Good afternoon. And thank you for standing by. Welcome to Western Digital's Fiscal Third Quarter 2020 Conference Call. [Operator Instructions] As a reminder, this call is being recorded.Now I will turn the call over to Mr. Peter Andrew. You may begin..

Okay. Thank you, and good afternoon, everyone.

Joining me today are David Goeckeler, Chief Executive Officer; and Bob Eulau, Chief Financial Officer.Before we begin, let me remind everyone that today's discussion does contain forward-looking statements, including product development expectations, business plans, trends and financial outlook based on management's current assumptions and expectations and as such, does include risks and uncertainties.

We assume no obligation to update these statements. Please refer to our most recent financial report on Form 10-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 David..

Thanks, Peter.

I would like to thank everyone for joining us this afternoon, and I hope that you and your families are well given the COVID-19 pandemic we are all facing.I joined Western Digital a little over a month ago because I have strong conviction in the digital transformation that is reshaping every industry, every company and how all of us live our daily lives.

This transition will continue to rapidly increase the amount of data generated, stored and consumed in the world.Western Digital is uniquely positioned to accelerate and benefit from this transformation as the only company providing a broader array of NAND flash, SSD and HDD solutions.

We have a strong portfolio, established footprint, operational scale, brand and great customer relationships from the cloud to the edge to the endpoint.

On today's call, we'll discuss what we're doing to position the company for continued success and to be best prepared to capture the significant opportunities in front of us.While I couldn't have anticipated the unprecedented series of events that have transpired since I joined the company on March 9, I do believe that the underpinnings of the technology architecture we are all now leveraging on a daily basis has been well established over the past several years.

The public cloud rapidly accelerating innovation across a wide array of increasingly intelligent devices, all brought together by high-speed networks.All elements of this architecture are continually upgraded, new cloud APIs, new and more powerful edge and endpoint capabilities and emerging 5G networks.

Increased capabilities across any point of this architecture drive incremental opportunity for all that participate in the ecosystem.Data is the critical component that unlocks value across this ecosystem, and our portfolio is well positioned from the cloud to the edge to the endpoint.

I'm confident our team's innovation in NAND and HDD technologies will drive significant new opportunity for our customers and value for our shareholders.

As you can probably tell, I'm excited to be here and see great opportunities for Western Digital.Before we review our results for the third quarter, I would like to address how we are operating amid the COVID-19 pandemic. First and foremost, our priority is to ensure the health, safety and well-being of our employees, customers and suppliers.

We are carefully following precautionary measures and best practices across our global sites and all production facilities remain operational.We encountered some supply disruptions in the quarter. However, due to the efforts of our operations team, we saw supply trends improve as the quarter progressed.

We also incurred additional costs associated with logistics and other manufacturing activity.Demand remained strong in the third quarter as expected.

Revenue was $4.2 billion, right at the midpoint of the guidance provided in January.We experienced healthy demand from our major cloud customers throughout the quarter and maintained our leading position in the capacity enterprise drive category.

The current environment has accelerated the movement to the cloud, transforming the way businesses operate, students learn, and the way friends and families connect.

These trends will continue to drive innovation and data storage growth for a number of years, and we are well positioned.High-capacity hard drives are the foundation to enabling the world's essential zettabyte scale data infrastructure, providing unmatched capacity and TCO efficiency.

Our 14-terabyte products continued to perform well, and industry analysts expect this capacity point to remain the industry's highest volume drive, at least through the third quarter of calendar 2020.We are leading the industry in bringing next-generation energy-assisted drives to market as we recognize revenue for our 16- and 18-terabyte drives during the quarter.

Customer interest in these products, specifically our 18-terabyte drive is very high and the ramp is on schedule.Customer acceptance of our enterprise SSDs continue to grow.

Our latest 96-layer NVMe-based SSDs have completed more than 20 qualifications with well over 100 qualifications in progress at multiple cloud and OEM customers worldwide.Demand for our notebook solutions was greater than expected due to the shift to working from home and e-learning.

We experienced record client SSD revenue during the quarter and expect continued growth in the fiscal fourth quarter.Desktop hard drive revenue was down due to normal seasonality and a shift towards mobile notebook solutions.

In addition, smart video hard drive demand was softer than expected as a result of COVID-19.Mobile flash bit shipments remained modest in the quarter, as we strategically managed our exposure to this part of the market. Retail was particularly affected by COVID-19 in a typically seasonally weaker quarter.

As we approached the end of the quarter, we experienced a decline in demand from traditional brick-and-mortar retailers as they started to temporarily close their stores.

While many retailers shifted to curbside pickup and began pushing sales through their online channels, we expect physical store closures will create a headwind in our fiscal fourth quarter.Finally, new game consoles are expected to come to market shortly that are reimagining the next-generation of gaming.

These new platforms not only utilize nearly one terabit of - terabyte of internal flash storage, but also empower new cloud-based services for gamers, streamers and content creators that will drive incremental cloud storage demand.

We remain on track to ship into this new and growing part of the market in the coming quarter.Turning our outlook for the fourth quarter. Demand remains strong, and we expect growth in revenue and profitability. Of course, the COVID-19 pandemic continues to create a very dynamic environment for us to manage, but our teams are performing well.

Bob will go through the details of our Q4 guidance.I am convinced that Western Digital will play an increasingly vital role in the digital transformation underway.

The combination of right products, customer engagement and end markets focus provides tremendous opportunities for us.Flash holds the greatest long-term growth opportunity for Western Digital. As I mentioned previously, the migration to flash within gaming consoles is yet another example of flash penetrating deeper into the edge and endpoint.

The adoption of 5G and the build-out of the edge to support a new generation of real-time services is another exciting development. We see an expanding TAM for flash that will enable a multiyear growth opportunity.In hard drives, we have already aligned our portfolio to capitalize on long-term growth areas.

Our technology and products are indispensable to the growth of the public cloud, the seminal technology trend of our era.

We are the first to market with next-generation energy-assisted drives, and we will continue to deliver new innovations to build upon our aerial density leadership.I joined Western Digital to be at the center of this incredible opportunity, innovating in one of the critical building blocks of the digital world, storage.

Given the breadth and strength of our portfolio and the attractive markets we operate in, we need to best position the company for ongoing success.As a result, we have made the decision to suspend our dividend in order to reinvest in the business and support our deleveraging efforts.

Bob will go into more details on our deleveraging objectives.Before I turn the call over to Bob, I'd like to take a moment to thank the entire Western Digital team, who have come together during this challenging time. It's been incredible to see the support, teamwork and leadership displayed across all levels.

Together, I am confident we will get through this and emerge stronger than before.I will now ask Bob to share our financial highlights..

Thanks, Dave, and welcome to Western Digital. As Dave mentioned, the world has changed in the last few months. I'm impressed by how well the Western Digital team has come together and navigated through this challenging quarter.

Results in the fiscal third quarter were generally in line with the guidance provided in January as demand held up well in most of our end markets. We had COVID-19-related impacts, which I will detail in a few minutes.Revenue was $4.2 billion, down 1% sequentially and up 14% from a year ago.

By end market, Client Devices revenue of $1.8 billion was up 2% on a sequential basis and increased 13% year-over-year. Record client SSD revenue drove most of the sequential and year-over-year growth.

As we look into the fiscal fourth quarter, we anticipate client SSD will experience another strong quarter of revenue growth.Notebook and PC-related hard drive revenue declined and now represents under 20% of our total HDD revenue.

Smart video was a bit weaker than expected, primarily due to COVID-19.And finally, while mobile was up sequentially and year-over-year, we remain under-indexed to this part of the market. Data center devices and solutions revenue of $1.5 billion was up 2% sequentially and up nearly 22% year-over-year.

Capacity enterprise hard drive revenue was flat on a sequential basis, while enterprise SSD revenue grew.Client Solutions revenue was $821 million, down 13% sequentially and up 2% year-over-year. Our retail business was impacted as we approached the end of the quarter due to COVID-19-related lockdown.

These lockdowns will have an impact on our fiscal fourth quarter.Demand remains strong in our end markets as we look into the fiscal fourth quarter.

Growth in client devices and data center devices and solutions should more than offset the decline in client solutions.By product category, flash revenue was $2.1 billion, up 12% sequentially and up 28% year-over-year. Flash ASPs were up 5% sequentially and bit shipments were up 7% sequentially.

As we look into the fiscal fourth quarter demand for our flash-based solutions remains strong, and we anticipate that flash prices will rise on a sequential basis.Hard drive revenue was $2.1 billion, down 12% sequentially and up 2% year-over-year.

On a sequential basis, the average price per hard drive increased 5% to $85, and exabyte shipments were down 6%.As we move on to cost and expenses, please note, all of my comments will be related to non-GAAP results unless stated otherwise with COVID-19 impacts detailed where appropriate.Gross margin for the third quarter was up two percentage points sequentially to 27.9%.

The start-up costs of our fab in Kitakami, K1, were $62 million and the COVID-19-related costs in the quarter were $13 million. For clarity, both items are included in the reported non-GAAP gross margin.

The COVID-19 costs were primarily related to reduced factory utilization and higher logistics and other costs.Our flash gross margin was 26.5%, up seven percentage points from last quarter due to a stronger pricing environment and cost reductions.

In the quarter, we began to ship production units out of K1.The hard drive gross margin declined to 29.3% from 30.8% in the prior quarter, mostly due to the COVID-19 impact and mix shifts.Operating expenses were $738 million, slightly lower than expected.

Other income and expense was $91 million, higher than expected due to unfavorable foreign exchange rate movements. The tax rate came in at 23.5% in the quarter, which was lower than our prior range of 25% to 27% for the full year.We now estimate our fiscal year 2020 tax rate to be between 24% and 25%. Earnings per share was $0.85.

Operating cash flow for the third quarter was $142 million, and free cash flow was $176 million. Our free cash flow was better than expected in a quarter that is usually seasonally low.

So far, in fiscal 2020, we have generated $847 million in free cash flow and expect to generate very good cash flow in the fourth quarter.Capital expenditures, which include the purchase of property, plant and equipment and activity related to flash ventures on our cash flow statement, were an inflow of $34 million due to the timing of funds flowing back and forth to the joint venture.

For the full fiscal year, we expect cash, capital expenditures to be an inflow of a couple hundred million dollars.Gross capital expenditures, which includes our portion of joint venture leasing and self-operating funding, is expected to be approximately $1.7 billion this fiscal year.

We are assessing our fiscal 2021 capital expenditures based on the current economic environment.Our liquidity position continues to be strong. At the end of the quarter, we had $2.9 billion in cash and cash equivalents, and our gross debt outstanding was $9.8 billion.

In the fiscal third quarter, we distributed $149 million in dividends to our shareholders and made an optional $150 million debt paydown. Fiscal year-to-date, we've lowered our debt by about $920 million.Our first priority for cash utilization is to reinvest in the business.

Since we are suspending our dividend, our second priority is repayment of debt. Our current plan is to reevaluate the dividend and other shareholder return policies, and our total debt is under $6 billion and our net debt is under $3 billion. Our goal through a cycle is to have a growth leverage in the range of one to 3.5 times EBITDA.

Our current debt-to-EBITDA leverage was 5.0 times in the third quarter.I want to make it clear, suspending the dividend is not related to our debt covenants. We have substantial room under our covenants.Moving on to non-GAAP guidance for the fiscal fourth quarter. We expect revenue to be in the range of $4.25 billion to $4.45 billion.

Gross margin is expected to be between 29% and 31%. This range includes approximately $65 million in costs associated with the K1 fab. We're also anticipating the impact of COVID-19.Operating expenses are expected to be between $740 million and $760 million. The midpoint of the guidance range assumes normal variable compensation expense.

Interest and other expense is expected to be between $75 million and $80 million. The tax rate should be between 24% and 25%. As a result of this detailed guidance, we expect earnings per share between $1 and $1.40, assuming approximately $302 million in fully diluted shares.

We're using a wider range this quarter, primarily due to the uncertainty in the environment.With that, we will now begin the Q&A session. Operator, we're ready for our first question..

Thank you. [Operator Instructions] Our first question will come from Aaron Rakers with Wells Fargo. Please go ahead..

It's Aaron Rakers from Wells. Maybe I'll start with just asking about it.

I think on Slide eight in the prior presentation, you guys gave some commentary around the outlook that you have for the flash business as far as industry supply bit growth, as well as your expectation, I think previously noting that you'd expected mid-30% growth on enterprise, high-capacity nearline drive shipments for the full year.And on the second point, can you just - it looks like you definitely kind of underperformed some of your peers on nearline.

Just if you could help us understand what you're seeing in that market relative to the performance we've seen out of your competitors?.

So the first question, I missed part of it, but it sounded like that was on aligning a supply and demand of bit growth in the second half of the year. So look, I mean, let me start out with what we're seeing right now. I mean, we saw good demand.

We saw, as Bob talked about, margins up this quarter.We're - next quarter was, as we expected and as we guided, margins up again. Obviously, as we get into the second half of the year, things get a little more difficult to really project.

I think we're looking at various different recovery scenarios and how we will invest in those, and we'll be prudent about how we do that.On the nearline side, I mean, look, we're happy with where the product performed. The 14-terabyte is still performing well. 18-terabyte shipped for revenue this quarter, as we talked about.

That we made that commitment, we delivered on that. The ramp is on schedule. We see great interest from that. There's no doubt we're in a little bit of a product transition in the industry, and that will play out over the next couple of quarters, but we're happy with where the portfolio is.

Bob, do you have anything to add?.

No, I think that's a good summary. I mean, we're ramping as planned..

Okay. And then, Bob, just as a quick follow-up, if I can. I know you mentioned that you've got an ample amount of room as far as your covenants. At 5 times debt-to-adjusted EBITDA, can you just remind us again what those covenants are? What the thresholds look like? I think it was a little bit lower than that.

So just refresh us again on the covenants and when maybe covenants change going forward?.

Yes. So the covenants are related to an adjusted EBITDA number that we use for compliance purposes. And so that the ratio is well below the five we show as a non-GAAP debt-to-EBITDA number. And we, as you saw, made progress in the quarter. Our gross leverage went from 5.7 to 5.0 this quarter. So we're definitely trending in the right direction.

And as I said, we have plenty of room under the covenant. We just haven't given a lot of specifics on the actual compliance covenant..

Okay, fair enough. That is it. Thanks..

Yeah..

Thank you. Our next question will come from Joe Moore with Morgan Stanley. Please go ahead..

Great. Thank you. If you could talk about the decision around the dividend, and we've highlighted this is something you should consider.

But I just curious how much of it is the current environment and the uncertainties around COVID-19 versus just coming in as a new CEO and wanting to get to these leverage targets before you start paying cash out?.

You know, like anything, I think it's a combination of a lot of things. But certainly, the current situation, bring some focus to the desire to deleverage a little faster. But the real issue - and of course, the real issue is I come into the business, and the company is really well positioned.

When I think - I talked about it in my remarks, when I think about the technology trends that are going on right now, I mean, it's happening in the cloud. Obviously, everybody knows that public cloud is a huge transition. We continue to see incredible growth, and we will. We can talk about that for a long time. We're very well positioned in that market.

We perform in the fourth quarter.

We'll see the hard drive market of the - the portfolio has been repositioned for that capacity - hard drive capacity enterprise market, and we'll see - actually see that market return to growth after several years of kind of decline and maybe going sideways a little bit.So we're very well indexed to what I think is one of the biggest technology trends we've seen in a very, very long time.

And as that continues, that's going to be good for our portfolio. And then we have the flash portfolio, which if you look at the edge, we have just new markets coming online all the time, where we've talked about gaming, and we see VR headsets, all kinds of things are going to drive demand in that side of the market as well.

So we're playing - the portfolio is very well positioned, and we have lots of opportunities to invest in the growth of the business. And when I think - when you put that all together, it was the right time to move on to a different model..

Great. And then as a follow-up. If you could assess the current environment, we see a fair amount of tightness, particularly on enterprise-grade NAND. How much of that do you think is just tight supply/demand of raw NAND versus tighter supply of PCB controllers, things like that? It seems like it's a combination of both.

Do you still think that the underlying NAND market is pretty healthy?.

Yes. We're still very bullish on the enterprise SSD market. And as you know, Joe, we've got goals to get up to 20% market share there. In the short term, you're right, it's a matter of balancing and making sure we've got the right controllers to go with the NAND for that market.

And so that's probably the controller side is more of a challenge than the NAND side, but we're very, very optimistic on that business..

Great. Thank you..

Thanks, Joe..

Thank you. Our next question will come from Karl Ackerman with Cowen. Please go ahead..

Hi, good afternoon and welcome to the team Dave. Two questions if I may..

Thanks, Karl..

Two questions, if I may.

I was hoping you could provide a little bit more clarity on when we should expect the volumes of your 16- and 18-terabyte drives to cross over your 14-terabyte drives? I can appreciate your conservatism given limited use of the second half, but should we actually see the 18-terabyte time line accelerate given robust data center demand?.

Karl, I think one of the things you're going to see from me is I'm going to really focus on forecasting one quarter at a time. So it's not going to happen next quarter, but you knew that. I think we're looking several quarters out, I guess, is what I'll say at this point.

I think - will it accelerate given the increased cloud demand we're seeing? We're seeing a lot of demand for that product already. I don't think it's going to accelerate one way or another based on if that demand - I mean, we're basically going to - we have the demand we need to ramp the product.

So we're looking forward to it being a great launch now, and the team is very focused on continuing to make supply available, but we're excited about the product..

Thanks. And as a follow-up, if I may.

Are you capacity constrained on nearline today? And in NAND, while it's probably difficult to ascertain what your customers' inventory levels are, has NAND inventory on your own balance sheet declined on a days basis in March? And any thoughts on how that could trend in the June quarter?.

Why don't you take the inventory question?.

Yes. I can start with the inventory question. So our inventories were up just slightly this quarter. I actually think in the next quarter, you'll see inventories coming down quite a bit because of some of the supply chain challenges. But I'd say everything seems to be an equilibrium in general..

Yes. I would say the same thing about the supply. Are we supply constrained? I think the balance is what we expected at this point, right? We continue to see strong demand there..

Thank you. Our next question will come from Sidney Ho with Deutsche Bank. Please go ahead..

Great. Thanks for taking my questions. So I have two questions. First one is on the gross margin guide being 29% to 31% on a GAAP basis, I know there is a number of moving parts there. I think, you talked about NAND prices going up.

Can you just help us build the bridge between where you were in fiscal Q3 where there's a bunch of expenses included? And how that gets to fiscal Q4?.

Yes. So Sidney, this is Bob. I'll take that. So the - actually, we probably have more absorption variance and cost headwinds in the fourth fiscal quarter than we had in the third. And we are trying to move prices up where we can in the market as a result of those incremental costs.

So it's absorption, it's logistics costs, it's other costs and making sure the environments are safe around the world. So it's actually a bigger challenge in the fourth quarter..

Okay. Maybe my follow-up question is, you lowered your gross cash CapEx to $1.7 billion from - I think last quarter, you said $2 billion to $2.5 billion. Just trying to figure out what has changed there in terms of the CapEx plans? I understand for next year, you guys are not ready to give a guidance.

But just maybe qualitatively or directionally, how are you thinking about tech migration, wafer capacity additions, those kind of things would be great? Thank you..

Yeah. So without talking too much about the specific number, as you know, this was always anticipated to be a low growth CapEx year for us. Because if you go back a year ago, we were reducing the amount of capacity we had. We actually took some off-line about a year ago, as you'll recall.

And then along with our partner, we had pushed out some of the CapEx expectations. So we'd always expected this to be a light year. And I still expect CapEx will be up next year. I'm not ready at this point to say how much that will be..

Thank you..

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

Yes. Thanks for taking my question. I want to go back to your hard disk drive. You spoke last few years. It seems like you and your competitor are skipping a node. Your competitor may have gained some market share in 16 terabyte, and now you are aggressively qualifying 18. And this has been a pattern for the past two years.

How should we think about this looking forward, especially as areal density is going to hit the ceiling? Is there any update on your strategy?And in that context, my follow-up question for David is, this is the first time that you have the mic, if you could please tell us how do you see the company moving forward? And what are the key strategies that you're employing? I understand that you've been on board for probably maybe one or two months, but both NAND and hard disk drives are very dynamic.

Things changes on a monthly, quarterly basis. To the extent that you can share with us your long-term vision and your strategy would be very helpful? Thank you..

Okay. So on the - thanks, Mehdi. On the first question, you're right, we are in a product transition, and we are excited about the 18-terabyte drive. I'm not yet an expert on hard drive areal density, but I've come up to speed on it relatively quickly.

I mean, you're right, it's getting harder and harder to drive more density but we have an enormous amount of R&D in this area. And we're going to invest aggressively to make sure we maintain our lead in areal density.And I think you'll hear more from us coming up about that.

There's lots of things going on as there always is and in R&D organizations, and that's been one of the things that has not been surprising to me when I came in, but it's great to see is just the depth of talent that's in the organization to drive the road map in that critical technology.And like I said - I mean, this is - when I look at the strategy of the company - I mean, we will have more to say about this in the future.

But when I look at this coming in, I think the company is very well positioned in the fact that it made the pivot to flash. And the way I look at the world is how it evolves as you've got this.We're in like almost - it's kind of almost cliché to say it about this unprecedented amount of technological change and always seems to be going faster.

But I mean, really, over the last number of years, the change that the cloud and the public cloud is driven and the amount of technological change its pushing on every industry and every company is just astounding. There's lots of reasons for that.

And many ways is democratizing the access to the most sophisticated technology, everybody can have it now through an API call. And that's just causing just a huge wave of investment and technological change and advancement for every company, every industry for all of us.Our portfolio is very well positioned to support.

We provide one of the key building blocks or fundamental elements of that digital world, storage. And I think in the cloud and our leadership in areal density, we are very, very highly correlated to that growth vector in the industry.

But not just that, it's also - on the flash side, you've got the edge and endpoints and what's happening there and they're becoming more sophisticated networks, which is something I'm pretty familiar with, giving my history.Networks are getting faster, that's enabling a lot more higher - much more capable end points to be interconnected, that's driving the flash side of the business.

We talked about this in the prepared remarks. Just look at the gaming market, all of a sudden becomes - opens up to this - there's a new market that just opens up to us. And there will be more and more of those happening.

And then these two things reinforce each other.The more innovation there is at the edge, on the endpoints, it drives more data, more data that needs to be stored, more data that needs to be processed, insights need to be derived from it. And that becomes kind of this virtuous cycle that happens.

And I think the company is very well positioned on both sides of that.So we'll have more to say on how we zero in on that. You're right, it is a very dynamic market. It's very sensitive to supply and demand changes, but the general trajectory is a good one. We're in a good market. It's always great to be in great TAMs that are growing.

As I said, even the hard drive business, which is - we've now - I say we, the team here has repositioned the portfolio around capacity enterprise, and you're seeing the growth now come back to that technology base, which is great to see.So look, I'll stop there. We'll have - I'll have more to say in the future.

But as I said, I'm super happy to be here. I think it's - I think what this company provides is incredibly fundamental and critical for the world that we're all going to, and we use every day. So - and we'll dial that even more - dial that in more as we go forward. So thanks for the question. I really appreciate it..

Thank you..

Thank you. Thank you. Our next question will come from C.J. Muse with Evercore. Please go ahead..

Yeah. Good afternoon. Thank you for taking the question. I guess first question on gross margins.

Can you repeat what the K1 charges are in the June quarter? And how you see that progressing through the rest of the calendar year? And then, can you also share with us what COVID expenses you're assuming? And I'm assuming, again, that's all mostly HDD related.

And is that something that we should be thinking about as we model out into the back half of the year?.

Yes. This is Bob. I'll take a cut at this, C.J. I believe I said the K1 costs were at $62 million in the current quarter and guided to around $65 million next quarter. I think that will be roughly the level through the rest of the calendar year, and then you should start to see it drop off pretty quickly next year as volume starts to ramp more.

So I think that's kind of the way we're seeing it right now.In terms of COVID-19, we aren't going to get specific in terms of the cost. As I mentioned, we'll have more absorption variances this quarter. We'll also have more logistics costs this quarter and a number of other costs. We're going to be able to partially offset that with pricing.

And our customers will share in some of that, but we're still net-net, going to have some headwind there for COVID-19. But I don't want to get too detailed on that because it's just too hard to tell how it will actually play out..

Sure. Very helpful. I guess my follow-up question.

How are you thinking about managing your bit inventory on the NAND side in terms of, clearly, some of the lack of visibility, uncertainty associated with COVID-19? And so I guess, would love to hear your thoughts on how you're managing the wafers? And as part of that, what kind of visibility do you have to the second half for cloud spending to be sustainable? Thanks so much..

Yes. So C.J., as you know, we're just guiding one quarter out right now. As you can imagine, probably like every company, we have multiple scenarios that we're evaluating. As I said, we think inventory is roughly in equilibrium right now. And we'll just have to take it one quarter at a time as we move forward.

So far, demand has held out pretty well for us, and we'll just have to see how that continues through the year. But I don't see major changes right now..

Thanks, C.J..

Thank you. Our next question comes from Toshiya Hari with Goldman Sachs. Please go ahead..

Good afternoon. And thank you for taking the questions. First one, again, on gross margins in the NAND business. Very nice expansion in the March quarter.

90 days ago, you guys talked about gross margins potentially being in the 35% to 40% range in the back half of the year.Again, I appreciate you guys aren't guiding for the full year, but is that still the right appropriate range? Or have things evolved given COVID-19 and its ramifications?.

So you got it right that we're going to stick to one quarter at a time. But I mean, they're going in the right direction. I mean, the fact - I mean, we - the forecast for next quarter is the forecast for next quarter. We feel good about where the demand is.

As Bob said, I think I mentioned it before as well, we're looking at all different kinds of scenarios for the second half of the year. And as we get more information, we'll make decisions about our investment portfolio to support that.So it's not surprising. I think everybody sees the same thing right now.

Visibility is a little bit difficult, but it's - we'll see how it goes week-by-week as we go through the quarter..

Understood. And then as a quick follow-up, kind of a follow-up question to Mehdi's question earlier. David, I appreciate you've only been around for a month plus here.

But I was hoping you could share maybe one or two things that you'd like to change or improve upon at the company? In response to Mehdi's question, I think you talked about being comfortable with the portfolio and having the confidence in sort of the growth profile of the company.But how about from an operational standpoint? Any one or two things that you hope to change or improve upon, I guess, as an add-on to that? If you had to pick one or two kind of financial metrics that you tend to focus on and prioritize, if you can kind of speak to those, that would be helpful, whether it'd be revenue or margins, EPS, cash flow? Thank you..

Yes, Toshi, I mean, I think it's - I appreciate the question. I guess I'll say in general, it's a difficult quarter to draw lots of long-term conclusions about much of anything right now. The - I will say, the operations team has just done an incredible job.

I mean, I've watched this play out now over the last seven weeks or so that I've been here.And we have a global footprint with factories and fabs all over the world, China, Japan, the Philippines, Malaysia, Thailand, here in the U.S.

And to see how all the best practices have been shared, and all of those have been kept open and functioning at some level and then increasing capabilities, working with our suppliers, I think that's a tremendous strength of the company.Again, I have more to say about that later.

But again, I think this - the past seven weeks is not a time where you want to look at anything and draw a really long-term conclusion given the dynamic situation we're in.As far as financial metrics, there is lots of good ones.

Clearly, gross margin is something we're going to be very focused on, making sure we're investing our resources in the places that can draw the highest return. That is obviously a very big focus and cash generation, quite honestly, and make sure we're managing for that. So those are two that are at the top of a whole long list..

Very helpful. Thank you..

Thank you. Our next question comes from Jim Suva with Citigroup. Please go ahead..

Hi, good afternoon. This is Mike Cadiz for Jim Suva at Citi. Gentlemen, would you mind giving us a little more color, please, on the current factory utilization levels? And secondly, an overview on the health of your component supply chain at this time? I appreciate it. Thank you..

Yes. I think that it's been improving week over week. And as it stands right now, we're in good shape. Obviously, it's an incredibly dynamic situation. I'll say that right from the start. I mean, every day, it changes.

And every day, of course, you get new information and make the best decision about how you're going to move forward, but the team has done a great job of that, kept things open the whole time.Literally, over the past two or three weeks, things have gotten significantly stronger, and it puts us in a position right now where I think we're - I don't want to use the term normal because I don't think anything is normal in the world right now, but we're operating at a level that - I mean, obviously, we're operating at a level that can support the forecast that we just put forward.So I feel really good about what the team has done and the position they've put us in around the world.

And we're staying super vigilant to make sure, one, that we implement best practices across all of our facilities.We are working from home at a significant level everywhere we can, and that's making the situation better. But the people that have to come in to keep the businesses running. And as you know, we are an essential business.

And everywhere we operate, that hasn't been an issue about getting any kind of authorization to operate, but making sure that the people that are in, the facilities are safe, and we've had good success there as well.Our supply chain, we've been working with our supply chain.

We've been helping out our supply chain to make sure they get the appropriate government release to continue to operate. We've been doing some diversification of that to fill some gaps and some non-regrets moves on that. But right now, the supply chain, again, it's the same thing as our own facilities.

It's - week by week, it's gotten better to a point where right now we feel like we're in a relatively strong position..

Yes. I mean, where all vendors producing at this point, and that could change when everybody's producing it..

Thank you. Our next question comes from Mitch Steves with RBC Capital Markets. Please go ahead..

Hi, guys. Thanks for taking my questions. I had two couple of small ones, I guess. So the first one just regard to the dividend and kind of cancellation there.

So what type of leverage metric are you guys trying to get to? Or is there any sort of way to think about when it will be reinstated in terms of a financial metric?And then secondly, just given the supply chain disruptions of what we're seeing in economic wide disruptions, what's the new view in terms of what you guys believe smartphone units will look like out, call it, 12 to 24 months, whatever time frame you want to use?.

All right. Mitch, it's Bob. I'll start. One of the things we've done is we've studied the capital structure quite a bit. And what we've concluded is, obviously, it's a cyclical business. We want to have a growth leverage that works for us through the cycle.

We're expecting, as we bring our debt levels down, that we'll manage to anywhere from one to 3.5 times EBITDA depending on where we are in the cycle. And as I mentioned, the goal is to get our gross debt down to about $6 billion and our net debt to $3 billion. And yes, I don't know if you want to take..

First of all, hey, Mitch. How are you doing? Thanks for the question. I don't think we forecast smartphone units. I mean, again, the second half and what's going to happen. We're going to take it quarter-by-quarter at this point.

We - obviously, we feel good about our guide for the next quarter and what we see on the supply and demand side to have a lot of confidence in that. And we'll have more to say about the second half next quarter..

Yes. The thing I would add, as you recall, Mitch, I mean, we're under-indexed to the mobile phone market. So we're not trying to forecast it, and we're not as exposed to it as some of our customers - I'm sorry, some of our competitors..

Understood. Thanks..

Thanks, Mitch..

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

Thanks. Good afternoon. I just had a question on the retail channel. You mentioned there's - obviously, there's a pretty big disruption in the channel right now.

Can you talk about, one, how it impacted the guidance for the current quarter?And then secondly, when we think about sort of those brands, which are pretty strong in retail league, Western Digital and the old SanDisk products, you're sort of focus on those longer-term given that you could probably redeploy those bits and heads and media into more profitable areas? Thank you..

So I think as we talked about for the fourth quarter, we expect some headwinds in that business. I think it's typically a seasonally weak quarter anyway. And obviously, with stores not being open, it makes it a lot tougher. Last quarter, as we talked about towards the end of the quarter, we obviously saw a deterioration as stores were closed.

And we also saw the mix shift to lower-margin products as well.We've got that all factored into the guide. I mean - again, we're very comfortable with the guide. The guide is a guide.

And so we've got all the dynamics that we expect to happen in the retail channel baked into those numbers.Longer term, again, we'll have more to say about longer-term strategy. But I think it's a great strength of the company, those brands. I think it's an area where we can drive differentiation and we can drive margin in those channels as well.

They're not just - it's not just all low-margin business.So I feel good about that capability. And honestly, it's one of the things that attracted me to the company. So we'll - again, we'll have more to say about what the long-term strategy is there, but I think it's definitely an asset..

Great. Thank you very much. Good luck going forward..

Thank you, Steve..

Thank you. Our next question will come from Srini Pajjuri with SMBC Nikko Securities. Please go ahead..

Thank you. Good afternoon, guys. Dave, I guess, I'm trying to understand the current demand is sustainable, I guess, into the second half. I guess we are all trying to do that at this point.

But what I'm trying to get at is that you guys tend to have pretty good visibility on the hyperscale cloud side given your design cycles.I just want to hear your thoughts as to what your customers are saying about the second half? And what sort of design activity on the drive side you're seeing? Any thoughts would be helpful?.

Yes. Again, I always couch everything we're going to guide one quarter at a time, but it's a fair question. I mean, we - I guess the only thing we can say is we continue to see strong demand from the big cloud vendors, cloud suppliers.

There's always a question, are they building inventory, are they buying ahead, the old consumption digestion kind of thing. Everything we see is there's strong demand for what their products are. I think they're saying the same thing.

Not saying anything new there.How long it lasts? I mean, what I talked about in the intro of - in my prepared remarks, I mean, I think this world that we're all living in because of COVID-19, where there's just a lot more work at home, learn at home, there's just a lot more dependence on cloud and endpoint technology, I think that architecture has been set for some time now, and it's impacting every business.

We've seen a massive acceleration to that, unfortunately, because of a global pandemic.The question is how much - is that going to continue to stay as it starts to subside? I don't - obviously, there'll be some variability in that given that there's so many people at home now.

But like I said, I think the model is set, and I think it's how fast we're going to get there. I don't think there's a question on is it the right destination? So we'll see as we move into the second half.Our conversations with all those customers continue to be fantastic, you're right.

One of the things that's been great as I've come into this company, is just to understand the depth of our relationship and the strength of our footprint and those customers is extremely impressive.And so we're going to stay very close to them and continue to work with them as they build out their infrastructure.

But right now, I don't think - we don't have any sign that - well, I think what we're seeing is the increased demand and nothing tells us that it's nothing but real demand. And how far it extends into the second half, we'll see as we get more visibility..

Helpful. Thank you. And then, Bob, I guess, as you try to improve the free cash flow going forward, a couple of line items, I want to hear your thoughts on. First, on the OpEx. And then the other thing I noticed is that you've been paying a fairly high tax rate, relatively speaking, at least on a non-GAAP basis compared to your semi peers.

I'm just curious as to why that is? And when do you expect that to come down? Thank you..

Yes. So two good questions. OpEx, I think the best assumption is it will be around the levels we guided to this quarter for the next few quarters anyway.On the tax rate, the dilemma is we have a fantastic structure when we're making more money than we are right now.

And so right now, when our profitability levels are relatively low, we have certain minimum taxes we have to pay around the world and it makes our tax rate quite high. So it will come down as the overall profitability starts to come up..

All right. Thank you..

Thank you. [Operator Instructions] Our next question comes from Harlan Sur with JPMorgan. Please go ahead..

Good afternoon. Thanks for taking my question. It looks like the team saw continued strong growth in the ramp of your new enterprise SSD platforms. I know you guys are targeting 20% market share.

But based on your shipments in the March quarter and assumption on industry shipments, did you guys actually achieve double-digit percentage market share in the March quarter?.

Yes. I'd say the share was fairly flat. That market is growing quite a bit. So we're - as I mentioned earlier, we're a bit constrained on controllers right now, but the demand is definitely there..

Okay. Great. And then on the COVID-19 operational issues, team, maybe just give us a bit more color on where these are coming from? I know that you guys - there are shelter-in-place and movement control in the Bay Area, Philippines, Thailand, Malaysia, all of the areas where you guys have a footprint of operations.

Any geographies, which are creating more of a pressure point from an operational or a logistics perspective? Thank you..

I don't really want to call out any one area over another because it -one, it changes quite a bit based on local situations. But obviously, if - there's a couple of different categories things fall in to. First is logistics. It's gotten more expensive to get to move stuff around. A lot of stuff went on domestic flight.

So there's a lot or passenger flights. There's a lot fewer of those. So those costs are going up.

Just the general number of places that are open and how difficult it is to move things around is a big category of cost.And then in places where we maybe do have a little bit of under - we can't run at full capacity, although that's getting to be less and less of an issue over the last couple of weeks there's some absorption costs that Bob talked about.

And then there's some just general costs of just increased cleaning and those kinds of things. But those are relatively minor based on the other two.

I don't know, Bob, anything else come to mind?.

No, I think that's right. I mean, I think certainly, May will be better than April, and I think June will be even a little better than May..

Yes. It really has been a week over week. It's gotten much better..

Thank you..

Thank you. Our next question will come from Tristan Gerra with Baird. Please go ahead..

Hi, good afternoon. We've been reading recently about HDD pricing going up to match higher logistical costs.

What's your sense of pricing in HDD going forward? And will the supply disruption create potentially an environment where pricing could be favorable for the next few quarters?.

Oh, I don't know about for the next few quarters. But we have been somewhat successful in moving pricing to cover some of the increased costs. I think that's what our focus is on anything around pricing in the industry. But we're not looking at it.

We're looking at it in the sense of what it takes to cover the increased costs that we have in the business. And we have a good idea what those are going to be for next quarter. And when we get there, we'll figure out what's going to happen in that.

Bob, anything to add to that?.

No, I agree..

Okay. Great. And then just a quick follow-up. You've talked a lot about supply chain disruptions, but - and how this has improved recently.

But is there a quantification that you could put into maybe a percentage of output that's currently for this current quarter going to be impacted by those disruptions? I know that you've talked about your expectation for inventory levels to come down.

Just trying to put things together in terms of whether there is still a meaningful impact - material impact on the supply coming from those disruptions this quarter?.

Yes. I don't want to put a specific number on it because the potential - it's a very - as I said - said several times, a very dynamic environment. I would say that we have confidence in the supply - what the supply that's going to be produced to support the guide for the next quarter. We have a lot of confidence in that.

But it could - things change every day. But I said the trend has been going - it's been getting better and better to where it's given us the confidence to put the guide in place that we have..

Great. Thank you..

Thank you. The last question comes from Weston Twigg with KeyBanc Capital before we end with a short statement by our CEO. Please go ahead..

Hi. Thank you for taking my question. I had a couple of quick ones. First, I was just wondering if you had a chance to look at the recent commerce rule change regarding company military exposure in China, Russia and Venezuela. I think specifically in China, you had previously said you have 20% to 25% exposure.

And I'm wondering if you had a chance to think about how much of that might fall under the new definition under this rule?.

We've had a chance to take a quick look at it. And we don't believe it will have a material impact on our business. But obviously, we're going to monitor it very, very closely..

That makes sense. That's helpful. And then the other question I had was just on notebooks. It's been a big driver of near-term revenue.

Can you talk about the density trends in notebooks in the back half of the year if that might be - I don't know if it's stable or going up or not, but if that might be an offset if units are down?.

Yes. Again, we're going to stick to talking about things for next quarter. I don't have anything in particularly insightful to say about density trends and notebooks at this point. Bob, I don't know if you do..

Yes. No, I don't. I mean, obviously, it's come up over the last year, but I think as we go forward, we don't really know..

We can follow-up with you with some more details..

All right. Sounds good. Thank you..

Thank you, Weston..

All right. Thank all of you for joining us here today. We look forward to seeing you virtually at the upcoming JPMorgan and Bank of America conferences. Enjoy the rest of your day. Thank you..

Yes. Thanks, everyone..

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