consumer and client end markets, resulting in stronger than planned ASP increase.

In particular, WD Black gaming SSD product, which offers high reliability best-in-class performance, expansive storage capabilities in a hyper-realistic gaming experience achieved a new record revenue with bit shipment growth of over 50% year-over-year. On the technology front, we remain on track to ramp in array of QLC-based client SSDs, utilizing BiCS6 technology. Our ability to combine this new high-performance node with our in-house controller development allows us to offer a portfolio of client SSDs with unmatched performance and value. We expect these products to lead the transition to QLC Flash in calendar year 2024. Additionally, BiCS8 is progressing well and we remain on track to productize this technology.

Turning to HDD. The sequential revenue increase was driven by improving nearline demand and pricing. Moreover, we are encouraged by demand in China with revenue doubling on a sequential and year-over-year basis, both of which were ahead of our expectations. We anticipate year-over-year growth in HDD throughout this calendar year. In both the first quarter and second quarter, we shipped approximately one million ultra-SMR drives per quarter. We forecast ultra-SMR hard drive shipments to increase significantly in the fiscal third quarter and SMR drive shipments to continue to outgrow that of CMR drives going forward.

Importantly, the adoption of ultra-SMR is broadening to our major customers worldwide, including a third cloud titan in the US this year as well as hyperscale and smart video customers in China. We expect to complete the qualifications of our 26-terabyte and 28-terabyte ultra-SMR drives for these customers this quarter and throughout the calendar year and forecast SMR to comprise the majority of nearline demand by calendar year 2025.

We have strong conviction that our portfolio strategy of first commercializing Western Digital's industry-leading ultra-SMR technology, which will be followed by our transition from EPMR to HAMR offers the best TCO to our customers in both the near-term and long-term while delivering leading portfolio profitability in the industry. Over the next several years, we will be introducing a number of exciting products including multiple generations of nearline drives combining EPMR, opti-NAND, and ultra-SMR technologies in the 30 to upper 30 terabyte capacity range, all of which will be ready for high-volume production to support the explosion of AI training, data and content.

Before I turn it over to Wissam, I wanted to share some perspectives on our outlook. In Flash, starting with demand in calendar year 2024, we estimate industry bit growth to be around the mid-teens percentage, similar to the growth rate in calendar year 2023. On the supply side, we estimate that fab outbid production growth to remain in the mid-single-digit percentage range. We believe our business agility and our highly capital-efficient and low-cost fixed architecture have enabled us to align supply with demand via nodal transition much more quickly than our peers.

We will continue our disciplined approach to dynamically managing our inventory capacities and capital expenditures to keep our supply aligned with end-customer demand. Although flash pricing has started to increase, our profitability and cash generation continued to be well below the level that justify an increase in capital investments. We anticipate wafer equipment spending will remain at historic lows in the near term and Flash to be under-supplied for an extended period of time.

Overall, we will continue to focus on allocating our bids to the most attractive end markets and anticipate flash ASP increases to be the primary revenue growth driver throughout this calendar year. In HDD, our competitive portfolio strategy has enabled us to consistently achieve profitable share gain in the last two calendar years. We are confident that this trend will continue as nearline demand continues to improve. Then we continue to ramp our ultra S&R -- ultra-SMR enabled products.

Let me now turn the call over to Wissam, who will discuss our financial second quarter results.

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

Thank you, and good afternoon, everyone. Following on David's comments, the success of the strategy we have been executing is reflected in our financial performance. Non-GAAP results in the fiscal second quarter exceeded or were at the high end of the guidance ranges we provided in October. Total revenue for the quarter was $3 billion, up 10% sequentially and down 2% year-over-year. Non-GAAP loss per share was $0.69 as strong execution with our broad go-to-market channels benefited flash ASP and gross margin.

Looking at end markets, cloud represented 35% of total revenue at $1.1 billion, up 23% sequentially and down 13% year-over-year. Sequentially, the growth is attributed to higher nearline shipments to data center customers and better nearline pricing. Nearline bit shipments were 67 exabytes, up 23%. The year-over-year decrease was due to lower eSSD bit shipments.

On a year-over-year basis, HDD cloud revenue increased for the first time in six quarters. Client represented 37% of total revenue at $1.1 billion, down 2% sequentially and up 3% year-over-year. Sequentially, an increase in flash ASP was more than offset by a decline in flash bit shipments. The year-over-year increase was due to higher flash shipments, primarily driven by client SSD shipments into PC applications, more than offsetting a decline in ASP.

Consumer represented 28% of total revenue at $0.8 billion, up 15% sequentially and 6% year-over-year. Sequentially, the growth was primarily due to seasonal strength in flash bit shipments. On a year-over-year basis, the increase in flash bit shipments was partially offset by a decline in flash ASP, as well as lower HDD shipments.

Turning now to revenue by business segment. In the fiscal second quarter, flash revenue was $1.7 billion, growing 7% sequentially as flash ASPs increased 10% on a blended basis and 7% on a like-for-like basis stronger than anticipated entering the quarter. Bit shipments decreased 2% after record shipments in the prior quarter.

On a year-over-year basis, flash revenue grew slightly with a 21% increase in bit shipments, offsetting lower prices. HDD revenue was $1.4 billion, increasing 14% sequentially as total exabyte shipments increased 14% and average price per unit increased 9% to $122. On a year-over-year basis, HDD revenue declined 6%, while total exabyte shipments increased 2% and average price per unit increased 23%.

Moving to gross margin and expenses please note, my comments will be related to non-GAAP results unless stated otherwise. Gross margin was 15.5% above the guidance range provided in October and, improving 11.4 percentage points sequentially, while declining 1.9 percentage points year-over-year. The sequential increase was primarily driven by higher flash ASPs as we proactively optimized product mix, which more than offset higher-than-anticipated underutilization charges of $156 million or a 5.1 percentage points headwind.

Flash gross margin was higher than expected at 7.9% up 18.2 percentage points sequentially and down 6.6 percentage points year-over-year. This includes underutilization charges of $107 million or a 6.4 percentage points headwind to gross margin. HDD gross margin was 24.8%, up 1.9 percentage points sequentially and 4.1 percentage points year-over-year. This includes underutilization charges of $49 million or a 3.6 percentage point headwind.

We continue to tightly manage operating expenses, which were $561 million for the quarter, down 15% year-over-year and at the lower end of the guidance range.

Operating loss in the quarter was $91 million which included underutilization charges of $156 million. Fiscal second quarter loss per share was $0.69 inclusive of a $14 million dividend associated with the convertible preferred shares.

Operating cash flow for the second quarter was an outflow of $92 million and free cash flow was an outflow of $176 million. Cash capital expenditures, which include the purchase of property, plant, and equipment and activity related to our Flash joint ventures on the cash flow statement represented a cash outflow of $84 million.

The quarter-ending inventory was $3.2 billion, declining $281 million from the prior quarter. Days of inventory decreased five days, to 115 days. The majority of the decline was in flash where flash days of inventory remained at a four-year low.

During the quarter, we issued $1.6 billion in convertible notes, repurchased $508 million of the outstanding 2024 convertible notes, and paid down $300 million of the delayed-draw term loan.

Gross debt outstanding was $8.5 billion at the end of the fiscal second quarter. We expect to retire the remaining balance of approximately $600 million of the 2024 convertible notes at maturity in February 2024.

At the end of the fiscal second quarter, cash and cash equivalents were $2.5 billion and total liquidity was $4.7 billion including the undrawn revolver capacity of $2.25 billion.

For the fiscal third quarter, our non-GAAP guidance is as follows. We expect revenue to be in the range of $3.2 billion to $3.4 billion. We expect sequential revenue growth to be mainly driven by an increase in HDD. We anticipate Flash revenue to be up slightly as we remain focused on optimizing bit shipments and ASP. We expect the gross margin to be between 22% and 24%, which includes HDD underutilization charges of $30 million to $40 million. We expect operating expenses to be between $600 million and $620 million with the increase driven by the reinstatement of certain incentive compensation programs as the financial outlook has strengthened.

Interest and other expenses are expected to be approximately $95 million. We continue to expect income tax expenses to be between $20 million and $30 million for fiscal third quarter and $80 million and $120 million for fiscal year 2024. We expect a preferred dividend of $15 million, we expect earnings per share to be $0.05 plus or minus $0.15 based on approximately 330 million shares outstanding.

As the financial outlook has improved, we will remain disciplined in executing the business proactively managing our supply and inventory to meet customer end demand and controlling capital spending, all with the goal of improving profitability.

I'll now turn the call-back over to David.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thanks, Wissam. Let me wrap up and then we'll open up for questions. I want to emphasize that the steps the Western Digital team has taken to instill and deploy an industry-leading product portfolio, while also moving quickly to adapt to both volatile market dynamics and anticipate future trends have enabled us to capitalize on the upswing we see ahead.

Through our product leadership and ability to dampen business cycles and improve through -- through-cycle profitability, I am confident we are well-positioned to execute on our current strategy, which will reaffirm our strength over the long term. Let's now begin the Q&A.

Questions and Answers

[Operator]

[Operator Instructions] Our first question comes from Joe Moore with Morgan Stanley. Your line is now open.

[Joseph Moore, Analyst at Morgan Stanley & Co, LLC]

Great. Thank you. Wanted to know if you could talk about the gross margin improvement in Q1. I guess, how would -- how do you portion that between the drive business and the NAND business and I guess, I would think we're being judicious on volume, you get some pretty good NAND pricing. I guess, I might have expected a little bit more gross margin improvements. Just curious. What I'm missing there? Thanks.

[David Goeckeler, Chief Executive Officer at Western Digital]

Yeah, Joe, so we've been. It's good to see the pricing inflect. If you look into Q1, we are happy with the gross margin, we delivered in the Flash business in the December quarter at 7.9. I think we were able to capture the turn in the market well. So it gives us a little higher base going into the March quarter. But if you look at the both businesses, you see Flash will be down on bits and up on price. So we still see strong price increases quarter to quarter, but we're down on volume. Let's call it low double digits. And then in the HDD business, we see increase in volume and increase in price.

[Joseph Moore, Analyst at Morgan Stanley & Co, LLC]

Okay. Thank you.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thanks.

[Operator]

Our next question comes from Aaron Rakers with Wells Fargo. Your line is now open.

[Aaron Rakers, Analyst at Wells Fargo & Company]

Yeah, thanks for taking the question. Just kind of building off that last question. I know you talked about the hard-disk drive underutilization expectation in this current quarter kind of embedded in that 22% to 24% guide. What's the underutilization assumption you're making on the Flash business? And just in general, how do you think about the trajectory of Flash gross margin, let's say, in theory, if pricing in your implementation of price increases continues? How do we think about the return to kind of a 30% plus gross margin in Flash? So just trying to think about the puts and takes in the guidance and then the longer-term kind of view at what you characterize this normalized gross margin.

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

Hey, thanks, Aaron. So for Flash in our guide, we don't have underutilization for Q3. In fact, we executed ahead of schedule and reached our targeted supply of inventory goals faster than we anticipated. And so, as you know, we continue to dynamically manage supply and Inventory to meet our end demand. And so the fab utilization reflects that. If you recall in our results in Q1, Flash inventory was down almost $400 million. Last quarter, we saw another over $200 million decline in inventory that were -- we exited the quarter at levels we haven't seen in a few years.

So having said that, obviously, we will continue to be disciplined in how we manage our supply and inventory to meet end customer demand on Flash, and also, of course, control our capital spend. With respect to your question at the 30%, let me clarify, was your question 30% on the Flash or on the HDD side?

[Aaron Rakers, Analyst at Wells Fargo & Company]

Like, I guess, I'm going to say both, but I'd say Flash.

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

Opened the door, wide-open.

[Joseph Moore, Analyst at Morgan Stanley & Co, LLC]

Yeah, exactly.

[David Goeckeler, Chief Executive Officer at Western Digital]

I thought, I heard you say Flash and I was going to start talking about it. Well, let me start talking about HDD. Look at HDD, we're pretty much very close to that level. When you look at what we delivered in the second quarter and when you also look at the guide, it does reflect continues margin improvement on the HDD side and so I also anticipate that there should be continuous improvement as the recovery continues in that business. So 30% is very much within reach and we should be able to achieve it pretty soon.

On the Flash side, the -- a lot has to do with continuing to optimize the product mix to drive that ASP up. And also, of course, continuing to deliver on our cost-reduction and so on the cost-reduction we've done well so far, we've been in the mid-teens. I expect us to also hit that mid-teens percentage cost reduction for this fiscal year. So as the pricing continues to improve, I would anticipate that we would be -- we would also be there let's say in the next few quarters.

[Aaron Rakers, Analyst at Wells Fargo & Company]

Thank you.

[Operator]

Our next question comes from CJ Muse with Cantor Fitzgerald. Your line is now open.

[CJ Muse, Analyst at Cantor Fitzgerald]

Yeah, good afternoon, guys, thanks for taking the question. I guess, I was hoping to focus on the NAND bit side of the house. You're talking about optimizing product mix but here we have bits down in December. It looks like they're down, implied down again in the March quarter. So, can you speak to I guess your plans there? When do you think that that will open up and can you be a little more specific in terms of which end-markets you're focused on and how we should think about when they come to market and the timing and implications to pricing.

[David Goeckeler, Chief Executive Officer at Western Digital]

Yeah, so I'll start and Wissam can add some too. So yeah, we had bits down. We had a record quarter, last quarter, two quarters ago and then we were down a little bit this past quarter, then we will be down more. It means just a reflection of the flow-through of the underutilization that we were doing to kind of keep supply and demand matched. We've talked about this a lot and not let our inventory get out of control. I think we've been very good about keeping our inventory. We're at a four-year low on inventory. So on the NAND side, so, let's CJ, we're just going to keep very focused on what demand is, where we're at in inventory, and adjust the utilization of the fab to make sure those stay aligned as we go forward. So I think as we said in the script, we kind of assume that throughout this calendar year, you're going to see most of the growth in Flash be from pricing. As far as quickly.

Go ahead, please. No, I was going to move on to the second part of your question.

[CJ Muse, Analyst at Cantor Fitzgerald]

Yeah, please go ahead.

[David Goeckeler, Chief Executive Officer at Western Digital]

Okay, so mix is like. Mix is just a very dynamic process like literally day-by-day, week-by-week in the business. We have a big consumer franchise. We sell all over the world. We have hundreds of thousands of points of presence in e-tail platforms. We have a big channel business where pricing can get adjusted weekly and then all the way up to obviously the quarterly negotiated market. So we're just always dynamically understanding where pricing is going to be and then again in each of those segments we have different products. We have client SSDs that are WD Black, all the way down to WD Green.

So it is in different segments of the market, all with different price points, all with different margins, all with different demand profiles and it's a constant process of just making sure we put the supply where we're going to get the best return. This last quarter we talked about, we mixed a little bit out of clients into consumer as you would expect in a strong consumer quarter and we'll continue to do that to a place where we're still waiting for it to come back as enterprise SSD. That's still been pretty, pretty depressed and as that market starts to come back we expect to mix into that as well.

[CJ Muse, Analyst at Cantor Fitzgerald]

Very helpful, if I could ask, just a quick follow-up. Wissam, can you shed some light on how to think about opex into June quarter and beyond? Thank you.

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

Yes, of course, CJ. So on the opex side for the June quarter, I expect us to be more or less in line. Beyond that, as the business profitability continues to improve, I expect a gradual increase but we're laser-focused on profitability and so I don't anticipate to increase our opex faster than revenue growth, of course. And when you look at where we've come from and where we are today, we're still at or maybe more than 20% lower than where we were at the beginning of the cyclical downturn.

[CJ Muse, Analyst at Cantor Fitzgerald]

Thank you.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thanks, CJ.

[Operator]

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

[Karl Ackerman, Analyst at BNP Paribas]

Yes, thank you, gentlemen. I have two if I may. The first, why do you think there was a doubling of China demand for GI [Phonetic] applications this quarter, and how sustainable do you think that is, I ask this because the Chinese economy hasn't been robust for some time. So any thoughts on that would be helpful.

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

Yeah, I wouldn't attribute to the smart video market, it's more of the China hyperscalers coming back and better demand there.

[Karl Ackerman, Analyst at BNP Paribas]

Got it, okay. Thank you for that. I guess to switch to the NAND flash business, if I may, it's nice to see an improving outlook for March, certainly one quarter ahead of many of our expectations. However, I'm a bit surprised to see your NAND ASP trajectory in December below that of your peers. I guess could switch the may effect, if I may. It's nice to see an improving outlook for March. Certainly, one-quarter ahead of many of our expectations. However, I'm a bit surprised to see your NAND ASP trajectory in December below that of your peers. So is there any reason why your NAND prices or ASPs perhaps would fall behind peers from here and/or maybe there would be a catch-up opportunity as well? Thank you.

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

Yeah, price, price delta obviously, you have a big dependency on your starting point and we were starting from a better gross margin position than anybody else in the industry by quite a bit, so, and then on top of that, you have mix-based on what's happening in the quarter and kind of where the product is going. I think if you look at the profitability of the franchise, it's still leading the industry.

[Karl Ackerman, Analyst at BNP Paribas]

Thank you.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thank you, Karl.

[Operator]

Our next question comes from Tim O'Malley with Barclays. Your line is now open.

[Thomas O'Malley, Analyst at Barclays]

Hey guys, thanks for taking my question. It's Tom O'Malley here at Barclays. I think. I wanted to ask,

[David Goeckeler, Chief Executive Officer at Western Digital]

Was your evil twin or something?

[Thomas O'Malley, Analyst at Barclays]

I know.

[David Goeckeler, Chief Executive Officer at Western Digital]

Who's that guy?

[Thomas O'Malley, Analyst at Barclays]

So I wanted to ask on the competitive environment. Your competitor obviously talked about a million unit shipments of HAMR in the first half of the calendar year here. I just wanted to get your comments on, are you seeing any change in your interactions with your customers, are they pointing to HAMR as a solution that they're going to move to earlier in the year? Can you just talk to just the broader ecosystem, and if you're seeing a transition there or if it's the other side, really, clearly you're seeing some better trends with your ultra-SMR drives? Just any color on that transition with your customers will be helpful.

[David Goeckeler, Chief Executive Officer at Western Digital]

I think customers just want to understand everybody's roadmap, right, and they're not looking for a particular solution. I mean, for example, we've been shipping EPMR drives for years versus PMI drives and nobody really asks us for EPMR drives. So they just want the capacity point at TCO at a reliability level and be able to satisfy their demand and I think that's the way we've optimized our portfolio, we've commercialized EPMR, we're very happy with the technology, we have ultra-SMR on top of that allows us to deliver both the highest capacity points in the industry, the best TCO position at very-very large scale. We can produce millions and millions of those drives per quarter.

So that's what customers are looking for and they're looking to understand on your roadmap that you can continue to drive that TCO equation forward because they're obviously betting extremely large data centers on our ability to do that and our customers I can tell you, our customers have an enormous amount of confidence in our roadmap in our current products and you're seeing that in the performance of the business, you're seeing accelerating growth, you're seeing better profitability, you're seeing share gains, that's a clear indication that customers are very happy with our products.

Now, in particular, on the transition of EPMR to HAMR. I know this has gotten a lot of attention. For our portfolio, given our ultra-SMR technology has been adopted by the market. HAMR does not make sense until you get to four terabytes per platter because HAMR adds a lot of cost to the product, so it adds a lot of cost to your bill of material, so we can deliver. We see the next couple of generations or a couple of years of ability to deliver a very strong TCO proposition at scale on the EPMR plus ultra-SMR platform that customers have clearly adopted. We see it as the majority of our demand in calendar year '25. That -- we will transition to HAMR when we get to that four terabytes per platter. That's the economic crossover, right, that we're looking for from a portfolio management point of view. So that gives you a little more color on how we're thinking about the technology, the transition, and how customers are thinking about it. I think it's very clear customers are very happy with our roadmap and they understand in great detail, where we're going.

[Thomas O'Malley, Analyst at Barclays]

Perfect. And then just one quick one on HDD gross margins. I think when you look at the underutilization charges that are still present. You can look at, just taking that out and what that means to the gross margins over the next couple of quarters, but is there any way to frame like a revenue level that gets you back to that 30% gross margin target for the HDD business or is it kind of just a wait-and-see when utilization picks back up and it will get there eventually. Anyway, just to frame that from a modeling perspective as to when that can get back to your range. Thank you.

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

So, Tom, if you look at our numbers and you adjust for the underutilization charges, we're almost there. So what I would say, instead of giving a number or movement, let's say in quantifying it, what I would say is I expect us to be in the 30% level at a lower level than our normal run-rate that we've had in any prior through-cycle periods. We've taken quite a bit of cost out of our cost structure as you very well know. And so that will help us get there at a faster pace.

With respect to underutilization, I do anticipate to probably have a bit more in the other quarter of underutilization beyond this one and then we'll see where we are in the June quarter we can talk about it then.

[Thomas O'Malley, Analyst at Barclays]

Thank you very much.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thanks, and welcome.

[Operator]

The next question comes from Krish Sankar with TD, Cowen. Your line is now open.

[Krish Sankar, Analyst at TD Cowen]

Two of them. The first one on NAND, either Dave or Wissam. How do you think of the sustainability of NAND pricing into the back half given that there is a view that the first-half pricing could be up in calendar close-up, we have over 50%. How do you think about the sustainability and what would be the trigger point for you to start adding capacity in NAND? And then just as a follow-up on the hard drive side, you kind of mentioned HAMR add which kind of makes a lot of sense given the laser MFT but I'm curious whenever you just start doing it, would you do to 10 disks? And if the market wants the HAMR solution from WD, how soon can you get it?

[David Goeckeler, Chief Executive Officer at Western Digital]

Okay, well, there's a lot in there. So on NAND look, what we obviously look at a lot of things in NAND, and then there's a lot of stuff that goes into supply of NAND from utilization rates to nodal transitions to capex investments and it's a complicated equation, but our current view is we see NAND under-supplied for quite some time in the market and that's appropriate given where we are in the profitability of the business. As I said in the prepared remarks, it's like we're happy to see the inflection in pricing and the performance of the business and it's ahead of where we thought it was going to be, but we've got a long way to go before we're going to get to the profitability levels where we're going to -- where investment is going to come back and I think that the answer to your question, we need very clear visibility into through-cycle profitability numbers that match our model and we're coming out of a deep hole and that would imply that you need to pay above your through-cycle level for a while to get to that level over time.

So that's what we're looking at and we expect pricing to -- pricing is notoriously difficult to predict and we're very careful that we don't forecast it, but clearly, we're predicting good pricing increases into the next quarter and we will stay very disciplined of managing supply and demand in our business. We talked about how bits are down sequentially.

On HDD, I'm sorry, could you just repeat the HDD question again so that I make sure, I got it?

[Krish Sankar, Analyst at TD Cowen]

Yeah, sure. I was just trying to figure out on the HDD side a, number-one would HAMR would you be doing with 10 disks? Second one is if the market wants a solution from Western Digital, a HAMR solution, how soon can you get it out?

[David Goeckeler, Chief Executive Officer at Western Digital]

Yeah, so let me, we will defer the details of product launch on HAMR and how many disks it's going to have until we get closer to that process. I mean, it's a project, it's we're happy with where the progress of it is given what I said earlier, we've got it. We've built the technology roadmap that allows us to get to 40 terabytes on very well-proven cost-controlled high manufacturing ability, technology, and we're looking forward to delivering that to the market over the next couple of years. The reality is no customer-like demands of a particular technology. The customer wants a capacity point at a certain TCO at a certain level of reliability and a certain level of performance and our technology roadmap is built to deliver that. What's inside the box is less important.

The real thing is, you have to deliver all of those that we just said and you have to be able to manufacture it at a level of millions and millions of units per quarter to satisfy the market and that's what our customers are looking for. Our EPMR and ultra-SMR technology, that's exactly what it delivers. The ability to deliver increasing TCO, which if we can deliver increasing TCO, we can continue to drive pricing higher. We can produce it at very high scale, could be qualified very-very quickly and it's a very highly reliable and high-quality products and our customers are increasingly adopting that technology as you see from our forecast.

[Krish Sankar, Analyst at TD Cowen]

Thanks, David. Very helpful.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thanks.

[Operator]

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

[Wamsi Mohan, Analyst at Bank of America]

Hi. Thank you so much. I appreciate the answer you just gave around pricing, but if I could ask this in a slightly different way. How would you think about pricing one-way that you have in Flash relative to past cycles, I mean, given that your commentary on how you managed your inventory, given your comments on expectation to be under-supplied for a long time? Would you venture to say that the pricing one-way that you have should be longer than what you had in past cycles?

[David Goeckeler, Chief Executive Officer at Western Digital]

On NAND. Yeah, I'm sorry. Look I mean, think it's the cycle we just I guess we're not out of it, we're coming out of it, like I said, like, we're just taking the first steps out of a cycle, we haven't seen before I think in the 3D era. So what we're doing, Wamsi is just making sure we get our supply-and-demand matched and make sure we keep our inventory control and deliver the best profitability given the portfolio we have and continue to optimize the portfolio so that we can have the best mix and therefore the best profitability.

It's very difficult to predict future pricing and but our general point is that although things are going in the right direction, we're not close to a point where the capex investment is going to come back and I think that's the real number on what future supply is going to be. I mean clearly, there is some utilization that is going to come back, but it's going to be needed quite frankly, and we're going to wait to see on as I said, through-cycle profitability, where we have visibility to that so we invest more in this business.

[Wamsi Mohan, Analyst at Bank of America]

Okay. Thanks. If I could, you mentioned about entering a multi-year growth period with generative AI, and especially at the edge, the demand for NAND bit. When do you think that the industry will start to see this demand for NAND bits, at the edge, start to inflect higher?

[David Goeckeler, Chief Executive Officer at Western Digital]

Yeah, look I think we're going to see it, as we start to go into PC refresh cycles. Admittedly, we're still very early in this right, getting the cloud, I mean, the big part right now is getting the cloud, capable of delivering Gen AI to all of us and then drive that architecture down to the edge. I think we're starting to see in some of the market, some of the future specs of products where they are increasing the amount of NAND. So we're optimistic about that. As we go through the next couple of years as this architecture gets deployed and adopted. So I can't like put it down to a particular quarter for you but certainly, as new technology launches or new technology adoption, it's moving at a faster pace than any technology, I've seen in a very long time.

[Wamsi Mohan, Analyst at Bank of America]

Okay, great.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thanks, Wamsi.

[Operator]

The next question comes from Mehdi Hosseini with SIG. Your line is now open.

[Mehdi Hosseini, Analyst at Signal Hill]

Yes, there, thanks for taking my question. Just wanted to get a clarification. David, did you say that NAND bit demand is tracking to mid-teens and that compares to bit supply growth of 5%?

[David Goeckeler, Chief Executive Officer at Western Digital]

We see demand around the mid-teens, and that's fab out. What we see is kind of fab production of mid-single-digits, and obviously, there's inventory between those.

[Mehdi Hosseini, Analyst at Signal Hill]

Okay. Look, what got me confused is you also said your NAND inventory is a multi-year low. Did I misunderstand you?

[David Goeckeler, Chief Executive Officer at Western Digital]

You are not misunderstanding me.

[Mehdi Hosseini, Analyst at Signal Hill]

Okay, so If your inventory is the multi-year low and demand is well exceeding supply, so you basically are not going to ship to supply or you're not going to ship to demand throughout the year. The price -- and then price increase would reward.

[David Goeckeler, Chief Executive Officer at Western Digital]

We're going to, yeah, we will ship to our share demand throughout the year.

[Mehdi Hosseini, Analyst at Signal Hill]

Okay. Would that impact your market share or are you focusing on a select growth profitable market?

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

No, we don't anticipate that to impact our market share, Mehdi. The stats that you mentioned on supply and production were for our estimates and what we see from third-party estimates on the overall market.

[Mehdi Hosseini, Analyst at Signal Hill]

Okay, overall market not a reflection of...

[David Goeckeler, Chief Executive Officer at Western Digital]

Exactly. Go ahead, Mehdi. I'm sorry, please go ahead.

[Mehdi Hosseini, Analyst at Signal Hill]

Yeah, so these are market trends not so specific to Western Digital. And then if I may just have a quick follow-up. In terms of the NAND cost down, should we assume that long-term trend of what down 10% in terms of CAGR cost?

[David Goeckeler, Chief Executive Officer at Western Digital]

No, we're comfortable with the 15% cost downs. We believe that if you look, we're ahead of that right now in FY '24, quite frankly, but it'll come back. And I think when you look at the full year, you can still model 15% for the fiscal year.

[Mehdi Hosseini, Analyst at Signal Hill]

Okay. All right. Thank you.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thank you.

[Operator]

Our next question comes from Steven Fox with Fox Advisors. Please go ahead.

[Steven Fox, Analyst at Fox Advisors]

Hi, good afternoon. I was just wondering on enterprise SSDs, you mentioned that they're still depressed and you'll mix into it. But given the supply situation that you just talked about and where we are in the cycle, like what is your, how do you envision coming back in that market? And like, can you just remind us what a normal mix of enterprise SSDs looks like in your Flash business? Thanks.

[David Goeckeler, Chief Executive Officer at Western Digital]

Well, I mean, for us, it's an emerging part of the portfolio. I think going right into the downturn, we got qualified at numerous or a number of cloud titans in our NVme-based enterprise SSD. And then we kind of went into a market where, quite frankly, enterprise SSD has been the most depressed part of the NAND market in the downturn, and we haven't seen that come back yet. So, as that starts to come back out of digestion, it'll just be another opportunity for us to mix into that. How much we mix into it will be depending on what the price is on that -- in that segment versus other options, we have for those bids. We don't necessarily have a fixed percentage we're going for, it's just we have the product, it's qualified. As demand comes back, we'll consider that demand as part of the whole portfolio calculus.

[Steven Fox, Analyst at Fox Advisors]

Would the big picture be that it trails enterprise HDDs by a certain amount of time in general? Like do you have a vision for just as enterprise spending recovers, where that product cycle would be? Well, certainly it is trailing enterprise HDD. I mean, I don't know if I could make a generalization about that because it's just one cycle here, but clearly, there's more inventory digestion in the hyperscale market on enterprise SSD than there was in capacity enterprise HDDs. As we talked about, we see continued growth in capacity enterprise HDDs. We started out this fiscal year projecting sequential growth throughout the fiscal year, and now we're talking about sequential growth throughout the calendar year. So we see good demand trends coming back on capacity enterprise HDD, which again is a good sign that enterprise SSDs will come back. It's just there's more inventory digestion to get through. Got it, very helpful. Thank you.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thank you.

[Operator]

Our next question comes from Mark Miller with The Benchmark Company. Your line is now live.

[Mark Miller, Analyst at Benchmark]

Your cash flow significantly improved during the quarter, but still there was an outflow. When do you expect to be positive from a free cash flow perspective?

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

Yeah, Mark. So turning free cash flow positive is a top priority for us. We're very much focused on it and we have line of sight to achieving it. We expect to achieve free cash flow positive in the second half of the fiscal '24, either this quarter or the next. As you know, we typically don't guide for cash flow.

[Mark Miller, Analyst at Benchmark]

Do you expect -- will you have to draw on your revolver or do you expect you won't have to draw on it?

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

I don't see that at this point.

[Mark Miller, Analyst at Benchmark]

Thank you.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thanks, Mark.

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

Thank you.

[Operator]

The last question comes from Ananda Baruah with Loop Capital. Please go ahead.

[Ananda Baruah, Analyst at Loop Capital]

Hey. Hi. Thanks, guys, good afternoon. Thanks for taking the question. David, thanks a lot. Just wondering if you have, you guys have an early opinion on if NAND bit rate increases as Gen AI sort of impact, not just edge cycles, but sort of corporate cycles, Fortune 1000 and hyperscale storage as well, and all the other MRC constituencies? Do you have any opinion on if there's a sort of increase in NAND supply over time? And if you do, do you think the increase can be material and noticeable? Thanks.

[Wissam Jabre, Executive Vice President and Chief Financial Officer at Western Digital]

Yeah, there's a good point here, which is like my comments earlier were about the cycle and what we see in NAND and investing in it. We're big believers in the NAND market and there's going to be a lot of bit growth in the future. And also the great thing about the NAND market is you still have the ability to produce new nodes and more efficient as far as how much capital you need to put in to get that growth.

So look, the overall thesis on NAND continuing to grow, we have a long technology roadmap where we can continue to deliver cost downs. That's still a great story. And we expect, to your point, we expect Generative AI to be additive to that, especially on the edge. The NAND market has really rotated through this downturn, really rotated to an edge-centric market, which again, our portfolio is very, very well-positioned for with our consumer business, with our client SSD business, with our gaming business, with our position with PC OEM. So we're very well positioned there. And yeah, as we see that demand come back and it resets the economics of the industry, we have the ability to go satisfy that demand. And so, I think we're very bullish about that.

[Ananda Baruah, Analyst at Loop Capital]

That's a useful context. Thanks a lot.

[David Goeckeler, Chief Executive Officer at Western Digital]

Thank you. All right, thanks, everyone. We appreciate your time today. We'll see you throughout the quarter. Take care.

[Operator]

[Operator Closing Remarks]