Q1 2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to Western Digital's first quarter of fiscal 2020 conference call. At this time, all participants are in listen only mode.

After the speaker presentation, there will be a question and answer session to ask a question. During the session you will need to press star one on your telephone if you require any further assistance. Please press star Zero I would now like to hand, the conference over to your Speaker Mr. Peter Andrew. Please go ahead Sir.

Okay. Thank you and good afternoon, everyone before we begin let me remind everyone that today's discussion contains forward looking statements, including product development expectations business plans trends and financial outlook based upon management's current assumptions and expectations and as such it does include risks and uncertainties we assumed.

No obligation to update these statements. Please refer to our most recent financial report on Form 10-Q filed with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially. We will also make references to non-GAAP financial measures today.

Reconciliations between the non-GAAP and comparable GAAP financial measures are included in the press release and other materials that are being posted in the Investor Relations section of our website with that I'll now turn the call over to Steve Milligan our CEO .

Thank you Peter and good afternoon, everyone. Joining me today, or Mike Cordano, President and Chief operating Officer, and Bob MULO Chief Financial Officer.

Before we discuss our results for the first quarter of fiscal 2020, I want to spend a moment talking about the other news we announced today.

After a long and fulfilling career with western digital spanning two decades, five informed our board that I plan to retire as CEO .

I will continue to serve as CEO until the board has identified and appointed a successor.

Western digital as a significantly different company than the one I first joined in 2002.

We are more diversified more resilient and much better positioned to capture the opportunities of today's evolving data marketplace.

Since my appointment as CEO Western digital has transformed from a storage component provider to a diversified enabler of data infrastructure with the broadest portfolio in the industry.

Offering customers, a powerful combination of hard drive storage and flash memory products.

We have successfully executed many key strategic initiatives.

Including the company's acquisition of Sandisk.

The integration of Western digital HST, and sandisk as well as the extension of Western Digital's 19 year partnership with key Osha.

We now operate a powerful platform that uniquely positions us to provide new architectures and capabilities to manage the volume velocity and variety of data.

As we think about what comes next for our company.

I believe now has the right time from Western digital begin to begin the transition to its next phase of leadership.

Serving as western digital CEO for the past seven years has truly been one of the highlights in my career.

I want to thank our team for their support and dedication.

I could not be prouder of what we've accomplished together and consider myself quite fortunate to have worked alongside such a talented team.

In terms of next steps I look forward to continuing to work closely with the team while the board conducts the search for our next CEO .

Given our strong management team, we expect this transition to be seamless.

For our shareholders, our employees and the customers that rely on our best in class service and products.

Once my successor is onboard I will remain with the company in an advisory role until September 2020 to ensure a smooth transition.

I will also continue to serve as a director on the Western Digital board for a transition period. After my successor is appointed.

With that said, let me turn to our performance for this quarter.

Fiscal 2020 is off to a good start.

Revenue exceeded the guidance range, we provided in July and non-GAAP EPS was at the upper end of the range.

The upside was driven primarily by the success of our capacity enterprise drives for the data center.

We are executing well on the data center utilizing the power of our portfolio.

At the core of our success in this market is our industry, leading capacity enterprise hard drive solutions in the exceptional value, we provide to our datacenter customers for their diverse storage needs.

During the quarter, we made two important announcements to further extend our product leadership.

First.

We introduced 16 in 18, terabyte, CMR drives and a 28 terabyte.

SLR drive all enabled by our energy assisted recording technology.

These drives are expected to sample this quarter.

Additionally, through our continued investments in heads media and mechanical design, we began shipping an air based 10 terabyte drive providing significant benefits to our customers.

I'm pleased to announce we commence the initial the initial revenue ramp of our nvme based enterprise Ssds to major Hyperscale and OEM customers during the September quarter.

Efforts to qualify and ramp additional customers with our next generation products based on our 96 layer Threed Flash technology are going well.

And should position us to further increase our participation in this important market.

Western digital Western Digital's ability the offer both hard drive and Flash Flash based solutions differentiates us from our competitors and allows us to more strategically partner with our datacenter customers.

Outside the data center, the overall demand environment across the consumer mobile PC and retail end markets is solid.

Furthermore, we are seeing improving trends across our flash product portfolio and continue to believe that the flash industry has passed a cyclical trough.

With a broad and growing product portfolio Western digital remains well positioned to benefit from the long term drivers of the growth and value of data.

With that I will now ask Mike to share our business highlights.

Thank you, Steve and good afternoon.

Before I get into my prepared remarks, I want to congratulate Steve on his upcoming retirement.

High value and appreciate the partnership we have built together over the past decade, and a lot to acknowledge team for his leadership and numerous contributions to western digital.

We have quite a bit of time and work to do between now and September of next year.

Forward to working together to execute on our plans.

As Steve mentioned fiscal 2020 is off to a goodstart.

We had record hard drive exabyte shipments driven by the success of our capacity Enterprise drive family.

We also had record exabyte shipments in flash as we benefited from demand elasticity and share gains in ssds for Pcs and notebooks.

And datacenter devices and solutions, our capacity enterprise X by shipment growth was over 60% year over year led by the ramp of our 14 terabyte drives.

These drives now represent the majority of our capacity enterprise unit and exabyte shipments.

Industry analysts expect to 14 terabyte capacity point to be the industry's highest volume product during the first half of calendar year 2020.

Building on our aerial density leadership and execution on mechanical design, we announced our plan to accelerate the introduction of our nine platter energy assisted capacity enterprise drive platform.

Enables us to ship 16, and 18 terabyte CMR and 20 terabyte of some are drives on a unified platform simplifying the qualification process and reducing the time to market for our customers.

We will be sampling all of these drives by the end of this quarter and will commence volume shipments in the first half of calendar 2020.

In addition, we began shipment shipping at new 10, terabyte Air based product powered by our innovative airflow architecture underscoring our aerial density and mechanical design leadership.

Given the strength of our capacity enterprise portfolio.

And the opportunities we see in this market, we now believe our exabyte.

Shipment growth will exceed 40% in calendar year 2019 up from our prior estimate of 30%.

In enterprise Ssds are Emmy based products experienced a strong quarter of growth.

And we expect continued growth in the December quarter.

Where our qualify our next generation 96 layer product with additional customers, which positions us for further market share gains in calendar year 2020 and beyond.

We have a unique and sustainable competitive advantage within the data center built on strong customer relationships and a strong product product portfolio.

Our strategic position within this important end market will drive future revenue growth.

In client solutions revenue grew on a sequential basis, driven by an improving pricing environment and a seasonal increase in bet shipments.

This quarter, we began shipping 96 layer QFC based retail products and external ssds.

The trust in reputation of our brand and our customers preference for the performance our reliability of our solutions our key differentiators.

In client devices. The main contributor to our year over year decline was our decision to limit our participation in the mobile market.

On a sequential basis, we expect to ship more bets into the mobile market in the December quarter.

In Pcs and notebooks, we gain market share and client ssds as our exabyte shipment growth exceeded 70% year over year.

Our bit production of 96 layer mix for surpassed 64 layer pixthree during the September quarter.

We are on track to commercialize fix for across all our product lines by the end of calendar 2019.

Our JV partner coax, Yep, and western digital executed well, bringing the LPG fabs back to full production after the power outage limiting our output reduction to four exabytes.

Our flash supply is tight and we continue to believe that any excess inventory in the flash industry supply chain will be substantially reduced by the end of calendar 2019.

We expect flash industry supply bit growth to be in the mid 20% range in calendar 2019, and in a low 30% range in calendar 2020.

In addition to continued growth in our existing flash portfolio and capacity enterprise markets.

We see several new incremental growth opportunities.

First the launch of a next generation gaming consoles will be important events for the gaming industry and our flash business.

We expect these new console to utilize high capacity flash storage to improve the gaming experience.

Second we expect to expand our product portfolio and diversify our customer base for the mobile market with our you fs.

MMC and custom solutions.

Finally, our recent announcements of Threed flash products for the automotive and industrial markets will further expand our opportunities and these growing and more stable flash based markets.

I will now turn the call over to Bob for details on our financial performance.

Thanks, Mike I also want to congratulate Steve on his upcoming retirement and look forward to helping enable a seamless transition to the next CEO .

I'm pleased to announce that revenue for the September quarter exceeded the high end of the guidance range. We provided in July and non-GAAP earnings per share came in at the high end of the range.

Revenue for the September quarter was $4 billion business was up 11% sequentially as we experienced growth in data center devices and solutions and client solutions.

Revenue was down 20% year over year, as we faced a tough compare tough comparable quarter in fiscal 2019.

By end markets data center devices, and solutions revenue increased 20% sequentially and 6% year over year due to the success of our capacity enterprise drives for the data center.

Please recall that a year ago based on discussions with our customers. We predicted that in the second half of calendar 2019, we would return to growth in capacity enterprise, we are experiencing that predicted rebound now.

On a sequential basis client solutions revenue grew 18% on seasonally stronger flash bit shipments and a stronger flash pricing environment.

Client solutions revenue declined 4% year over year, primarily due to reduction in hard drive Tam.

Client devices revenue was up 1% on a sequential basis and decreased 39% year over year.

The year over year decline was the result of our decision to scale back flash bit shipments to the mobile market.

Flash price declines and a reduction in the hard drive Tam.

By product category Flash revenue.

$1.6 billion up 8% sequentially and down 36% year over year.

Flash Asps were flat and did shipments were up 9% sequentially.

Our drive revenue was $2.4 billion up 13% sequentially and down 3% year over year.

Average price hard drive was $81.

Exabyte shipments were up 23% sequentially hitting a new record level.

As we move on to cost and expenses. Please note all my comments will be related to non-GAAP results unless stated otherwise.

Gross margin for the September quarter was 24.8%.

With a flash gross margin of 19.3% and our hard drive gross margin of 28.5%.

We completed all of our cost of revenue reduction activities, we outlined in January resulting in a decrease of more than $100 million in quarterly spending.

The hard drive gross margin was up slightly from the June quarter, and we expect the December quarter gross margin to be approximately 30% as we fully realize the benefits of the cost reduction efforts.

Flash gross margin was up on a sequential basis as we benefited from a better flash pricing environment.

Came one fab cost was $64 million higher than expected.

Excluded from the cost of revenue was $68 million charge related to the power outage.

Operating expenses were $767 million.

Adjusting for our normal 13 week quarter operating expenses were below the $740 million run rate target.

During the quarter, we completed all of our operating expense reduction efforts announced in January .

In addition, once we complete the exit of our storage systems business, we should start to see in approximately $25 million per quarter reduction in operating expenses beginning in the March quarter.

Operating cash flow from the September quarter was $253 million and free cash flow was $294 million.

Capital expenditures, which include the purchase of property plant and equipment and activity related to flash ventures on our cash flow statement, where an inflow of $41 million.

As previously noted we are benefiting from the timing of the funds flowing back and forth between us and the joint venture.

For the full fiscal year, we continue to expected capital expenditures that will flow through our cash flow statement to be under $500 million.

Total capital expenditures, which include our portion of joint venture leasing and self operating funding is expected to be similar to last fiscal year between 2.5 and $3 billion.

In the September quarter, we distributed $147 million in dividends to our shareholders.

We paid down debt by $319 million, which included an optional 250 million dollar debt pay down.

As our cash generation continues to improve our first priority will be to reinvest in the business to maximize long term shareholder value.

After paying our dividend our next priority will be to reduce our debt.

At the ended the quarter, we have $3.2 billion in cash and cash equivalents.

$2.25 billion revolver remains unused and our gross debt outstanding was $10.4 billion.

No.

And $20 were flat on a sequential basis, but higher than projected as the joint venture fabric covered faster than expected.

This resulted in a sequential increase in flash inventory, particularly at the end of the quarter.

While hard drive inventory declined about $100 million sequentially.

Moving on our non.

Ladies and gentlemen, please standby.

Sherry can you hear us on your side.

Yes. Your line is open.

Okay do we know when we cannot.

And with guidance. So again this is non-GAAP guidance and its as follows we expect revenue to be in the range of $4.1 billion to $4.3 billion.

We expect gross margin to be approximately 25% to 26%.

Please note that this range includes approximately $75 million and costs associated with the K one fab.

Operating expenses are expected to be between 750 and $770 million above the $740 million run rate target due to higher variable compensation spending.

We expect interest and other expense of $85 million, we and we expect a tax rate to be 26% plus or minus two points.

As a result of this detailed guidance, we expect earnings per share between 45, and 65 cents, assuming approximately 302 million in fully diluted shares.

With that I will now turn the call over to the operator to begin Mcewen a session. Operator, we'll now take our first call first question.

Thank you ladies and gentlemen, we will now begin the question and answer your question is.

If you have a question. Please press star one on your phone if you would like to withdraw your question. Please press the pound one moment. Please for the first question.

First question comes from Aaron Rakers with Wells Fargo.

Yes, thanks for taking the question and Steve Congrats on a retirement has been great working with you.

Two questions. If I can real quick so first of all I guess, what are the things that stands out a little bit as say the capacity shipment number on flash up only about 9% sequential by my math, it's up maybe high single digits on a year over year basis. So.

Can you can you talk a little bit about.

Seems like the product portfolios in a great physician Nbn. These ramping client SSD capacity shipments for strong I'm just curious of why we it seems to be a little bit muted as far as the capacity shipment.

Trends in flash and what's your expectation going into the December quarter for capacity ship.

Yes, So let me address that so the primary reason for that is really the point that I made in Bob made in our comments is we did not participate in a substantial way in the mobile marketplace in the quarter just completed so thats the primary driver of that shipment in the quarter.

Okay, and renewal and recall and you're hearing and recall. This is Steve recall that that lack of participation in the mobile market was by choice from our standpoint, given that the profitability levels for that segment of the market, we're not at all attract.

Yes.

Okay Fair enough and then as as the second question on on near line capacity Enterprise strives.

In the slide deck you note that that you now expect overall the market to quote unquote approach, 30% year over year growth I think last quarter, you talked about needle growth meaningfully exceeding that 30% level. I know you guys, you're talking about north of 40% growth and your capacity shipments, but what's changed over the last quarter has there been a bit of a softening.

In terms of your expectation I guess going into the December quarter, or what's really driving that that change if of course expectation. So Aaron I think for US we actually updated our our performance on the year. We had originally had stated last quarter, we'd be north of 30% for us we updated that guidance that north of 40, we're actually seeing strength in exabyte.

Consumption across the capacity enterprise segment.

Now the other thing that's happening for us Thats more unique is the power of the 14 terabyte product is doing quite well.

Obviously, we are gaining market share in that segment that showing up on an exit by business.

Are there constraints in the market, which is tempering the overall market the industry expectation now I think we would suggest the industry Mark industry will grow at North of 30, we will grow at north of 40, and again Thats all up from our last outlook on on both numbers.

Okay fair enough. Thank you.

In Q.

Thank you. Our next question will come from Mehdi Hosseini with S&P.

Yes, Thank you and as Steve Good luck with the with Unix and dividend was very nice.

Looking the view moving on to questions.

Just two follow up.

We.

It's very helpful. When you talk about Exabytes shipped been guide, especially for the near line and as you look into the next year, how do you see that exabyte shipments.

Hi, good changing again digits for 2020 versus 2019, and how would how should we think about the mix of the near line exabyte as as a percentage of the overall exabyte shipments for for West Intage.

Yes, So let me just comment specifically at capacity enterprise, we would expect for 2020, our current outlook is about 35% year over year growth. So continued strength year over year.

And so we don't we don't split out total HDD exabyte growth and we don't specified.

Okay and general by the way Mehdi that 35% is consistent with our longer term expectations Rex.

Sure.

You kind of pre into my prepared question as by saying that you didn't participate in the mobile segment as it relates to you and then shipment and due to debate as to what happens to that inventory into channel reserve to move on.

Segment as you look into the March quarter.

We did the background, how do you see the supply and demand in NAND looking into the March quarter, and Im not asking for the guide I just want to better understand your view you didn't participate in that market and in that context, how do you see your prices trending into March quarter.

So I'll take that many we.

First off as we indicated we believe that we passed the trough in terms of this last cycle.

In the overall inventory situation is improving and other words supply is getting much more aligned to demand.

And we would expect that largely for ourselves and for the industry as we exit the December quarter that things will be fairly imbalance now when you move into the first quarter and let me actually broaden that question a bit when you move into the first half of the year one of the things that we have to keep in mind is that we will see.

Typical seasonal Dillon.

Decline in terms of.

From a demand perspective supply as relatively linear and so we will have to just like we do every largely every year in terms of the calendar cyclicality, we'll have to manage through that.

But then as we move to the back half of the year, where we will see in this is the back half of calendar year.

A calendar year 20, we will see that begin to flip demand the can begin to improve and we will see.

Rather than modest improvement in our financial results that we've been seeing we should see an accelerating improvement in our performance from a financial perspective, as we move into the back half of calendar 2020.

Maybe just give you some numbers to work with there we talked about low thirtys on supply bit growth, we would expect demand for the calendar year to be slightly above that.

Great. Thank you.

Thank you. Our next question comes from Karl Ackerman with Cowen.

Good afternoon, I think we're taking my questions and Steve.

Again, congrats on your retirement and best of luck in your future endeavors.

Two questions if I may.

Speaking on mobile for a moment.

You referenced that mobile margins have not been attractive.

The last two quarters, but.

Is that because you don't have captive DRAM I guess, how important is that is it for you to have either captive DRAM or a new long term supply agreement for DRAM as you contemplate your competitive position in smartphones over time.

Yes, let me answer that so let me delineate mobile so theres the discrete and component part a mobile and then there's the Emcp, which includes DRAM I think strategically we do not see Emcp is a long term start strategic place for us to operate or focusing our.

Ladies and gentlemen, please standby.

Lines.

Speaker.

Yes, Jerry can you hear us now, yes again.

Yes.

You want to pickup.

Okay. Let me, let me back up and repeat that I don't know, where we dropped off our.

And the economics in mobile improving along with other segments of the market.

That's that's helpful. Mike as my follow up.

Shifting gears to gross margins from them and clearly you in your peers are operating well below normalized run rates in and NAND at the same time, though I think your outlook for hard drives hard drive gross margins.

Good, but still a little bit below where we were roughly year ago, I guess will the exit of the systems business or areas of assistance business be the primary driver for gross margin improvement hard drives and I guess, how do we think about the margin implications from the incremental desk and heads on those higher capacity drive. Thank you, yes. So.

Let me I'll address that and then bobbing and Mike can chime in.

Any additional color. So the first thing is the exiting in the system business will have no material impact one way or the other on a gross margins.

So if you look at an hour or hard drive gross margins I mean, let's be let's be clear about that are hard drive gross margins. Although you know good levels are not more we want them to be we weren't those hard drive gross margins to be north of 30%.

In the low 30% range, we are still dealing with some of the cost overhang of exiting our korlym for manufacturing facility that were that is now behind us and so we should see our drive margins.

Improve into that low 30% range as we exit this.

As we exit the December quarter, and then obviously, our intent is to sustain and possibly improve that over a period of time flash gross margins are clearly not where we want them to be they are improving albeit at a slow rate.

We will continue to expect as we see this sort of ripple through the market because different customers started at different levels different market started at different levels. The pace of that improvement is not linear for all of those aspects, but we'll continue to see steady improvement in or flash margins this quarter and then into subs.

The current quarters.

And as I indicated earlier, we expect that improvement.

Two.

Improve add a improved rate as Adam editor rate as we move into the second half of calendar 2020.

Okay.

Thank you gentlemen.

Thank you. Our next question comes from Mark Delaney with Goldman Sachs.

Yes. Good afternoon. Thank you for taking the question. It's a follow ups around gross margins and maybe first just to better understand the outlook for NAND and that again.

Looking for margins to improve somewhat next quarter I understand around ASP going on like for like basis, if you'd give more color on what you're assuming there given the comments about a cyclical bottom.

Yes, I can start and first so I want to remind you on the NAND side, we do other headwind what became one startup costs and bringing up that fab and we are beginning production there, but there's probably in the neighborhood of three point headwind that we're faced with on demand side and as Weve.

Ramp volume that obviously, the margins will improve everything else being equal.

So in terms of flash overall, as we get to equilibrium between supply and demand, we're definitely expecting the pricing will get better as we move through 20 like Steve was saying, so I think it'll take a little bit of time to work through that but I think we're going to being a good price.

Okay.

Thanks, Bob and then my follow up was on the at the hard drive gross margin again, along along the lines of the prior questioning.

I have been under the impression that for the December quarter hard drive gross margins could hit 30%, especially given the upside that the company seen in the near line business, which I think typically runs at least 30% of not not higher.

Is there anything in terms of increased headwinds around gross margins at the comp.

Any as seen in the December quarter out as maybe keeping hard drives gross margins under 30%.

Are we going into the wrong impression about the ability to 30% with my previous expectations for for the just let me let me I'm sorry, Let me, let me because I get kind of them. This one I feel strongly about we will we our intent is to have gross margins north of 30% for hard.

Or hard to our business this quarter the December quarter.

And so there is no.

Headwind at present.

Of course, there can be things will happen, but theres nothing at present that indicates that we won't hit that level.

And the other thing I would add Mark is if you look out over time, we expect more and more growth in terms of capacity enterprise capacity enterprise will become a bigger percentage of our overall mix and that will help the margins go up as well.

Got it. Thank you very much in Steve Good luck with your future endeavors.

Thank you.

Thank you. Our next question comes from Mitch Steves with RBC capital market.

Hey, guys. Thanks for taking my question I think it on the folks, but just on the gross margin kind of the NAND inflection I think a lot of people are looking for kind of like 80 cents or even a dollar for the December quarter Guide you to improving memory environment. So I guess, maybe could you help us at least I understand how you guys think of the inflection in terms of how much leverage you're going to get on the gross margin side. If we look out let's say three or four core.

Orders.

I understand the comment about how you're going to see more material inflection in the back half for calendar Tony.

So a couple of things, let me talk about the dynamics in the current period, we talked about so when we look at where we started from all all end markets in flash were not created equal relative to pricing and margin.

We also noted that mobile was a inferior performing segment for us we're taking more of that on this quarter as a percentage that total so that is having a bit of a headwind relative to the flash market in the current quarter, Steve comments earlier on 2020, we see supply demand in pretty good shape as we come.

Into 2020, but the normal seasonality of the year, we got to make sure we're managing through that in a in a cautious way and we expect that is your moves on as we head towards the middle the or the backend that we'll continue to improve in the rate of margin improvement in flash will accelerate in the back half of the year.

Okay, and then in terms of the NAND gross margin means that go back to like 30 in the back half of 20, I mean, just any sort of rough metric would be helpful.

Well, we are I mean, let me be clear on this we're not we're not providing guidance beyond what we've done in terms of plus gross margins, but I'll tell you, where I'll tell you, where we need to get too and where we want to get too is back to where plus gross margins are in that 40% range that that's a margin level that we view as attainable over.

Period of time, and it's also a margin level that we believe is required to get sufficient return on the capital that we are investing in this business, so thats, where we want to head to.

Okay. That's very helpful. Thank you.

Thank you. Our next question comes from CJ Muse with Evercore.

Yes, thanks for taking the question I guess another question on gross margins.

Specific to the NAND side.

Can you quantify the K one fab costs in the September quarter, I think you said 75 million in the December quarter, and how we should think about that.

Progressing.

2020.

And then I guess as as.

A second question.

On the flash fits side.

It looks like.

Implied in there given these.

Costs, roughly a bit growth of only 10% or so in the quarter. So it looks like youre only growing about 19, 20% for the year versus many of your competitors, who are suggesting low thirtys for the industry and so I guess is that a function of just deciding not to want to play.

And no mobility side is it a function of not having the right bits or or or is there something else. Thank you know let me let me address the last question first in terms of us growing him first on the big growth that we're seeing from a demand or revenue perspective is consistent with previous expectations and hasn't changed and by the way one of them.

Things that you have to keep in mind is that we took a meaningful amount of production offline starting earlier this year independent of the power outage, because we saw the oversupply conditions.

Well, we saw it coming and we saw that situation being let's just call. It untenable and so we were reducing our bit output from a supply perspective to help offset.

That growth that unnecessary growth from a supply perspective that created.

The substantial price decline that we in the industry realized.

In the back half 18, and also in the 19.

So.

Bob to address the.

Yes, loads and plus yes, so CJ in terms of that the September quarter that we just finished the came one costs were at $64 million and what I said in the guidance as we expect into December quarter that will be in the neighborhood is 75 million.

We think they will start to come down from that point in time, but this is I mean this is new production capacity, we're putting in place it becomes a part of our fixed cost structure overtime.

Okay, Yes, CJ whatever one other comment I'll make is when you think about this on a bit share comparative basis. When you think about it from a bit capacity output basis. Obviously, we continue to remain in the same proximity a ratio to others. So this is simply us choosing to not produce very low margin.

Product for the reason as Steve said.

Makes sense. Thank you.

Thank you. Our next question comes from Steven Fox with Cross research.

Skews and good afternoon, and sorry for another gross margin question, but.

Maybe we'll have to start banning gross margin question, Yes last one let me get it does it gets us and.

So in terms of just the mix impact on NAND gross margins can you maybe talk a little bit without what's going on mix how mix is affecting the gross margin guidance for the current quarter versus what you just reported in NAND gross margins and then along similar lines you mentioned some some incremental growth next year from things like next generation gain.

Thing and industrial can you talk about their mix impact on gross margins and if I dare getting one more given what you said about the first half of the calendar year are you able to lease hold gross margins around current levels or based on what you do with where you choose to put your bits or do we backtrack a little thank you well again I'm going to.

Im going into last question first.

We would expect that our profitability levels.

Certainly from a margin percentage standpoint, we'll continue to modestly improve as we move into the first half the year.

Okay and back to the mix, let me just reiterate within the flash business, we're taking on a greater proportion of mobile business. This quarter, which is a margin drag and as dampening our our sequential margin performance to some degree on the flash side and that Bob also talked about the fab startup. So those two things are affecting the flat.

Cash margin and this and this quarter when we go into 2020, certainly a number of the new markets are good bit consumers the gaming business.

We think that that is going to be not only a good consumer bets, but at a reasonably attractive margins and industrial and automotive are even better yet relative to margins and more stable and non cyclical and Bob already indicated that the K. One costs are kind of a three point drag and then if you neutralized for mix I think that.

We would all be seeing a much more satisfying increase in our flash margins. When you neutralized for those two items and I think that's important for all of us to keep that in mind that the trajectory is in the right direction.

It's just that there are other moving parts that tend to mask.

Those improving trends.

Got it and Steve Congrats on all your accomplishments that western digital thanks. Thank you very much.

Thank you. Our next question comes from Sidney Ho with Deutsche Bank.

Great. Thanks.

Maybe one more question on this slash side I know you talk about few times about strategically walking away from the mobile mobile mix can you remind us you'll mix within the NAND flash business today, and how you think that we change the year for now is Jim more tailwind coming from this.

Nick change in mix and what are the area said has better margins of west margin than the than the average for.

So we don't specifically disclose the ratio of flash participation, but I can't give some color on relative performance certainly the areas of big investment for us that we emphasize our where we want to grow our participation so enterprise SSD.

Fast growing higher overall margins than the average overtime.

Industrial embedded.

Both similarly situation higher margins are good growth rates.

Then ultimately certain segments of mobile overtime are attractive and we're focused on those hence our you fs product investments. So the higher end higher performance part of that marketplace. So we put a big emphasis on quality of revenue and seeking out those higher margin more stable end markets and those would be examples that we're focused on.

Great My follow up question I'm sure you welcome a high tries question.

Let's talk about introducing 16, sorry, if I see minus 18 terabyte SM are you ended up launching high capacity about two months later can you talk about why you meet that change in the relative and what kind of feedback you're getting from your customers. So far.

Yes. So the reason we made that decision it's actually quite simple is that we we made faster progress in terms of our nine nine planner platform than what we had previously anticipated and so the advancements that we were making from a mechanical perspective allowed us to pull in that platform sooner than what.

We anticipated, which was favorably received by our customers from a market place perspective, which I'll ask Mike I'll elaborate on yes, I think a number of dimensions of this obviously it gets them to 18 and 20 terabyte sooner than they would have otherwise so they tcl benefit when you combine cost per bed with the.

Other elements like slot tax because you know you eliminate some slots required.

And also the quality that we deliver with our products the whole economic equation is better and then we talked about we get a multi platform qualification so for them their ability to qualify a single platform that covers all of those configurations is both a so simplifying their efforts.

Auction of their efforts and it gets us to market earlier, so all positive trends from the customers perspective, and getting to that new 18, terabyte CMR and 20 terabyte FMR capacity earlier is a big value.

Thank you. Our next question comes from a non Deborah from loop capital.

Hi, Thanks, guys, you're taking the question and that Steve Congrats as well for me.

We have a little more time that he died out but it saleable line.

I do have a gross margin question guys, but I'm excited I just feel quite yet.

Back to leave here.

First a clarification.

The comment earlier in the into Q1 day about 35%.

Gross accounted for 20 year over year.

Is that your hyperscale.

Outlook for calendar 20 or is that another no thats, yes, thats total capacity enterprise, so hyperscale and OEM consumption of that class a product together.

Thanks for that and.

Could you update for US you haven't updated view on what this cycle might look like this this hyper scale cycle might look like now having made sometime within the last couple of quarters.

Yes, I think the only thing we can say as we continue to see strength of the cycle into the first half of 20, I don't think we'd want to go any beyond that that supported in the 35% year over year over year growth parameters. So we don't see enrolling area no.

And the any any sense is it the incremental strength is pull and.

This year, it's been a little bit stronger than we thought is pulling to this year here tea leaves point sustainability as you need can move into the March quarter. So it would point to sustainability into the first half of the calendar year 2000.

Okay, that's great and then I guess just quickly on.

On the flash gross margin so.

As we think about different layers of the headwind that they could roll off sounds like there's some mobile and that 300, sorry, the K ones that databases.

That sounds it gives you participate more mobile the headwind will diminish.

Sort of in coming quarters before we get the inflexible few quarters will the K one possible that 300 basis points headwinds will that also kind of gradually roll off until we get into September quarter.

And then and then what whether the other levers that will also contribute to.

Yes to that to the gradual.

Expansion of margins before we get to the second half next year I just want to Miss anything along this year I'm understanding it appropriate. Thanks, yes. So I'll start with that came one question. So right now and we're just beginning production in that fab and so it will be a gradual improvement in absorption over the next few quarters and and events.

But it will be fully absorbed and have a cost structure similar to what we experience elsewhere.

Yes, I think the other drivers are really looking at individual segments and as I talked about we are continuing to expand the product portfolio and increased participation and let's call it higher quality revenue segments like enterprise SSD.

Other sort of high end mobile marketplaces, as we progress into 2020, so think of it as customer and product mix improvements as well.

Thank you. Our next question comes from the Java cash with Mizuho.

Hi, Thanks, guys. Good luck on guys, Steve on and good luck, we did next in dollars.

Just on the flash side I was wondering looking back on the gross margin and Thats. The last question here.

Yes.

If you could look at you said you have the appendix it so the mobile segments, but wondering if you look at first have you expect this step up as you exit so those segments and what kind of.

Margin improvement should you expect in the Flash said with as you move more into the SSD.

Less price sensitive markets.

Yes, I suppose on that sorry go ahead.

Well I was going to respond to that I'm, sorry, So let me clarify we have not exited from the maximum orica, we chose not to participate in segments of that market for a period of time because the margins. It was not it made ECM and made no economic sense okay.

As we see the pricing environment in that market begin to stabilize and improve consistent with improving supply and demand dynamics, we will be increasing our participation in that market starting this quarter.

Got it got it and on the hardest time side.

Dr. What succeed and trade data, but can you give us some kind of how when you expect to them. Some of those products as you go to 2020. Thanks, Yes. So so obviously, we said were sampling those in the current quarter and we expect our ramp that in the first half a calendar 20.

So that that's in the not too distant future.

Okay.

Okay.

Thank you and our final question today will come from Niehoff, Chuck ski with Maxim.

Yes. Thank you.

Just for identification purposes here or yeah education purposes, what does the NAND flash industry typically seasonally peak in terms of the demand from a monthly perspective.

Okay.

Well I mean.

And this is sounds like a facetious answer it's either the old adage the best quarter of years October November and December .

It's around that time right.

But I don't know literally which month.

Yes.

Okay.

So Mike I think you made a comment that.

The next by loss from the power outage turned out to be Forex by six exabytes, but you still expect that the excess inventory industry wide would be flushed out by the end does this year, so given that lower X by loss.

Have you seen better demand and expected over the past three months.

Yes, so I think in general are bit consumption of demand has been at are well above what we thought so our comments, where we thought by the end of the year the industry inventories would be substantially improved and we stand by that.

And what's been the driver of that better than expected demand for NAND flash bits.

I think we've seen generally speaking some a little bit better mix in terms of capacity per unit and I think some of the end markets.

Our a little more robust than maybe we originally expected including mobile.

Got it thank you.

Alright, showing no okay, because I'm showing no further questions in the kids I'd like to turn the call back over to management for any closing remarks.

Alright, Thank you for joining us today I would also like to extend the thank you to all of our employees customers and business partners. We look forward to a successful year together.

Great. Thanks.

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

Ladies and gentlemen, thank you for standing by welcome to Western Digital's first quarter fiscal 2010 20 conference call at this time, all participants on the listen only mode.

I think the speaker presentation, there will be a question and answer session to ask a question. During this session. You want me to press Star one on your telephone if you require any further assistance. Please press star Zero I would now like to hand, the conference over to your Speaker Mr. Peter Andrew. Please go ahead sorry.

Okay. Thank you and good afternoon, everyone before we begin let me remind everyone that today's discussion contains forward looking statements.

Including product development expectations business plans trends in financial outlook based upon management's current assumptions and expectations and as such does include risks and uncertainties. We assume no obligation to update. These statements. Please refer to our most recent financial report on Form 10-Q filed with the FCC for more.

Permission on the risks and uncertainties that could cause actual results to differ materially.

We will also make references to non-GAAP financial measures today reconciliations between the non gap and comparable GAAP financial measures are included in the press release and other materials that are being posted in the Investor Relations section of our website with that I'll now turn the call over to Steve Milligan our CEO .

Thank you Peter and good afternoon, everyone. Joining me today, or Mike Cordano, President and Chief operating Officer, and Bob you out Chief Financial Officer.

Before we discuss our results for the first quarter of fiscal 2020, I want to spend a moment talking about the other news we announced today.

After a long in fulfilling career with western digital spanning two decades I have informed our board that I plan to retire as CEO I.

I will continue to serve as CEO until the board has identified and appointed a successor.

Western digital as a significantly different company and the one I'm first joined in 2002.

We are more diversified more resilient and much better position to capture the opportunities up todays evolving data marketplace.

Since my appointment as CEO Western digital has transformed from a storage component provider to a diversified enabler of data infrastructure with the broadest portfolio in the industry offering customers a powerful combination of hard drive storage and flash.

Memory products.

We have successfully executed many key strategic initiatives.

Including the company's acquisition of Sandisk.

The integration of Western digital HCS tea, and sandisk as well as the extension of Western Digital's 19 year partnership with key Osha.

We now operate a powerful platform uniquely positions us to provide new architectures and capabilities to manage the volume velocity and variety of data.

As we think about what comes next for our company.

I believe now has the right time.

Western digital begin to begin the transition to its next phase of leadership.

Serving as western digital CEO for the past seven years has truly been one of the highlights in my career.

I want to thank our team for their support and dedication.

I could not be prouder of what we've accomplished together and consider myself quite fortunate to have worked alongside such a talented team.

In terms of next steps I look forward to continuing to work closely with the team while the board conducts the search for our next CEO .

Given our strong management team, we expect this transition to be seamless.

For our shareholders, our employees and the customers that rely on our best in class service and products.

Once my successor is onboard I will remain with the company in an advisory role until September 2020 to ensure a smooth transition.

I will also continue to serve as a director on the Western Digital board for a transition period. After my successor is appointed.

With that said, let me turn to our performance for this quarter.

Fiscal 2020 is off to a good start.

Revenue exceeded the guidance range, we provided in July and non-GAAP EPS was at the upper end of the range.

The upside was driven primarily by the success of our capacity enterprise drives for the data center.

We are executing well on the data center utilizing the power of our portfolio.

At the core of our success in this market is our industry, leading capacity enterprise hard drive solutions in the exceptional value, we provide to our datacenter customers for their diverse storage needs.

During the quarter, we made two important announcements to further extend our product leadership.

First.

We introduced 16, and 18 terabyte CMR drives and a 28 terabyte.

Yes, I am our drive all enabled by our energy assisted recording technology.

These drives are expected to sample this quarter.

Additionally, through our continued investments in heads media and mechanical design, we began shipping and air based 10, terabyte drive providing significant benefits to our customers.

I'm pleased to announce we commenced the initial the initial revenue ramp of our nvme, the based enterprise Ssds to major Hyperscale and OEM customers during the September quarter.

Efforts to qualify in ramp additional customers with our next generation products based on our 96 layer Threed Flash technology are going well.

And should position us to further increase our participation in this important market.

Western digital Western Digital's ability the offer both hard drawn and flat flash based solutions differentiates us from our competitors and allows us to more strategically partner with our datacenter customers.

Outside the data center, the overall demand environment across the consumer mobile PC and resale end markets is solid.

Furthermore, we are seeing improving trends across our flash product portfolio and continue to believe that the flash industry has passed a cyclical trough.

With a broad and growing product portfolio Western digital remains well positioned to benefit from the long term drivers of the growth and value of data.

With that I will now ask Mike to share our business highlights.

Thank you Stephen good afternoon.

Before I get into my prepared remarks, I want to congratulate Steve on his upcoming retirement.

Thank you and appreciate the partnership we have built together over the past decade, and a lot to acknowledge Steve for his leadership and numerous contributions to western digital.

We have quite a bit of time and work to do between now and September of next year.

Forward to working together to execute on our plans.

As Steve mentioned fiscal 2020 is off to a good start.

We had record hard drive exabyte shipments driven by the success of our capacity Enterprise drive family.

We also had record exabyte shipments in flash as we benefited from demand elasticity and share gains in ssds for Pcs and notebooks.

And datacenter devices and solutions, our capacity enterprise exabyte shipment growth was over 60% year over year led by the ramp of our 14 terabyte drives.

These drives now represent the majority of our capacity enterprise unit and exabyte shipments.

Industry analysts expect to 14 terabyte capacity point to be the industry's highest volume product through the first half of calendar year 2020.

Building on our aerial density leadership and execution on mechanical design, we announced our plan to accelerate the introduction of our nine platter energy assisted capacity enterprise drive platform.

Enables us to ship 16, and 18 terabyte, CMR and 20 terabyte Asimov drives on a unified platform simplifying the qualification process and reducing the time to market for our customers.

We will be sampling all of these drives by the end of this quarter and will commence volume shipments in the first half of calendar 2020.

In addition, we began shipment shipping new 10, terabyte airbase product powered by our innovative airflow architecture underscoring our aerial density and mechanical design leadership.

Given the strength of our capacity enterprise portfolio.

And the opportunities we see in this market, we now believe our exabyte.

Shipment growth will exceed 40% in calendar year 2019 up from our prior estimate of 30%.

In enterprise Ssds are in via me based products experienced a strong quarter of growth.

And we expect continued growth in the December quarter.

Our qualify our next generation 96 layer product with additional customers, which positions us for further market share gains in calendar year 2020 and beyond.

We have a unique and sustainable competitive advantage within the data center built on strong customer relationships and a strong product product portfolio.

Our strategic position within this important end market will drive future revenue growth.

In client solutions revenue grew on a sequential basis, driven by an improving pricing environment.

And a seasonal increase in bet shipments.

This quarter, we began shipping 96 layer Q LC based retail products and external ssds.

The trust and reputation of our brand and our customers preference for the performance and reliability of our solutions our key differentiators.

In client devices. The main contributor to our year over year decline was our decision to limit our participation in the mobile market.

On a sequential basis, we expect to ship more bits into the mobile market in the December quarter.

In Pcs and notebooks, we gained market share in client ssds as our exabyte shipment growth exceeded 70% year over year.

Our bit production of 96 layer mix for surpassed 64 layer bicsthree during the September quarter.

We are on track to commercialize fix for across all our product lines by the end of calendar 2019.

Our JV partner coax, Yep, and western digital executed well, bringing the LPG fabs back to full production after the power outage limiting our output reductions to four exabytes.

Our flash supply is tight and we continue to believe that any excess inventory in the flash industry supply chain will be substantially reduced by the end of calendar 2019.

We expect flash industry supply bit growth to be in the mid 20% range in calendar 2019, and in a low 30% range in calendar 2020.

In addition to continued growth in our existing flash portfolio and capacity enterprise markets.

We see several new incremental growth opportunities.

First the launch of the next generation gaming consoles will be important events for the gaming industry and our flash business.

We expect these new console to utilize high capacity flash storage to improve the gaming experience.

Second we expect to expand our product portfolio and diversify our customer base for the mobile market with our you fs.

MMC and custom solutions.

Finally, our recent announcements of Threed flash products for the automotive and industrial markets will further expand our opportunities and these growing and more stable flash based markets.

I'll now turn the call over to Bob for details on our financial performance.

Thanks, Mike I also want to congratulate Steve on his upcoming retirement and look forward to helping enable a seamless transition to the next CEO .

I'm pleased to announce the revenue for the September quarter exceeded the high end of the guidance range. We provided in July .

non-GAAP earnings per share came in at the high end of the range.

Revenue for the September quarter was $4 billion business was up 11% sequentially as we experienced growth in data center devices and solutions and client solutions.

Revenue was down 20% year over year, as we faced a tough compare tough comparable quarter in fiscal 2019.

By end markets data center devices, and solutions revenue increased 20% sequentially and 6% year over year due to the success of our capacity enterprise drivers for the data center.

Please recall that a year ago based on discussions with our customers. We predicted that in the second half of calendar 2019, we would return to growth in capacity enterprise, we are experiencing that predicted rebound now.

On a sequential basis client solutions revenue grew 18% on seasonally stronger flash bit shipments and a stronger flash pricing environment.

Client solutions revenue declined 4% year over year, primarily due to reduction in hard drive Tam.

Thanks.

Client devices revenue was up 1% on a sequential basis and decreased 39% year over year.

The year over year decline was the result of our decision to scale back flash that shipments to the mobile market.

Flash price declines and a reduction in the hard drive Tam.

By product category Flash revenue was $1.6 billion up 8% sequentially and down 36% year over year.

Flash ASP is were flat and debt shipments were up 9% sequentially.

Our drive revenue was $2.4 billion up 13% sequentially and down 3% year over year.

Average price hard drive was $81.

Exabyte shipments were up 23% sequentially hitting a new record level.

As we move on the cost and expenses. Please note all my comments will be related to non-GAAP results unless stated otherwise.

Gross margin for the September quarter was 24.8%.

With a flash gross margin of 19.3% and our hard drive gross margin of 28.5%.

We completed all of our cost of revenue reduction activities, we outlined in January resulting in a decrease of more than $100 million in quarterly spending.

The hard drive gross margin was up slightly from the June quarter, and we expect the December quarter gross margin to be approximately 30% as we fully realize the benefits of the cost reduction efforts.

Flash gross margin was up on a sequential basis as we benefited from a better flash pricing environment.

Okay, one fab cost was $64 million higher than expected.

Excluded from the cost of revenue was $68 million charge related to the power outage.

Operating expenses were $767 million.

Adjusting for our normal 13 week quarter operating expenses were below $740 million run rate target.

During the quarter, we completed all of our operating expense reduction efforts announced in January .

In addition, once we complete the exit of our storage systems business, we should start to see in approximately $25 million per quarter reduction in operating expenses beginning in the March quarter.

Operating cash flow from the September quarter was $253 million and free cash flow was $294 million.

Capital expenditures, which include the purchase of property plant and equipment and activity related to flash venture is on our cash flow statement, where an inflow of $41 million.

As previously noted we are benefiting from the timing of the funds flowing back and forth between us and the joint venture.

For the full fiscal year, we continue to expect capital expenditures that will flow through our cash flow statement to be under $500 million.

Total capital expenditures, which include our portion of joint venture leasing and self operating funding is expected to be similar to last fiscal year between 2.5 and $3 billion.

In the September quarter, we distributed $147 million in dividends to our shareholders.

We paid down debt by $319 million, which included an optional 250 million dollar debt pay down.

As our cash generation continues to improve our first priority will be to reinvest in the business to maximize long term shareholder value.

After paying our dividend our next priority will be to reduce our debt.

At the ended the quarter, we have $3.2 billion in cash and cash equivalents are $2.25 billion revolver remains unused and our gross debt outstanding was $10.4 billion.

Total inventory dollars were flat on a sequential basis, but higher than projected as the joint venture fab recovered faster than expected.

This resulted in a sequential increase in flash inventory, particularly at the end of quarter, while hard drive inventory declined about $100 million sequentially.

Moving on our non.

<unk>.

Gentlemen, please standby.

Jerry can you hear us on your side.

Yes. Your line is open.

Right. Okay, do we know when we cut off.

And with guidance. So again this is non-GAAP guidance and Thats as follows we expect revenue to be in the range of $4.1 billion to $4.3 billion.

We expect gross margin to be approximately 25% to 26%.

Please note that this range includes approximately $75 million in cost associated with the K one fab.

Operating expenses are expected to be between 750 and $770 million above the $740 million run rate target due to higher variable compensation spending.

We expect interest and other expense of $85 million, we and we expect the tax rate to be 26% plus or minus two points.

As a result of this detailed guidance, we expect earnings per share between 45, and 65 cents, assuming approximately 302 million in fully diluted shares.

With that I will now turn the call over to the operator to begin the Q and any session. Operator, we'll now take our first call first question.

Thank you ladies and gentlemen, we will now begin the question and answer your question.

If you have a question. Please press star one on your phone if you would like to withdraw your question. Please press the pound one moment. Please for the first question.

Next question comes from Aaron Rakers with Wells Fargo.

Yes, thanks for taking the question and Steve Congrats on a retirement has been great working with you.

Two questions. If I can real quick so first of all I guess, what are the things that stands out a little bit as say the capacity shipment number on flash up only about 9% sequential by my math, it's up maybe high single digits on a year over year basis. So.

Can you talk a little bit about.

It seems like the product portfolios and a great position Nbn. These ramping client SSD capacity shipments were strong I'm just curious of why we it seems to be a little bit muted as far as the capacity shipment.

Trends and flash and what's your expectation going into the December quarter for capacity ship.

Yes, So let me address that so the primary reason for that is really the point that I made in Bob made in our comments is we did not participate in a substantial way in the mobile marketplace in the quarter just completed so thats the primary driver of bit shipment in the quarter.

Okay and then.

Hey, Aaron recall this is Steve recall that that lack of participation in the mobile market was by choice from our standpoint, given that the profitability levels for that segment of the market, we're not at all attractive.

Okay Fair enough and then as as the second question on on near line capacity Enterprise drives.

In the slide deck you note that you now expect overall the market to quote unquote approach, 30% year over year growth I think last quarter, you talked about growth meaningfully exceeding that 30% level. I know you guys are talking about north of 40% growth and your capacity shipments, but what's changed over the last quarter has there been a bit of a softening in.

In terms of your expectation I guess going into the December quarter, or what's really driving that that change of growth expectation. So Aaron I think for us we actually updated our our performance on the year. We had originally had stated last quarter, we'd be north of 30% for us we updated that guidance that north of 40, we're actually seeing strength in exabyte.

Consumption across the capacity enterprise segment.

Now the other thing that's happening for us Thats more unique is the power of the 14 terabyte product is doing quite well.

Obviously, we are gaining market share in that segment that showing up on an exabyte basis.

Are there constraints in the market, which is tempering the overall market the industry expectation.

No I think we would suggest the industry Mark industry will grow at North of 30, we will grow at no. It's north of 40, and again Thats all up from our last outlook on on both numbers.

Okay fair enough. Thank you.

Yes.

Thank you. Our next question will come from Mehdi Hosseini with as Sanjay.

Yes. Thank you Steve Good luck with the with units in dividend was very nice.

Looking we view moving on to questions.

Just two follow up.

We.

Very helpful. When you talk about Exabytes shipped been guide, especially for the near line and as you look into the next year, how do you see that exabyte shipments.

Target changing again disease for 2020 versus 2019, and how would how should we think about the mix of the Nearline exabyte as as a percentage of the overall exabyte shipments for for western ditch.

Yes, So let me just comment specifically at capacity enterprise, we would expect for 2020, our current outlook is about 35% year over year growth. So continued strength year over year.

And so we don't we don't split out total hdds by growth and we don't specified.

Okay and by the way many that 35% is consistent with our longer term expectations threats.

Sure.

You kind of pre into my prepared question as by saying that you didn't participate in the mobile segment as relates to you and then shipment and there's a debate as to what happens to that inventory into channel reserve to move on.

Segment as you look into the March quarter.

We did the background, how do you see the supply and demand in NAND looking into the March quarter, and I'm not asking for the guide I just want to better understand your view you didn't participate in that market and in that context, how do you see your prices trending into March quarter.

Yes, so I'll take that May we.

First off as we indicated we believe that we passed the trough in terms of this last cycle.

In the overall inventory situation is improving in other words supply is getting much more aligned to demand.

And we would expect that largely for ourselves and for the industry as we exit the December quarter that things will be fairly imbalance now when you move into the March quarter, and let me actually broaden that question a bit when you move into the first half of the year one of the things that we have to keep in mind is that we will see.

Typical seasonal Dillon.

Decline in terms of.

From a demand perspective supply as relatively linear and so we will have to just like we do every largely every year in terms of the calendar cyclicality, we'll have to manage through that.

Then as we move to the back half of the year, where we will see in this is the back half of calendar year.

A calendar year 20, we will see that begin to flip demand. They can begin to improve and we will see.

Rather than modest improvement in our financial results that we've been seeing we should see an accelerating improvement in our performance from a financial perspective, as we move into the back half of calendar 2020.

Many and just give you some numbers to work with there we talked about low thirtys on supply bit growth, we would expect demand for the calendar year to be slightly above that.

Great. Thank you.

Okay.

Thank you. Our next question comes from call everyone with Cowen.

Good afternoon, thank for taking my questions and Steve.

Again, congrats on your retirement and best of luck in your future endeavors.

Two questions if I may.

Speaking on mobile for a moment.

You reference that mobile margins have not been attractive.

The last two quarters, but.

Is that because you don't have captive DRAM I guess, how important is that is it for you to have either captive DRAM or a new long term supply agreement for DRAM as you contemplate your competitive position in smartphones over time.

Yes, let me answer that so let me delineate mobile so theres the discrete and component part a mobile and then there's the Emcp, which includes DRAM I think strategically we do not see Emcp is a long term stirred strategic ways for us to operate or focusing our.

Ladies and gentlemen, please standby.

Lines for.

Speaker.

Yes, Jerry can you hear US now, yes, we can.

With us.

Do you want to pickup.

Okay. Let me, let me back up and repeat that I don't know, where we dropped off our mobile market participation. Let me break into two components. One is the emcp business. It includes DRAM. The second is discrete and component participation in mobile and use applications strategically we've moved away from product investment in Emcp.

And over the longer horizon, that's not an area product focus for us. So when we talk about participation if that plus the discrete business, which we chose for economic reasons to minimize our our participation as we had higher value places to put our beds. So we see that.

Actually improving and the economics and mobile improving along with other segments of the market.

That's that's helpful. Mike as my follow up.

Shifting gears to gross margins from them and clearly you and your peers are operating well below normalized run rates and and NAND.

At the same time, though I think your outlook for hard drives hardrock gross margins.

Good, but still a little bit below where we were roughly year ago, I guess will the exit of the systems business.

Areas of assistance business be the primary driver for gross margin from an hard drives and I guess, how do we think about the margin implications from the incremental desk and heads on those higher capacity drive. Thank you. Yes. So let me I'll address that involve in and Mike can chime in.

Yes.

Any additional color. So the first thing is the exiting in the system business will have no material impact one way or the other on a gross margins.

So if you look at our our hard drive gross margins I mean, let's be let's be clear about that are hard drive gross margins. Although you know good levels are not where we want them to be we weren't those hard drive gross margins to be north of 30%.

In the low 30% range, we are still dealing with some of the cost overhang of exiting our call them for manufacturing facility that Werent that is now behind us and so we should see our drive margins.

Improve into that low 30% range as we exit this.

As we exit the December quarter, and then obviously, our intent is to sustain and possibly improve that over a period of time flashed gross margins are clearly not where we want them to be they are improving albeit at a slow rate.

We will continue to expect as we see this sort of ripples through the market because different customers started at different levels different markets started at different levels. The pace of that improvement is not linear for all of those aspects, but we'll continue to see steady improvement in our flash margins this quarter and then into subs.

The current quarters.

And as I indicated earlier, we expect that improvement.

Two.

Improve add a improved rate as an impediment rate as we move into the second half of calendar 2020.

Thank you gentlemen.

Thank you. Our next question comes from Mark Delaney with Goldman Sachs.

Yes. Good afternoon. Thank you for taking the question follow ups around gross margins and maybe first just to better understand that the outlook for NAND and that again.

And for margins to improve somewhat next quarter is I understand around ASP like for like basis, if you'd give more color on what you're assuming there given the comments about a cyclical bottom.

Yes, I can start and first of all I want to remind you on the NAND side, we do have a headwind what became one startup costs and bringing up that fab and we are beginning production there, but then there's probably in the neighborhood of three point headwind that were facelift on demand side and as Weve.

Sam volume than obviously, the margins will improve everything else being equal.

So in terms of flash overall, as we get to equilibrium between supply and demand. We are definitely expecting the pricing will get better as we move through 20 like Steve was saying, so I think it'll take a little bit of time to work through that but I think we're going to being a good price.

Okay.

Thanks, Bob and then my follow up was on the at the hard drive gross margin again, along along the lines of the prior questioning.

I have been under the impression that for the December quarter hard drive gross margins could hit 30%, especially given the upside that the company's seen in the near line business, which I think typically runs at least 30% if not higher.

Is there anything in terms of increased headwinds around gross margins have become the company has seen the in the December quarter, maybe keeping hard drives gross margins under 30%.

Are we going into the wrong impression about the ability to 30% with my previous expectations for for the just let me let me I'm sorry, Let me, let me because I get kind of.

This one I feel strongly about we will we our intent is to have gross margins north of 30% for hard.

Our hard drive business this quarter the December quarter, and so there is no.

Headwind at present.

Of course, there can be things will happen, but theres nothing at present that indicates that we won't hit that level.

And the other thing I would add Mark is if you look out over time, we expect more and more growth in terms of capacity enterprise capacity enterprise will become a bigger percentage of our overall mix and that will help the margins go up as well.

Got it. Thank you very much in Steve Good luck with your future endeavors. Thank you.

Thank you. Our next question comes from Mitch Steves with RBC capital market.

Hi, guys. Thanks for taking my question I think it when the folks have been just on the gross margin kind of an inflection I think a lot of people are looking for kind of like 80 cents or even a dollar for the December quarter Guide you to improving memory environment. So I guess, maybe can you help us. Please understand how you guys think of the inflection in terms, how much leverage you're going to get on the gross margin side. If we look out let's say three or four core.

Yes.

I understand the comment about how you're going to see more material inflection in the back half for calendar Tony.

So a couple of things, let me talk about the dynamics in the current period, we talked about so when we look at where we started from all all end markets in flash were not created equal relative to pricing and margin.

We also noted that mobile was a inferior performing segment for us we're taking more of that on this quarter as a percentage that total so that is having a bit of a headwind relative to the flash margin in the current quarter Steve's comments earlier on 2020, we see supply demand in pretty good shape as we come.

And the 2020, but the normal seasonality of the year, we got to make sure we're.

Managing through that add eight and a cautious way and we expect that is your moves on as we head towards the middle of the or the backend that we'll continue to improve in the rate of margin improvement in flash will accelerate the back half of the year.

Okay, and then in terms of the NAND gross margin is that go back to like Thirtys.

Backup 20, I mean, just any sort of question that you could be helpful.

Well, we are I mean, let me be clear on this we're not we're not providing guidance beyond what we've done in terms of class gross margins, but I'll tell you, where I'll tell you, where we need to get too and where we want to get too is back to where plus gross margins are in that 40% range that that's a margin level that we view as attainable over.

A period of time and it's also a margin level that we believe is required to get sufficient return on the capital that we are investing in this business, so thats, where we want to head to.

Okay. That's very helpful. Thank you.

Thank you. Our next question comes from CJ Muse with Evercore.

Thanks for taking the question I guess another question on gross margins specific to the NAND side.

Can you quantify the K one fab costs in the September quarter, I think you said 75 million in the December quarter, and how we should think about that.

Progressing.

2020.

And then I guess as as.

A second question.

On the flash fits side.

It looks like.

Implied in there given these.

Costs, roughly good growth of only 10% or so in the quarter. So it looks like you're only growing about 19, 20% for the year versus many of your competitors, who are suggesting low thirtys for the industry and so I guess is that a function of just deciding not to want to play.

And the mobility side is it a function of not having the right bits or or or is there something else. Thank you now let me let me address the last question first in terms of us growing them first on the growth that we're seeing from a demand or revenue perspective is consistent with previous expectations and hasn't changed and all by the way one of them.

Things that you have to keep in mind is that we took a meaningful amount of production offline starting earlier this year independent of the power outage, because we saw the oversupply conditions.

Well, we saw it coming and we saw that situation being let's just call. It untenable and so we were reducing our bit output from a supply perspective to help offset.

That growth that unnecessary growth from a supply perspective that created.

The substantial price decline that we in the industry realized.

In the back half 18, and also in the 19.

So.

Bob to address the.

Yes, loads and plus yes, so CJ in terms of that the September quarter that we just finished the came when costs were at $64 million and what I said in the guidance as we expect into December quarter end of it will be in the neighborhood and 75 million.

We think they will start to come down from that point in time, but this is I mean this is new production capacity, we're putting in place it becomes a part of our fixed cost structure overtime.

Okay, Yes, CJ whatever one other comment I'll make is when you think about this on a bit share comparative basis. When you think about it from a bit capacity output basis. Obviously, we continue to remain in the same proximity or ratio to others. So this is simply us choosing to not produce very low margin.

Product for the reasons as Steve said.

Makes sense. Thank you.

Thank you. Our next question comes from Steven Fox with Cross research.

Skews and good afternoon, and sorry for another gross margin question, but.

Hi.

Maybe we'll have to start beginning gross margin question, Yes, Laughlan, let me get it didnt get doesn't.

So in terms of just the mix impact on NAND gross margins can you maybe talk a little bit about what's going on mix how mix is affecting the gross margin guidance for the current quarter versus what you just reported in NAND gross margins and then along similar lines you mentioned some some incremental growth next year from things like next generation game.

And industrial can you talk about their mix and tack on gross margins and if I dare get in one more given what you said about the first half of the calendar year are you able to.

We sold gross margins around current levels or based on what you do with where you choose to put you bits or do we backtrack a little thank you well again I'm going I am going into last question first.

We would expect that our profitability levels.

Certainly from a margin percentage standpoint, we'll continue to modestly improve as we move into the first half the year.

Okay and back to the mix, let me just reiterate within the flash business, we're taking on a greater proportion.

Mobile business this quarter, which is a margin drag and as dampening our our sequential margin performance to some degree on the flash side and that Bob also talked about the fab startup. So those two things are affecting the flash margin.

And this quarter when we go into 2020, certainly a number of the new markets are good bit consumers the gaming business.

Thanks at that is going to be not only a good consumer bets, but at a reasonably attractive margins and industrial and automotive are even better yet relative to margins add more stable and non cyclical and bought already indicated that the K. One costs are kind of a three point drag and then if you neutralized for mix I think that.

We would all be seeing a much more satisfying increase in our flash margins. When you neutralized for those two items and I think thats important for all of us to keep that in mind that the trajectory is in the right direction.

It's just that there are other moving parts that tend to mask.

Those improving trends.

Got it and Steve Congrats on all your accomplishments that western digital thanks. Thank you very much.

Thank you. Our next question comes from Sidney Ho with Deutsche Bank.

Great. Thanks.

Maybe one more question on this flash side I know you talk about few times about strategically walking away from the mobile mobile mix can you remind us fuel mix within the NAND flash business today, and how you think that would change a year from now as Jim more tailwind coming from this.

No change in mix and what are the areas that have better margins, a horse margins and the 70 average before.

So we don't specifically disclose the ratio of flash participation, but I can't give you some color on relative performance certainly the areas of big investment for us that we emphasize our where we want to grow our participation so enterprise SSD.

Fast growing higher overall margins than the average over time.

Industrial embedded.

Both similarly situation higher margins.

Growth rates and then ultimately certain segments of mobile overtime are attractive and we're focused on those hence our you fs product investments. So the higher end higher performance part of that marketplace. So we put a big emphasis on quality of revenue and seeking out those higher margin more stable end markets.

Those would be examples that we're focused on.

Great.

Follow up question I'm sure you welcome I tried to questions.

Thank you talk about introducing 16, sorry by sea minus 18 Terabyte FMR you ended up launching high capacity about two months later.

Can you talk about why you meet that change in the relative and what kind of feedback youre getting from your customers so far.

Yes. So the reason we made that decision it's actually quite simple is that we we made faster progress in terms of our nine nine planner platform than what we had previously anticipated and so the advancements that we were making from a mechanical perspective allowed us to pull in that platform sooner than what we.

Anticipated, which was favorably received by our customers from a market place perspective, which I'll ask Mike that will elaborate on yet I think a number of dimensions of this obviously it gets them to 18 and 20 terabyte sooner than they would have otherwise so they tcl benefit when you combine cost per bed with the other.

Elements like slot tax because you know you eliminate some slots required and also the quality that we deliver with our products. The whole economic equation is better and then we talked about we get a multi platform qualification so for them their ability to qualify a single platform that covers all of those.

Configurations is both a so simplifying their efforts and cost reduction of their efforts and it gets us to market earlier, so all positive trends from the customers perspective.

And getting to that new 18, terabyte, CMR and 20 terabyte FMR.

Basket earlier is a big value.

Thank you. Our next question comes from Deborah from Loop capital.

Hi, Thanks, guys, you're taking the questions and Steve Congrats as well for me.

We have a little more time with.

But it saleable side.

I feel that gross margin question, guys, but I'm excited I just feel quite yet just provide similarly here.

So first a clarification.

Comment earlier in that in the queue today about 35%.

Gross or calendar 20 year over year was that your hyper scale.

Outlook for calendar 20 or is that another no thats, yes, thats total capacity enterprise, so hyperscale and OEM consumption of that class a product together.

Thanks for that and.

Could you update for US you haven't updated view on what this cycle might look like this this at this scale cycle might look like now, adding making kind within the last couple of quarters.

I think the only thing we can say as we continue to see strength of the cycle ended the first half of 20 I don't think we'd want to go any beyond that that supported in the 35% year over year over year growth parameters. So we don't see enrolling a ria no.

And the any any sense as if the incremental strength.

Paul and.

This year, it's not a little bit stronger than we thought is full into this year year tea leaves point sustainability as you need and moving to the March quarter. So it would point to sustainability into the first half of the calendar year 2000.

Okay, that's great and then I guess just quickly on.

On the flash goods margins so.

As we think about different layers of the headwind that they could roll off sounds like there's the mobile and that 300, sorry, the cable databases.

That sounds it gives you participate more mobile the headwind will diminish.

Sort of in coming quarters before we get the inflexible few quarters will the the K one possible that that 300 basis points headwinds will that also kind of gradually roll off until we get into September quarter.

And then and then what whether the other luxury but will also contribute to.

Yes.

Gradual.

Expansion of margins before we get to the second half next year I, just want to Miss anything along those Jim understanding it appropriate. Thanks, yes. So I'll start with became one question. So right now and we're just beginning production in that fab and so it will be a gradual improvement in absorption over the next few quarters and and events.

Well it will be fully absorbed and have a cost structure similar to what we experienced elsewhere.

Yes, I think the other drivers are really looking at individual segments and as I talked about we are continuing to expand the product portfolio and increased participation and let's call. It higher quality revenue segments like enterprise SSD and other sort of high end mobile marketplaces as we put.

For us into 2020, so think of it as customer and product mix improvements as well.

Okay.

Okay.

Thank you. Our next question comes from the Jamba cash with Mizuho.

Hi, Thanks, guys. Good luck on guys, Steve on and good luck again next in dollars.

Just on the flash side.

One thing going back on the gross margin and Thats a last question yet.

If you could look at you said you the appendix it so the mobile segments, but wondering if you look at first half we expect this step up.

Exit so those segments and what kind of margin improvement should you expect in the flash said, but as you move more into the SSD.

Less price sensitive markets.

Yes. This doesn't that sorry go ahead.

Going to respond to that I'm, sorry, So let me clarify we have not exited from the maximum orca, we chose not to participate in segments of that market for a period of time, because the margins. It was not it made and made no economic sense. Okay.

As we see the pricing environment in that market begin to stabilize and improve consistent with improving supply and demand dynamics, we will be increasing our participation in that market starting this quarter.

Got it.

And on the hardest time side.

Dr. What succeed and pay data, but can you give us some kind of how when you expect to them. Some of those products as you look you're going to 20. Thanks, yes. So so obviously, we said were sampling those in the current quarter and we expect our ramp that in the first half of calendar 20.

So that that's in the not too distant future.

Thank you and our final question today will come from Niehoff, Chuck ski with Maxim.

Yes. Thank you.

Just for identification purposes here or yes education purposes, when does the NAND flash industry typically seasonally peak in terms of demand from a monthly perspective.

Well I mean.

And this is sound like a facetious answer is either the old adage the best quarter of the years October November and December I'd say, it's around that time right.

But I don't know literally which month.

Yes.

Okay.

So Mike I think you made a comment that.

The next by loss from the power outage turned out to be Forex by six exabytes, but you still expect that the excess inventory industry wide would be flushed out by the end does this year, so given that lower X by loss.

Have you seen better demand and expected over the past three months.

So in general are bit consumption of demand has been at are well above what we thought so our comments, where we thought by the end of the year the industry inventories would be substantially improved and we stand by that.

And what's been the driver of that better than expected demand for NAND flash bits.

I think we've seen generally speaking some a little bit better mix in terms of capacity per unit and I think some of the end markets.

Our a little more robust than maybe we originally expected including mobile.

Got it thank you.

Alright, showing no okay. The speakers I'm showing no further questions in the queue I'd like to turn the call back over to management for any closing remarks.

Alright, Thank you for joining us today I would also like to extend the thank you to all of our employees customers and business partners. We look forward to a successful year together have a great rest of the that.

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