Western Digital Corp

NASDAQ:WDC

Earnings Call Transcript 2019-Q3

[Operator]

Good afternoon, and thank you for standing by. Welcome to Western Digital's Third Quarter of Fiscal 2019 Conference Call. [Operator Instructions] Now, I'd like to turn the call over to Mr. Peter Andrew. You may begin.

[Peter Andrew, VP IR]

Thank you and good afternoon. Before I begin, let me remind everyone that today's discussion contains forward looking statements including business plans trends and 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 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 will now turn the call over to Steve Milligan, our CEO.

[Stephen Milligan, CEO]

Thank you Peter, and good afternoon everyone. With me today are Mike Cordano, President and Chief Operating Officer and Mark Long, Chief Financial Officer. Also with us today is Robert Eulau, newly appointed Executive Vice President and Chief Financial Officer, who will formally take over the CFO role from Mark Long on May 9, 2019. Bob has more than 30 years' experience in various financial and operational leadership roles in the technology industry. And I'm pleased to welcome him to the Western Digital Team.

[Robert Eulau, EVP & CFO]

Thanks, Steve. I'm excited to be part of the Western Digital Team and I look forward to working with all of our investors and analysts in the future.

[Stephen Milligan, CEO]

Turning to our business, market conditions have generally been consistent with our expectations described in January. That being said, we are encouraged to see demand incrementally improve in certain areas such as capacity enterprise and client compute. Our expectation for the demand environment to further improve for both flash and hard drive products for the balance of calendar 2019 is largely unchanged. And looking at the quarter from a product perspective, sales of hard drives were a bit stronger than expected. Higher demand for capacity enterprise products drove most of the upside and we saw a nice rebound at higher capacity points. We are experiencing a very smooth product ramp with our 14TB product. In addition, we also realized a significant expansion of our presence in the mid-range. Demand for flash-based products was slightly better than expectations; however, prices declined more than we anticipated.

We are executing well on the plans we laid out last quarter, in terms of enhancing our product lineup, driving technology advancements, rightsizing our factory production levels, and lowering our cost and expense structures. We continue to make excellent progress toward commercializing our internally developed NVMe based platforms. I'm pleased to report the commencement of initial revenue shipments of our enterprise NVMe SSD and we are on track to accelerate the volume ramp of this product over the remainder of calendar 2019.

We also commence shipments of our NVMe client SSDs based on 96-layer, 3D flash, BiCS4 technology. The manufacturing ramp and commercialization of BiCS4, which we believe is the industry's lowest cost technology is progressing well. In the second half of calendar 2019, BiCS4 will become our highest volume runner in terms of flash output. In HDDs, we continue to lead the industry in aerial density through technologies such as SMR and energy-assisted recording and are on track to ship our first energy-assisted capacity enterprise drives later this year. From a flash supply perspective, we are continuing our previously announced wafer output reductions without compromising our cost leadership position. We made substantial progress on realigning our cost and expense structure. The Kuala Lumpur manufacturing facility has largely ceased operations and combined with other actions we are already realizing incremental cost savings.

Our focus is on driving long-term value creation for Western Digital and its stakeholders, while prudently navigating near business conditions. Emerging technologies such as 5G open up new applications and use cases creating immense amounts of data. Further, applications such as artificial intelligence, machine learning, autonomous vehicles, mobility and IoT will continue to generate growing data volumes that need to be captured, preserved, accessed and transformed.

The relentless pace of innovation bodes well for the long-term growth in the data storage requirements and the resulting opportunities for our company. I want to thank the Western Digital Team and our partners for their ongoing support. I would also like to thank Mark Long for his service to Western Digital. Mark has been instrumental in the transformation of the company and I wish him the very best in his future endeavors.

With that, Mike will now share our business highlights.

[Michael Cordano, President & COO]

Thank you, Steve and good afternoon. Starting with our highlights for the March quarter, within Data Center Devices and Solutions, our capacity enterprise drive category performed better than expected with demand strengthening as we move through the quarter.

For the first half of calendar 2019, we now expect total exabyte shipments in capacity enterprise to be flat to slightly up on a year-over-year basis. Additionally, if current demand trends continue, we see an opportunity for the category to reach 30% year-over-year growth in exabytes for calendar year 2019 .This updated industry forecast is a significant upward revision from our prior estimate that was in the low 20% range.

Our 14TB capacity enterprise drive qualification and adoption have been seamless and we are leading the industry in this transition. We are in the midst of a significant ramp of this product in the current quarter. We are on track to introduce our first energy assisted 16TB CMR and 18TB SMR hard drives later this calendar year. Compared to competitive solutions, our new products will be cost optimized offerings containing fewer disks and heads showcasing our significant aerial density advantage. Our refreshed product line in the mid-range capacities also did very well and in total, we have meaningfully increased our presence in the capacity enterprise category.

Just a few weeks ago, we were delighted to hear that the Western Digital storage solutions played a key role in unveiling of the first ever image of a super massive black hole. The event horizon telescope project utilized our high capacity helium drives, which performed reliably in harsh, high altitude, and remote environments. This unique event, highlights the fundamental role we play in the capture and transformation of data. In enterprise SSDs, NVMe product qualifications at hyperscale customers are progressing to plan. This product built on our internally developed controller and firmware, complements our other enterprise SSD solutions that are already shipping. Consistent with the platform approach we discussed last quarter, we expect to expand our enterprise SSD product portfolio throughout 2019 in a cost effective and predictable manner, including a version that incorporates BiCS4.

In Client Devices, demand for hard drives for the PC market was slightly better than our expectations. In client SSDs, our exabyte shipments more than doubled from a year ago quarter driven by strong price elasticity. Additionally, we've begun shipping our mainstream client SSD products based on BiCS4 technology. In client solutions, we are very pleased with the success of our external SSDs sold through retail and we have continued to expand our presence in this category over the last several quarters. In the March quarter, we also launched the world's fastest 1TB microSD card, establishing an industry first in the removal products category. Average capacity per unit for flash devices grew 44% year-over-year, reflecting significant price elasticity. From a flash supply perspective, we remain on track to achieve an overall reduction of 10% to 15% of our bit output in calendar year 2019.

Despite seasonal softness in the March quarter, our flash inventory level was essentially unchanged from the prior quarter. As we look to our fourth fiscal quarter, we expect to see a full quarter impact from our reduction in wafer starts, which will help to further reduce our flash inventory levels. This combination of stabilized inventory and lower supply growth in flash will allow us to be more selective in how we pursue flash revenue opportunities going forward. In terms of longer term planning for flash, the construction of the building showing what a Japan is on track with meaningful output from this fab expected in fiscal 2021. Based on this schedule and the planned slowdown in our capital deployments, we expect lower flash related capital spending for fiscal 2020 of our 96-layer based products continues as expected, we are pleased to be shipping the industry's leading technology into retail products and client SSDs.

In the June quarter, we estimate BiCS4 to represent more than 25% of our total shippable flash bits. We are on track to implement BiCS4 across our portfolio including mobile embedded and enterprise later this calendar year. As Steve mentioned earlier, we have largely stopped production activities at the KL facility. We have also consolidated our head manufacturing operations from Thailand to the Philippines. These continuing actions are allowing us to lower our cost structure and rightsize our manufacturing footprint to meet long-term demand.

Turning to our outlook, we see a few additional data points indicating incremental improvement in current demand conditions compared to a very tough fourth calendar quarter. Flash pricing conditions remain challenging, but we anticipate the rate of price decline will moderate as the year progresses due to a slowing rate of industry supply growth, elasticity driving demand for higher capacity points, and seasonal strength in the back half of the calendar year. Based on recent industry announcements, we estimate flash industry supply growth to be slightly more than 30% in calendar 2019, somewhat lower from our prior forecast.

To summarize, our current product portfolio is the best in our history. In HDDs, the migration to higher capacity drives plays to our strength in technology and manufacturing. In Flash, our product portfolio in 2019 has been significantly enhanced with the expansion of our NVMe product line for both client and enterprise SSDs and we continue to have brand leadership in retail. We are taking appropriate steps in a challenging market environment to position ourselves for ongoing success.

I will now turn the call over to Mark, for the financial discussion.

[Mark Long, CFO]

Thank you, Mike and good afternoon everyone. Revenue in the March quarter was $3.7 billion, in the middle of our guidance range. Flash revenue was $1.6 billion with a sequential bit decline of 5% and a sequential average selling price per gigabyte decline of 23%. The sequential decline in Flash revenue was primarily due to price, seasonality, and weaker sales of embedded mobile products. Our Drive revenue was $2.1 billion, which was similar to the prior quarter.

Non-GAAP gross margin in the quarter was 25.3%, below our guidance of approximately 28% due to a $110 million charge or 300 basis point impact incurred for lower of cost or market LCM reserves. Flash non-GAAP gross margin was 21% due to the rate of price productions and the aforementioned $110 million LCM charge, primarily related to an inventory write down of multi-chip packages that contain DRAM. Hard drive gross margin on a non-GAAP basis rose to 29% compared to the prior quarter driven by an increased mix of capacity enterprise drives, excluded from the non-GAAP cost of revenue is a $148 million charge related to the under-utilization of our portion of the flash joint venture fans. Non-GAAP operating expenses were $742 million; the lower guidance as a result of better progress towards our expense reduction targets.

As a reminder, for non-GAAP cost of goods sold, we expect the full benefit of our $100 million per quarter cost reduction efforts to be reflected by the end of the December quarter of 2019. And for non-GAAP operating expenses, we expect to see the full results of our $100 million per quarter expense reduction efforts to be reflected within the September quarter of 2019.

Our non-GAAP tax expense was $49 million, which was higher than estimated due to a quarterly effective tax rate true-up, and the fact that our tax expense is a relatively fixed dollar amount at this profitability level. Non-GAAP EPS was $0.17. The LCM charge impacted and diluted non-GAAP EPS by approximately $0.37. Operating cash flow for the March quarter was $204 million and free cash flow was a negative $110 million, primarily due to lower operating income. In the March quarter, we paid $146 million in dividends to shareholders. At quarter end, we had $3.8 billion in cash, cash equivalents, and available for sale securities and our principal debt outstanding was $10.8 billion. Earlier today, we announced the successful execution of an amendment to the existing financial covenants under our credit agreements. The amendment provides Western Digital with significant additional financial flexibility to navigate market cycles.

Turning to inventory, on a dollar basis, hard drive inventory decreased and flash inventory was essentially unchanged from the prior quarter after the impact of the LCM reserves. Looking into the June quarter, we expect of flash and HDD inventory to decline on a sequential basis.

I will now provide our guidance for the fourth fiscal quarter of 2019 on a non-GAAP basis. We expect revenue in the range of $3.6 to $3.8 billion, gross margin of approximately 24% to 25%, operating expenses between $720 million and $740 million, interest and other expense of approximately $100 million, tax expense between $20 million and $30 million, diluted shares of approximately $295 million. As a result, we expect non-GAAP earnings per share of $0.10 to $0.30. Finally, for modeling purposes, please note that the September 2019 quarter will have 14 weeks instead of the normal 13 weeks.

In closing before I turn the call to the operator for the Q&A, I would like to thank Steve, Mike, and the entire Western Digital Team for the opportunity to serve as the Company's CFO. It's been a great experience working with all of you. With that, operator, please begin the Q&A session.

[Operator]

Ladies and gentlemen, we will now begin the question-and-answer portion of the today's call. [Operator Instructions] And our first question comes from Wamsi Mohan with Bank of America.

[Wamsi Mohan, Bank of America]

Steve or Mark, this amendment to the credit facility is prudent, but would you say this is just preemptive versus your expectations of EBITDA and free cash flow generation over the next few quarters, has that changed in a material fashion?

[Mark Long, CFO]

Yes. We took the opportunity to amend our credit agreements because the markets were favorable and this does give us a significant amount of additional flexibility and we were able to do it with very low cost.

[Wamsi Mohan, Bank of America]

And do you expect -- your expectation of just sort of the EBITDA generation as you look over the next few quarters? How would you care to price that?

[Mark Long, CFO]

This was not in response to any near-term concerns. This was just a prudent move that gives us good long-term flexibility.

[Wamsi Mohan, Bank of America]

And if I could really quick, Steve you mentioned demand trends were largely unchanged. Could you just talk about sort of what has changed in that capacity enterprise uptake? What -- where do you think that is coming from a customer base standpoint and maybe even regionally if there are some color there? Thank you.

[Stephen Milligan, CEO]

Sure. I will have Mike comment on it I mean -- provide a little bit more detail on capacity enterprise, but as I indicated capacity enterprise was a bit stronger than what we expected, which we were very pleased to see that. Client compute as you will know, PC volumes continued to decline, but they declined at a more moderate rate than what at least we were expecting, one area of a bit of weakness from a demand perspective, which I think is largely known in the investment community is handset volumes were a bit lower than expected, so we did see a little bit of draw down as a result of that, but Mike can comment a little bit more on the capacity enterprise upside that we saw.

[Michael Cordano, President & COO]

Yes. Wamsi, I think capacity enterprise it was fairly broad-based. At the highest capacity, I think it would be viewed as sort of domestic hyperscale providers. We saw strength of demand both in our 12TB and 14TB products and then in a mid-range, we saw strength in Asia. So, we saw a fairly broad based strength across the capacity enterprise gateway.

[Operator]

Thank you. And our next question comes from the line of Aaron Rakers with Wells Fargo.

[Aaron Rakers, Wells Fargo]

Thanks for taking the questions. Two, if I can real quick. So, first of all -- just kind of thinking about how you rolled up to the guidance number that you've given, particularly around gross margin. Can you help us understand assuming that the Kuala Lumpur facility closure kind of keeps a positive trend on gross margin and also coupled with the commentary of the demand for the high capacity drives. If we were to assume hard disk drive gross margin kind of stays flattish here, it would appear like your flash gross margin looks to be maybe in that 17%, 18%, 19% range. So for first of all, am I kind of thinking about your guidance in the context of flash gross margin correctly and underneath that what assumptions are you making in terms of pricing and kind of cost down discussion as we go into the June quarter?

[Stephen Milligan, CEO]

So, I'll give some overall comment Aaron and then either Mike or Mark can add a little bit more specifics. One of the things that I will highlight if you go back particularly to fiscal Q2 our gross margin levels for the hard drive business had gotten kind of below what we normally expect at 27% I believe is the number. We saw a nice rebound this quarter as we begin to see some of those cost improvements that you noted as well as a better mix in terms of capacity enterprise. We would expect that that would continue and will continue -- and we'll work our way back up into a, let's call it, a more normalized gross margin level in the hard drive space, which clearly implies that given that we're guiding essentially the flat gross margins that we'll continue to see a downdraft in terms of flash gross margins in the current quarter as we see cost -- price pressures continue.

As Mike indicated in his commentary, we expect although of course we don't know for sure that that price decline will moderate as we move through the calendar year. So, it'll take a little bit of time for that to get into a more acceptable range of price declines. So, I don't know if that helps a bit Aaron in terms of high level commentary.

[Michael Cordano, President & COO]

Yes. The other thing I'll add Aaron is on the flash cost declines. We've kind of talked about being at the low end of long-term range at 15%-ish. So, you'll have to think about it that way on an annualized basis.

[Aaron Rakers, Wells Fargo]

And then just a real quick follow-up if I can, if I think about how you kind of consider a longer term gross margin what -- as we kind of get back to a more normalized trend in the product portfolio kicks in, what do you guys think is a good way to think about what you would consider as a normalized gross margin in the flash business. And I'll end it at that. Thank you.

[Stephen Milligan, CEO]

Talking about the margin range, I think is...

[Mark Long, CFO]

Yes. I mean, I think on an overall basis we are not changing our long-term model at this point. So, we just need to see the industry work off the inventory and the price declines to moderate as we've talked about and then as flash normalizes and Steve talked about the improvements in the hard drive gross margins through the back half, we -- we should see the kinds of dynamics we talked about at the last Investor Day.

[Stephen Milligan, CEO]

Yes. And to put a finer point on it Aaron, if you just look at our model that's high 30's, low 40's for Flash.

[Aaron Rakers, Wells Fargo]

So you think you can get there in the back half of the calendar year?

[Stephen Milligan, CEO]

We're not saying that Aaron.

[Aaron Rakers, Wells Fargo]

Okay.

[Mark Long, CFO]

No. We're talking about the long-term model. You said in the long-term, yes.

[Operator]

Thank you. And our next question comes from the line of Karl Ackerman with Cowen.

[Karl Ackerman, Cowen & Co.]

Hi, good afternoon everyone. I just want to go back to margins, if I could for a second so your margins in there would suggest that you're losing money on an operating level, but how much of your margin decline was due to the near-term costs ramp -- of ramping BiCS4 and your NVMe SSD that may reverse as volumes ramp for the balance of 2019? And secondarily to that, I think you initially announced total underutilization cost would be $250 million to $300 million, we've got probably another $75 million to go and so may you remind us, how much of the $400 million annualized benefit in COGS from your restructuring actions will be realized in June and then taking those two as a whole, how do we think about the margin trajectory at least qualitatively for the second half in that? Thank you.

[Michael Cordano, President & COO]

I'll talk to sort of flash cost downs and given the ramp of BiCS4, I just talked about the annualized rate that is more back half loaded, so we see a shallower cost decline in the first half more to come in the back half and Mark you want to.

[Mark Long, CFO]

Well, I think you are exactly right in terms of our underutilization charge with the majority of it occurring in the prior quarter and through this quarter. So, we haven't given a breakdown in terms of the amount of our Kuala Lumpur shutdown benefit that we're receiving in the Q4. But as we said, we will be getting that full $400 million a year of cost benefit exiting calendar Q4 this year.

[Stephen Milligan, CEO]

Yes. The other thing I'll comment on relative to our ability to navigate the market, our inventory position that we discussed being sort of more in check and improving sequentially allows us to be more selective and when we talk about selectivity, that's -- think about it as quality of the business which would be profitability via principle measurement and all that.

[Michael Cordano, President & COO]

Yes. I mean if you look at -- I'll provide a little bit of additional commentary, which will be largely consistent with what I talked about at the last earnings call is that you know as we move through the balance of the calendar year. One, starting from a top line perspective, we expect our top line to improve at a meaningful rate as we see demand pick up, capacity enterprise as well as seasonal pickup in demand from both a flash and from a hard drive perspective. That will allow us -- obviously we'll have higher revenue. We will also have more of the benefit of the cost and expense reductions, as we particularly move into the September quarter or then in December. And so, that will allow us to see some lift in terms of our earnings, as we move through the back half of the year. The big question which is the question that you're trying to get at is what is our margin level going to look like?

Let me provide a little bit more color on that, in the sense that we continue to expect that our hard drive margins will improve as we move through the balance of the calendar year. Flash becomes the wildcard, now I said this last call and I'm going to say it again because it really is the same answer. What are we assuming? We're assuming that we're going to continue to see pressure in terms of our flash gross margins as we move through the balance of the calendar year. And the reason that we're doing that principally is that, we want to plan for the worst and if you want to call it hope for the best. Now, we don't know exactly what's going to happen to Flash gross margins because a lot of that is dependent upon other factors that are outside of our control. What do our competitors do, production levels, demand levels, and all that.

So, we don't know exactly how it's going to play out, but from our standpoint it is safest to assume that we're going to continue to see our Flash gross margins remain under some degree of pressure as we move through the calendar year, albeit maybe at a moderating level from a pricing perspective as we move through to the back half of the year.

[Karl Ackerman, Cowen & Co.]

If I may, just ask more of a question on the hard drive business. Steve or Mike, would you endorse that part of the reason why near line demand has been soft at least for the last two quarters, maybe due to a push out in storage raise until these higher capacity near-line drive progressed through qualification? And secondarily, I'd appreciate hearing from your thoughts on how you view the competitive landscape changing if at all from your line draws as the industry provider's offer slightly different near line technologies in the back half? Thank you.

[Stephen Milligan, CEO]

So, I think the principle driver of growth was actually broader inventory levels within the broad based hyperscale levels. So, yes I think there is some modest waiting for the next capacity point that played, let's call it, a secondary role, but the primary role for calendar Q4 and the drop we saw was really inventory levels in them and our customers making an inventory correction. Relative to sort of competitiveness in the back half of the year, I talked about that. I think there is multiple approaches, we're quite comfortable with our approach, it gets there at the next viable capacity point with less heads and disks, which will give us a cost advantage vis-à-vis our competition. So, that's the application of our leading technology in a way that gives us an advantage though, from our standpoint we've talked about energy assist being important to us.

As a technology enabler, we continue to be confident that it will give us the benefits we expect and we'll see that in the next generation of products.

[Operator]

Thank you. And our next question comes from the line of Mark Delaney with Goldman Sachs.

[Mark Delaney, Goldman Sachs]

Good afternoon and thanks for taking the questions. The first question was on the NAND underutilization expenses and if somebody can be a bit more explicit about whether or not you still expect to be taking underutilization in the second half of the calendar year. And then related to that topic, my second question was, asking both now, whatever point those underutilization expenses do stop getting excluded. Where do you think you'll fall within that 15% to 25% annual cost per bit target that the company has for NAND cost downs. Thank you.

[Mark Long, CFO]

Okay. Well, in terms of the underutilization charge as you heard me say earlier, the majority of that will be taken and reflected in the first half of this calendar year. And then a very small portion is left for the remainder as it -- and that is the full extent of our current plan for utilizing the [indiscernible] as relates standing changes to that, Mike.

[Michael Cordano, President & COO]

Yes. Relative to any changes as you would expect, we'll continue to monitor market conditions. But at this point, no additional plans beyond what we've already announced. And then relative to sort of the cost implication once, of course we're through that period that's reflected in our estimate of around 15% annualized cost down.

[Operator]

Thank you. And our next question comes from the line of Mehdi Hosseini with SIG.

[Mehdi Hosseini, SIG]

Two follow-ups; Mike, you said near line exabyte growth of 30% 19 versus 18. Is that for Western Digital or is that the industry guide?

[Michael Cordano, President & COO]

Yes. Mehdi, we think that's an industry opportunity and obviously we would hope to do a bit better than that.

[Mehdi Hosseini, SIG]

And then, in regards to the NAND bit shipment growth of low 30%. What is your expectation for NAND production bit growth?

[Michael Cordano, President & COO]

That is production bit growth, not demand.

[Mehdi Hosseini, SIG]

I see.

[Michael Cordano, President & COO]

Supply growth.

[Mehdi Hosseini, SIG]

Supply growth, okay. And then, given your comment on inventory declining for both NAND and HDD into the June quarter, should we assume that days of inventory has finally peaked and is going to decline, looking-forward?

[Michael Cordano, President & COO]

We would expect days of inventory be roughly in the same range for Q4 and then to decline and begin to normalize in the backup.

[Operator]

Thank you. And our next question comes from the line of Munjal Shah with UBS.

[Munjal Shah, UBS]

I had one on capacity enterprise. You saw better demand this quarter. Have you seen any indications that the demand for second half could be stronger than what you initially thought, or do you see a risk that we can run into a similar situation as last year, where first half is stronger, and then that can have could be softer?

[Michael Cordano, President & COO]

No. Our view and the reason we commented on our expectations for calendar year growth is that we'll see some additional strength in the first half and we believe the second half will remain strong, so that drove our update in our forecast from the low 20's year-on-year total bit growth to approximately 30% year-on-your bit growth.

[Operator]

Thank you. And our next question comes from the line of C.J. Muse with Evercore.

[C.J. Muse, Evercore]

I guess I was hoping first question to focus on gross margins. I believe before you were thinking that you would take the cash charges most heavily in the March quarter and to be more bell shaped and now it appears like June quarter based on your guide is similar at a roughly $185 million and you're now taking further utilization plan charges into the back half of '19. So could you share with us.

[Mark Long, CFO]

So let's clarify that C.J. -- let's clarify so our underutilization charge, the largest portion was in the March quarter. Then we are expecting between $55 million and $75 million in the June quarter and then that will account for virtually all of the -- there'll be just a very small amount that will go beyond the June quarter.

[Michael Cordano, President & COO]

Yes. C.J. just to reiterate, we have not modified our production plan at all from the original announcement; so hence what Mark just said.

[C.J. Muse, Evercore]

And I guess as you think about the adjustment on the leverage ratio amendment, that was really all about the higher rate that goes into January 20 right so you still have the 4.25 times into September, December that's unchanged. So, curious as you look at adjusted EBITDA on an LTM basis and as you project into the back half, is that something that you're going to need to negotiate in your view today?

[Mark Long, CFO]

No. So that was the benefit of the amendment. The amendment really had two great features. One is what you talked about, which is we pushout step down for our total leverage maintenance covenant from 4.25 times to 4 times. We push out that step down by one year. So, it just provides that additional headroom. Now, the second important piece is, we changed the definition of adjusted EBITDA to increase adjusted EBITDA by the amount of the depreciation for our portion of the JV; CapEx basically that is.

[Stephen Milligan, CEO]

That's billed to us in effect by TMC.

[Mark Long, CFO]

Exactly. But it was previously not included in the definition of adjusted EBITDA. So that was a -- that provided us a significant benefit in the calculation of that leverage ratio.

[Operator]

Thank you. And our next question comes from the line of Tristan [ph] with Baird.

[Unidentified Analyst]

If market conditions warranted basically how much work do you have to further reduce expenses beyond the $800 million annual reduction that you're targeting?

[Stephen Milligan, CEO]

Well, we have not dimensioned that, certainly not externally. The one thing that I will add to that is -- and we commented on this previously is that when we look at let's just talk about our expense structure, forget about the cost structure for the time, but one of the things that we were attempting to not do was to disrupt or harm our future product road map. If market conditions, I mean it's hard to mention this because you don't know if market conditions got more challenging. First off, you'd have to evaluate why they got more challenging and sort of understand that but if they -- if they got more challenging, we would have to take a harder look at our go-forward product roadmap.

Right now, we don't think that's necessary based upon our expectations both from a market perspective and from a financial perspective, but that would be the next place that we would go look from an expense standpoint. And like I said, we have not dimensioned any potential opportunity as it relates to that.

[Unidentified Analyst]

And any commentary that you could provide in terms of NAND flash inventory that you see in the channel? So we know it's flat on your book, but what's your view in terms of what's sitting out there in the channel?

[Stephen Milligan, CEO]

Well, I think we've seen the channel is getting in better shape. I think it's a little bit of a different story with certain manufacturers and there's a different story with each of them obviously, but our case has been that we wanted to get ourselves in a better position relative to flash inventory. We feel comfortable about the actions we took. We think it's put us in that position. So, we see things sort of trending down from here.

[Operator]

Thank you. And our next question comes from the line of Sidney Ho with Deutsche Bank.

[Sidney Ho, Deutsche Bank]

Last quarter, you talked about it previously and now wafer starts will reduce supply by 10% to 15% which you kind of reiterate today. But then, you also said you will continue to assess the situation, with three more months of data, what are your thoughts today in terms of further lowering production and maybe remind us what portion of your best supply is in tuning in right now? Thanks.

[Stephen Milligan, CEO]

So at this point, we don't see any need to reduce our output schedule. We talked about the industry supply growth rate being around 30%, we're at or slightly below that. We're comfortable with that position relative to our production plan given our current view of market outlook. We have not commented on the percentage of output on 2D planar. I'll give you this color, the remaining percentage of output tends to be in long life cycle businesses that have quite good economics. So, we're very comfortable with the remaining percentage of our output that's on 2D planar.

[Sidney Ho, Deutsche Bank]

Maybe just to follow on that; I think you mentioned CapEx will be down in fiscal 2020. Are there any changes for this calendar year or maybe mixing calendar year versus fiscal year there?

[Stephen Milligan, CEO]

So I think just to dimension it, we'd previously said for fiscal '19, our expectation for cash CapEx would be in the $1.5 billion to $1.9 billion range. And we believe will come in at the low end around $1.5 billion for fiscal '19. For fiscal '20, as Mike indicated, we expect our cash CapEx to be lower, and it should be in the $1 billion range at this point.

[Operator]

Thank you. And our next question comes from the line of Joe Moore with Morgan Stanley.

[Joe Moore, Morgan Stanley]

I wonder in terms of the utilization comments you said that utilization charges are winding down now. Does that mean that the supply comes back on in the third quarter or should we be modeling for a step function increase in production in Q3 -- in calendar Q3?

[Stephen Milligan, CEO]

Yes. I think the way you should think about it is our industry growth rate for the year will be at or slightly below the 30% we talked about. We chose to implement it in such a way; we took pressure off of our inventory position in the first half of the year, which is seasonally slow. So, I think generally speaking we think we're well aligned with our view of market demand and our inventory position is in a reasonably good position, as we sort of go through this quarter into the back half of the year.

[Michael Cordano, President & COO]

Yes. And let me add to that because when we announced these cuts in terms of wafer starts, we had a -- we had a simple goal, which was to get our inventory levels down to a range that we felt comfortable with. With the plan cuts that we have made, we are moving in that direction. Our intent was not to eliminate all pockets of inventory within the system. That will require other activities. So, we are in a position to be where we thought we wanted to be and frankly, we were talking about exiting the June quarter. So, we're kind of in that spot or moving in that spot, but I just want to make sure that everybody is clear in terms of what we were trying to accomplish as a consequence of the web wafer starts that we made to our production levels.

[Joe Moore, Morgan Stanley]

And then, secondly on the lower cost of market inventory charge. Can you talk about I expect it's generally moving around -- what makes it move big enough to sort of trigger a charge like that and you expect it to repeat in the coming quarters? Thank you.

[Stephen Milligan, CEO]

Sure. So, with respect to the driver, it has to do with our multi chip package product that goes into smartphones and as we said, these carry the DRAM that we purchase and it turned out one of the reasons it was a higher charge than you might have expected was just a function of the amount of DRAM we had in inventory. And as it relates to future quarters, this is something we evaluate every quarter and this one just was higher than much higher than typical. So we spend time explaining that.

[Operator]

Thank you. And our next question comes from the line of Jim Suva with Citigroup.

[Jim Suva, Citigroup]

As we look back at the consumption and digestion in the cloud, what they've procured, purchased, and unused; can we look back and kind of help us understand whether if they just pre-buy a lot of our memory and storage or did they find better efficiencies with cloud to use it and is there still more like compression that's really helping them out. But what exactly was the disconnect of why it's taking so long to digest the inventory situation now that we're kind of coming out of there at some point? Thank you.

[Stephen Milligan, CEO]

Yes. So listen, the lowest -- all those factors are at play, but the principal one that occurred in the tail end of calendar 2018, if you remember, lots of components were on constrained supply, so DRAM Flash and even capacity enterprise. So, in that environment, the hyperscale players are very concerned about availability, about the ability to continue to build out their infrastructure, so they bought ahead of demand to secure that supply line. So once the supply -- overall supply environment began to change, they took upon themselves to normalize inventory position. So, that was the primary driver. Yes. There's always an efficiency effort going on within the hyperscale, but that's generally comprehended within our growth rate expectations, the thing that -- that impacted at least us in calendar Q4 was what I just described relative to inventory adjustment.

[Operator]

And that does conclude our question-and-answer session. I would not like to turn the call back over to the CEO, for any further remarks.

[Stephen Milligan, CEO]

All right. So thank you all for joining us and we look forward to continuing our dialogue. Have a great rest of the day.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference, this does conclude today's program. You may all disconnect. Everyone have a great day.