Western Digital Corporation

Good afternoon, and thank you for standing by. Welcome to the Western Digital's first fiscal first quarter 2021 conference call. Presently, all participants are in listening mode. Later, we will come to the question and answer session. At that time, if you would like to ask a question, you may press star 1 on your phone. As a reminder, this call is being recorded. Now, I will turn the call over to Mr. Peter Andrew. You may begin.

Thank you, Shannon, and good afternoon, everyone. Joining me today are David Geckler, Chief Executive Officer, and Bob Ulau, Chief Financial Officer. Before we begin, let me remind everyone that today's discussion contains forward-looking statements, including product portfolio 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 10Q 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 David for introductory remarks.

Thanks, Peter, and thanks everyone for joining us to discuss our fiscal first quarter results. I hope that you and your families are staying healthy and safe. Before we dive into our results, I'd like to take this opportunity to provide some color on our new business unit structure, which we announced in September. I have strong conviction in the market opportunity from rapid global adoption of the technology architecture built with cloud infrastructure tied to intelligent endpoints and connected by high performance networks. The value and urgency of data storage at every point across this architecture has never been clearer. Customers need solutions that can best address the requirements across a variety of use cases and end markets. The ability to capture this opportunity at every stage highlights the criticality of having a broad portfolio of both flash and hard drive products. We have the best and most comprehensive storage platform in the industry, and I believe over the coming quarters, we will continue to see the compelling benefits of this strategy. In particular, there are significant operational and go-to-market synergies with our integrated Flash and HDD portfolios, which are important competitive differentiators for WD. There is also a great deal of customer overlap between our Flash and HDD businesses, and we believe our longstanding deep and collaborative customer relationships will be a key factor in achieving strong performance over time. A great example is that following the acquisition of SanDisk, we built on our strong HED customer base to drive impressive adoption of SSD solutions on the client side. As a result of our established trusted relationships, our HED customers then turned to us to also provide them with Flash solutions. In fact, we now equip all of our top 20 customers with both Flash and HED products. Our demonstrated ability to support our customers by providing a breadth of options that gives us confidence that we can do the same in the enterprise SSD space in the years ahead. Ultimately, we understand our customers' needs and we can work with them to address their evolving and growing storage ecosystem to provide them with a wide range of solutions. At the same time, there are technical dynamics between Flash and HDD that are very different. While we develop innovative, compelling technologies in both areas, each requires separate, dedicated focus on product development, technical strategy, and execution on our roadmaps and product commitments. To that end, one of my first observations when I arrived at WD was that we could do a better job of capitalizing on these dynamics. So to help us accelerate our strategy, we have created FLASH and HGD business units, each with a dedicated general manager. This new structure is designed to accelerate growth and drive agility, sharper focus, and business accountability throughout the organization. Within each business unit, engineering and product management teams will be responsible for driving product strategy, roadmap, and pricing with overall P&L responsibilities. The GMs of each unit will work with their peers in operations, memory technology, sales, finance, legal, and human resources, to drive their businesses with accountability for results. As part of this reorganization, Rob Soderberry joined WD in September as Executive Vice President and General Manager of the new Flash Business Unit. Rob is a 30-year technology industry veteran with outstanding experience leading enviable product franchises at scale and has deep technology and product management expertise. Earlier this afternoon, we announced that Ashley Gorak Purwala is joining us as Executive Vice President and General Manager of our HGD business unit. Ashley brings 30 years of technology experience to the team and has spent the majority of his career at Dell Technologies in many different engineering and business leadership roles focused on complex data center infrastructure. Most recently, he was President and GM of Servers and Infrastructure Systems, We had full P&L responsibility for a $20 billion business and a global team of 4,500 technologists. We are thrilled to have both of these exceptional leaders on board. Now turning to our financial results. In the first quarter, results were at the upper end of the guidance ranges we provided in August. We reported revenue of $3.9 billion and non-GAAP earnings per share of 65 cents. Results were strengthened by retail, where we are executing a compelling innovation story reinforced by our powerful brand recognition and reputation for exceptional performance. Encouraging economic and market dynamics supported this performance as COVID restrictions eased during the period while consumer flash pricing stabilized. In addition, continued work from home and distance learning trends drove some upside in hard drive demand for desktops and notebooks. In general, some of the uncertainty we saw last quarter is starting to dissipate. For example, we have better clarity today on geopolitical dynamics, Huawei concerns, and stability in consumer flash pricing. We are also seeing positive indications around the progression of the 5G ramp and the growth of potential gaming, the growth potential of gaming, excuse me. However, some near-term headwinds remain. Demand trends continue to be mixed, and there have been recent COVID-related lockdowns and upsurges in several countries. While we are not out of the woods on these macro impacts, we are more optimistic than we were last quarter on some of these issues abating in calendar 2021. Turning to a recap of performance in our flash business. Our broad flash product portfolio, technical leadership, deep customer relationships, extensive distribution channel, and a low-cost architecture continue to differentiate us from our peers. Product highlights in the quarter included. Within retail, we refreshed our entire SSD product line, including introducing the ArmorLock security platform. ArmorLock is a data encryption platform featuring state-of-the-art security technology and ease of use in enabling secure storage. The first product to leverage this technology is the ArmorLock encrypted NVMe SSD. The initial reaction to this product has been terrific, particularly with professionals and content creators in the media and entertainment industry. As we enter a seasonally strong quarter, we are well positioned in the retail space and expect the fiscal second quarter to be another growth quarter in retail. Our WD Black product line has been expanding and continues to add innovative solutions for gamers, including the recently launched WD Black SN850. This is our first SSD to feature next-generation PCIe 4 technology, and early reception has been very positive. In fact, over 850,000 gamers streamed our Twitch launch in early October. Our comprehensive portfolio is enabling us to provide Flash products directly into consoles, as well as provide leading Flash and HDD retail solutions for the broader consumer gaming market. In total, gaming represented about 10% of our Flash revenue this quarter. Gaming continues to be a promising growth area for us, and we are excited about the future of this end market. We continued the enterprise SSD momentum we discussed last quarter. having now completed over 100 qualifications of our second-generation NVMe products. Over the next two quarters, we expect to start qualifications at additional cloud titans in one of our largest OEMs, which will further expand our addressable market. We have large cloud and OEM partners. Having large cloud and OEM partners complete a qualification cycle can be a multi-quarter process with deep commitment and investment from both parties required, but they typically lead to high volume purchases. We are well versed in this process, having undertaken thousands of qualifications over the past several years, which are inevitably successful. The enterprise SSD market has immense untapped potential and remains a key area of focus for us. I'm also confident the recent organization changes we've made will further sharpen our execution in this critical market. More broadly, our successful 20-year partnership with Keoksha continues to be a strength of the business. Our joint memory technology roadmap remains strong with impressive VIX4 and VIX5 yields and associated strong cost improvements underpinning our entire portfolio. We also regularly work with Keoksha on future facilities, facility planning, To that end, this afternoon, Kyokusha announced the construction of the shell for Fab7 in Yokaichi, which is expected to commence in the spring of 2021. We expect to continue our joint venture investments for Fab7 and look forward to our ongoing successful partnership. On the HDD side of the business, we continue to align our product portfolio towards growth markets, particularly in cloud and smart video. These end markets demand high-performance, high-capacity drives, and we are continuing to innovate in head and media design, firmware, and mechanical suspension to take advantage of this opportunity. We achieved important HCD business and product milestones in the quarter, which highlights our commitment to innovation and our focus on sharpening execution. First, I am pleased to announce that we reached our goal of producing over 1 million energy-assisted drives. We are seeing strong engagement with customers as we build on our capacity to aggressively ramp this platform. We have completed nearly 100 qualifications, including with one Cloud Titan, and have an additional 125 qualifications in process, including with two more Cloud Titans. We're excited about the progress we've made and expect the 18 terabyte capacity point to be the sweet spot in the industry. Second, on Monday, We announced qualifications have been completed on the 20 terabyte platform, and we have already started shipping for revenue. You may recall several years ago, we committed to delivering a 20 terabyte product to our customers by 2020. Reaching this critical milestone is a significant achievement and testament to our ability to deliver on our product roadmaps. Finally, in our OEM and retail end markets for HGD, We saw upside in demand driven by the work from home and distance learning trends and expect this to continue through the current quarter. I'm very proud of the team for the focus and commitment to achieving these important milestones, and I'm excited about how we are positioned for success moving forward. I'll now ask Bob to share details on our first quarter results before I talk about what we see going forward.

Thanks, Dave, and good afternoon, everyone. Overall, results for the first quarter were at the upper end of the guidance ranges we provided in August. We continue to make a number of long-term structural changes in the way we are running the business to accelerate growth and drive agility, focus, and business accountability throughout the organization. We are evaluating whether any changes are needed to our already comprehensive disclosure as a result of the new business unit structure that Dave described. Today, however, I will focus on our traditional disclosures. For the first quarter, revenue was $3.9 billion, down 9% sequentially and 3% year over year. Recall the last fiscal year period was a 14-week quarter. Looking at our end markets, client devices revenue was $1.9 billion, a bit better than expected, up 2% sequentially and 20% year over year. Within this end market, client SSD revenue declined sequentially from a record level as our customers digested some excess inventory and we faced lower flash pricing. Notebook and desktop hard drive revenue declined sequentially as the market continued to transition to SSD-based products. But demand was better than expected due to work, school, and game-from-home trends. Smart video demand was better than expected as this market started to recover. Gaming revenue experienced very strong sequential growth as we increased our shipments in preparation for the upcoming new game console launches. And finally, mobile flash revenue grew on a sequential and year-over-year basis, driven by demand from several China-based customers and new 5G product roadmaps here in the U.S. Moving on to data center devices and solutions, revenue was $1.1 billion, down 33% sequentially and 26% year over year. Both capacity enterprise hard drive and enterprise SSD revenue were down sequentially due to digestion at both cloud and OEM customers. Next, client solutions revenue was above expectations at $847 million up 23% sequentially as brick-and-mortar stores continued recovering and online and curbside pickup trends continued. Client Solutions was down 5% year-over-year. The work, school, and gaming-from-home trend benefited both hard drive and flash-based products, again highlighting the powerful go-to-market synergies of this channel. As Dave mentioned, flash pricing in retail has been fairly stable. Traditionally, this has been a leading indicator to pricing trends in other portions of the flash market. Turning to revenue by technology, flash revenue was $2.1 billion, down 7% sequentially, but up 27% year over year. Flash ASPs were down 9% sequentially on a blended basis and down 6% on a like-for-like basis. Bit shipments were up 1% sequentially. Hard drive revenue was $1.8 billion, down 10% sequentially and down 23% year over year. On a sequential basis, total exabyte shipments were down 7%, while the average price per hard drive decreased 9% to $79, reflecting the digestion we noted for our capacity enterprise drive product. As we move into costs and expenses, please note all of my comments will be related to non-GAAP results unless stated otherwise. Gross margin for the first quarter was down 2.6 percentage points sequentially to 26.3%, slightly above the midpoint of our guidance range. Flash K1 startup costs were $66 million. COVID-related costs were $28 million, essentially all attributable to hard drives down from $96 million in the prior quarter. Our flash gross margin was 26.4%, down 4.1 percentage points from last quarter, as pricing was down more than anticipated. We continued to achieve good cost reductions, which helped to partially offset the decline in pricing. Our hard drive gross margin was 26.2%. down 1 percentage point sequentially due to product mix and costs associated with the early ramp of our next-generation energy-assisted hard drives. COVID-related costs represented about 1.1 percentage point on our hard drive gross margins. Non-GAAP earnings per share was $0.65. Operating cash flow for the first quarter was $363 million, and free cash flow was $196 million. Capital expenditures, which include the purchase of property, plants, and equipment, and activity related to flash joint ventures on our cash flow statement, was a cash outflow of $167 million. In the fiscal first quarter, we reduced debt by $213 million, including an optional debt payment of $150 million. Our liquidity position continues to be strong. At the end of the quarter, we had $3 billion in cash and cash equivalents, and our gross debt outstanding was $9.5 billion. Our debt to adjusted EBITDA ratio was four times in the first quarter. Our adjusted EBITDA, as defined in our credit agreement, was $3.4 billion, flat sequentially, resulting in a leverage ratio of 2.8 times. As a reminder, our credit agreement includes $980 million in depreciation add-back associated with the joint ventures. This is not reflected in our cash flow statement. Please refer to the earnings presentation on the Investor Relations website for further details. Moving on to our outlook, as Dave mentioned, we're optimistic that conditions will improve next calendar year. However, our visibility remains limited in the near term as a result of the uncertainty of the pandemic and global economic contraction. Despite this uncertainty, we continue to execute effectively and build on our strong foundation of great products, deep customer relationships, and large and growing end markets. We are working on a number of substantial product transitions that will set us up well for the long term. By technology, we expect hard drive revenue will be up and flash revenue will decline. During the fiscal first quarter, we experienced a pull forward in demand due to geopolitical dynamics. The most significant was from Huawei, which represented mid to high single-digit percentage of sales. We are now planning on zero sales to Huawei in the fiscal second quarter. With all these factors in mind, our fiscal second quarter guidance is as follows. We expect revenues to be in the range of $3.75 to $3.95 billion, non-GAAP gross margin to be between 24% and 26%. This range includes approximately $30 million in costs associated with COVID and $50 million in costs associated with the K1 FAB. We expect the fiscal second quarter to be the final quarter in which we incur meaningful period expenses associated with the startup of the K1FAM. We expect operating expenses to be between $680 and $700 million. Interest and other expenses expected to be between $70 and $75 million. The tax rate is expected to be between 21 and 25 percent in the second quarter. And we expect non-GAAP earnings per share to be between 40 and 60 cents in the second quarter, assuming approximately 306 million fully diluted shares. In summary, we are managing well in an uncertain environment and positioning ourselves in both the flash and hard drive markets for the significant long-term growth opportunities that are ahead. Now I'll turn it back to Dave.

Thanks, Bob. Heading into the holiday season and into calendar 2021, we are optimistic about what lies ahead. As the technology industry evolves and grows and data becomes more critical and valuable, we will be positioned for success by continuing our history of innovation, delivering on our product roadmap across Flash and HGD, building on our strong customer relationship as a trusted storage provider of choice, and continuing to sharpen our execution across the business. The recent organizational changes will be integral to accelerating and enhancing our ability to address and capture major opportunities in front of us. I consider change a catalyst of opportunity, and I am very excited about the future of Western Digital. We will continue to think strategically and act thoughtfully with the best interests of our shareholders, customers, and employees in mind. I'll now turn the call over to the operator to begin Q&A.

Ladies and gentlemen, we will now begin the question and answer portion of today's call. If you have a question, please press star 1 on your phone. If you would like to withdraw your question, please press the pound key. One moment, please, for the first question. Our first question comes from Joe Moore with Morgan Stanley.

Great. Thank you. I wonder if you could talk a little bit about demand pricing that you saw in Q3. You talked about 6% like-for-like declines. It seems like The markets that are more observable pricing like solid-state drives were down more than that. So, you know, I was a little surprised that was kind of benign. And then, you know, maybe a little bit about how you see NAND pricing in the fourth quarter.

Do you want to start or do you want me to? Go ahead. Okay. Hi, Joe. It's Bob. I'll go ahead and start. So, yeah, I mean, we, you know, obviously still saw pretty significant price declines during the quarter. We were fortunate we were able to offset some of that with pretty good cost reductions during the quarter. And we think we're going to continue to see some price pressure going forward. As we said in our comments, in the retail channel, things seem to have stabilized. From an OEM perspective, prices are down in the December quarter, but we're hopeful that they will begin to stabilize as well.

And are you guys seeing solid-state drives be worse than, like, at a component level NAND sale, or is it the same?

Yeah, I don't know that we want to get to that level of detail. I'd say it's roughly the same. I don't think there's a big difference between the two.

Okay, great. Thank you.

Our next question comes from Toshi Ihari with Goldman Sachs. Your line is open.

Hi, guys. Thanks for taking the question. You mentioned that you saw a pull forward in the quarter, and you sized Huawei as sort of a mid-single digit to high single digit customer. I was hoping you could quantify how big the pull forward was, not just from Huawei, but from, I guess, all your customers, particularly in China, if you do have a number. And I guess maybe related to that, your inventory was up a little bit on a sequential basis. Was that mostly on the NAND side, or was it across both your businesses? And then, sorry, one more. How would you assess customer inventory levels as of today, both on the NAND side and HGD side? Thank you.

I'll start, and then Bob can add on. So, I think the pull forward, we did see some, clearly. I think it was fairly modest, maybe 1-2%. So, and then, of course, once the Commerce Department rules hit, that all stopped. Second question.

On inventory.

Inventory. You want to start with inventory, Bob?

Yeah. So you're right. The inventory was up quite a bit sequentially. And some of that was really due to particularly low levels of inventory in the June quarter. And most of it is on the hard drive side. And as we have talked about this year, it's been a very disrupted supply chain. So we really are taking actions with inventory to assure that we have the components that we need to build the products. We also are trying to have enough inventory so we can ship on the ocean rather than in air. As you probably know, the air freight rates are very high coming out of Asia right now. And then finally, we are in a very significant ramp with our 16, 18, and 20-terabyte products. So all those factors play into the increase in inventory, and we're confident, obviously, it's mostly our newer products will be able to sell that inventory. Okay. And then I think your other question was with respect to customer inventory levels. And I would say, you know, first of all, in the channel retail and commercial distribution, we think inventory levels are very normal. I don't see any issues there. From an OEM and from a cloud perspective, we're definitely seeing some customers who still are in the process of normalizing their inventory levels. So their inventories are still a bit high. But, again, we're hopeful that that will – That'll get normalized in the December quarter.

Yeah, just to reinforce one thing Bob said there. I mean, the ramp on the 1618 product is the fastest ramp we've ever done to a new capacity point by a significant amount. So we are getting prepared for demand for that product as we go forward. So, yeah, that's been an impact on the system as well.

Thank you. Good luck.

Thank you. Thank you.

Our next question comes from Carl Ackerman with Callen. Your line is now open.

Thank you. Two questions as well, please. The first question I have is your OpEx outlook of 690, I think, is very impressive. But what are your thoughts on OpEx from that level, considering the new change in organizational structure and initiatives on enterprises with these and energy-assisted airline drives?

Yeah, so OpEx is something, I mean, clearly we've been focused on. I mean, especially given the market we're in, but I think the new organization structure gives us more focus to make sure we're spending our OpEx on the most valuable thing. So I view the fact that we've got two highly experienced general managers coming in to drive the business as continuing to drive that focus to make sure we're investing in the right the right places. So, Bob, you want to say anything in addition?

Yeah, I can just add. I mean, I think that the second fiscal quarter is going to be unusually low in terms of OpEx. We've got some seasonal factors there that are benefiting us. As we move forward, I would expect, you know, as business ultimately gets back to normal and we start having more employees in the office, more travel, I would say OpEx will probably go up a bit. But we are pleased with the cost controls, and I think the new structure will give us a lot of focus.

Something we're going to keep a very close eye on.

Understood. For my follow-up, some investors are concerned or have been concerned that NAND profitability will remain subdued next year as some Korean peers ratchet up NAND CapEx despite soft demand. I guess, you know, what sort of initiatives have you taken to respond to such a scenario? And then similarly, you know, because NAND prices are dictated by supply and demand, do you think it's going to take several more quarters for NAND inventory to burn off and reach demand equilibrium? Or I guess are your earlier comments indicative that pricing will be more benign? Thank you.

Well, I mean, so first of all, I mean, the market requires a lot of ongoing investment just to keep up with the 30% demand increase in bit supply. I mean, clearly we're working through an oversupply situation. But we continue to have a point of view that, for the most part, the industry has done a pretty good job of being vigilant with CapEx. We're certainly – you know, we – We invest with our partner in Keoksha, so together we're a very big player, and we've been very much on top of CapEx, and we've really got a tight process around that to make sure that we're investing appropriately. On the demand side, we do see a lot of things ramping up. We talked about gaming in our prepared remarks, was 10% of our business this past quarter. We obviously have a 5G ramp starting now. You know, we're hearing from our customers in 21 on the cloud side that, you know, I think we can all, we all would agree that coming out of COVID that the demand for the cloud keeps going up. And we're seeing that. So it's hard to call that to a specific order. But we feel better about 2021. Bob, anything you want to add on top of that?

No, I agree. I mean, I think there's definitely some exciting trends in 2021 as 5G starts to take hold in a more significant way. And we aren't as big in mobile, but our competitors will be serving that market, and that'll consume a lot of bits. So I think overall, 2021 is shaping up to be a good year.

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

Yeah, thanks for taking the questions. I guess I have to ask two as well. So I guess the first question, if you could help us unpack the gross margin guide of 24% to 26% in this current quarter between the NAND business and the hard disk drive business. And relative to the HCD business, I can appreciate that you're ramping the first generation of the energy assist drive, but how do I think about the progression back to a, you know, call it 30% gross margin? What needs to happen there? And I do have another follow-up. Thanks.

So I'll take the second one first. I mean, it is about the business shifting to the higher capacity points, right? I mean, we're in a big transition now to a new platform. So as that transition starts to ramp, that will be accretive to gross margins. You know, I think on pricing, we're getting more disciplined on pricing as well. I mean, it's a very important technology, and making sure we keep our eye on that side as well is very important. But we certainly see a path to increasing gross margins as we drive through the ramp of this capacity enterprise product. Bob, you want to?

And what are you assuming in the quarter, the current quarter, guys?

What are we, I'm sorry, we're assuming on what?

Anyone want to unpack? Man versus hard drive margin.

Yeah, yeah. Okay, yeah, I'll do the unpacking on hard drive. So, you know, obviously it benefits us quite a bit as the market shifts to capacity enterprise, and we do expect to have over time significantly better gross margins as capacity enterprise becomes a bigger percentage of the total. In the December quarter, it turns out we're seeing a lot of strength in retail. And so that means the mix is unfavorable in the December quarter from a hard drive standpoint. And we do expect that to recover as we launch the new products going into next year. So I think on the hard drive side, we'll definitely see recovery. On the flash side, it's really a matter of how things go with pricing. As we mentioned, we're seeing some stabilization in the more transactional markets. And we're obviously a couple months away from negotiating for next quarter. with the OEMs, but we're hopeful that we'll start to see the pricing situation improve on the flash side as well.

Okay. And then as a quick follow-up, can you tell us just housekeeping-wise what the near-line capacity shift was, either sequentially or year-over-year growth?

Yeah, we don't break that out specifically on a quarterly basis. I'll try to see if I can dig up an exabyte number on a year-over-year basis.

Okay. Thank you. Thank you. Thanks.

Our next question comes from CJ Muth with Evercore. You want to follow this?

Yeah, good afternoon. Thank you for taking the question. I guess first question, can you speak to how you balance the obvious need to lower your costs and increase layer count with the fact that, you know, that adds bits to the market? So we'd love to hear kind of your philosophy today given, you know, this persistent oversupply that we're in.

Yeah, so I think there's a number of levers there. I mean, first of all, we're always driving the roadmap forward, the memory roadmap forward, so we can drive the cost down. So making sure that we keep the innovation up there is very important. And again, I've spoken about this many times. I think that's where our partnership with our JV partnership, we have a lot of collaboration with Keoksha on the R&D side of this business as well, which is is super helpful to driving the best cost position. And then we want to drive to that and then there's the mix and the fab of how fast we transition to the new nodes as far as the amount of supply we're going to get. And some of that is based on the products we're putting it into and are those products ready to take the new nodes and just making sure we've got that mix all right and then making sure we look at that whole equation and understand where the industry is at on bit growth and how much CapEx we're going to invest in those transitions to the new nodes to make sure that we keep the balance right and get the cost in the right spot.

Very helpful. And as a quick follow-up, can you talk a bit about, I guess, where you stand in terms of visibility to cloud recovery? Any green shoots there?

Yeah, I think coming out of COVID, there's no doubt that there's been more adoption of the cloud, and we're hearing good things for our customers going into 21. I think, as Bob said, we see the HDD market is kind of slightly up next quarter, and then into 21 we see greater recovery. So we're hearing good things from our customers about demand in the cloud.

Thank you.

Thank you.

Our next question comes from Lindsay Mohan with Bank of America. Your line is now open.

Yes, thank you. You articulated a million drives in energy assist currently. Where does that need to be for HDD margins to turn back higher and Would that incremental demand for you be more on the cloud side or on-prem side? What are you expecting to see first? And I have a follow-up.

I think, well, we see, I didn't, can you expand on the second part of the question, incremental demand for?

For the high-capacity drives on cloud or on-prem.

Yeah, I think we see some softness in the on-prem market, but on the cloud side, we see very good demand there. So I think that's where you'll see incremental demand. As far as what does it need to be, I mean, we're going to ramp very quickly on that platform, and we're always using that to drive yields up across the time, especially the head yield. So we just keep driving that as high as possible, and that'll help drive the gross margins on the product. I don't know if that exactly gets to your question, but if not, we can follow up.

Okay, no, thanks for that. And as a follow-up, your cash capex for this fiscal year is projected at $1.3 billion. Your free cash flow is not tracking to that level, at least as of yet. Should we assume that there won't be any meaningful other progress on either reducing debt or on capital return for this fiscal year?

Well, first of all, you're right. I mean, our cash capex will be about $1.3 million, and every incremental dollar of free cash flow we're going to use to reduce our total debt. So I'm not going to give a cash flow forecast for the year, but after investing in the business, it's the number one priority.

Thanks, Bob. Thank you.

Our next question comes from Mehdi Husseini with SIG. Your line is now open.

Yes, thanks for taking my question. I have two follow-ups, two questions with no follow-ups. I understand the rationale behind separating the flash from HDB. You have highlighted key strategic rationale, which mostly focuses on the top line and generating flash. I'm a little bit not sure about the cost synergies. It seems to me that you will be required to invest more in each sector before they become self-sufficient, so any color on cost or cost synergy or cost increase per business division would be very helpful. And then my second question has to do with the mix, you know, hard disk drive, 18, 20, It is interesting to me how you and your peer highlighting 20 terabyte samples and high-volume manufacturing into next year, but we're just beginning to start with the 18 terabyte. Is that simply reflecting the competitive nature of the near line, or how should I think about 18 versus 20? Because to me, one could cannibalize the other. So any insight here would also be great. Thank you.

Okay, so first of all, on the Flash and HTD side, it's about focus on the roadmap and execution in different businesses. I mean, obviously, they're different businesses. They're sold to the same customers. I think that's kind of to summarize. And I mean, what we're doing from an organization point of view is getting what I think is the best of both worlds is the fact that we've got one customer relationship and we've got focus on two different portfolios. And that's going to lead to the best, I think, the best allocation of our resources into the portfolio. I think it's going to lead to better execution. I think when I got here, this was one of the things that I saw, that if we could use more precision execution, there's just too many people that were thinking about two businesses at the same time as far as how you build them and drive the roadmap. And so getting that separated yet keeping the customer-facing pieces together is the strategy from an organization perspective. I think from a cost perspective, they each have R&D costs associated with them. This is about getting the most focus on that and making sure that that investment is going into what is going to be the highest return from a portfolio perspective. On 18 versus 20, the 20 is an SMR product, so it's a little different technology, and that's where you get the additional density from. So some customers have adopted SMR and some haven't, so they're not really – I wouldn't really think about that as a substitute there. If you've adopted SMR, you're going to get better density on the product. Some customers have adopted it. Some are looking at it. And it's just another technique we can use to drive density in our products.

Yeah, maybe if you're looking at from a volume and a revenue production basis, it should really be the AT&T that will be the leader there.

Yeah, there's no doubt about that.

Our next question comes from Shannon Cross with Cross Research. Your line is now open.

Thank you very much. First of all, David, I just wanted to say Ashley is a great hire. We've met with him several times during his, you know, covering Dell, and he has a really good reputation within the company. So I'm just curious, you know, looking at the HDB business, what do you think are the first sort of key initiatives or area of focus for him, you know, coming in from his server background? And then I have a follow-up. Thank you.

So first of all, Thanks for the comments. I am really, really happy that he's joining WD, and I've been super impressed with him as we've gone through the process to identify a leader. You know, I think the issues around the HDD business are kind of some of the things that we've been talking about here. It's a tremendous business. It's pivoting from this, you know, what was a big client business into capacity enterprise, Capacity Enterprise is going to be a growth business for the foreseeable future. We have essentially anybody that's building a public cloud is going to be using HDDs, and there's not going to be a substitute for a long time. There's going to be complementary technologies of enterprise SSDs, but there's a very, very big difference in my mind in the SSD space, where on the client business, you have two technologies, which are essentially substitutes. And in the cloud space, they're complementary technologies. So Ashley's going to focus on is how do we make that, you know, making sure we drive through that transition and we can deliver on, first of all, the enormous growth that our customers are asking us to deliver on. The growth rate in the public cloud is, I think we would all agree is huge scale and stunning growth and our storage portfolio is the foundation of that. Make sure that we can drive through this transition and return this business to growth and that we can meet that demand and then we can also focus on the profitability side of the equation and make sure we're delivering a high value solution to our customers and that we're also delivering the right value to our shareholders as well and getting that balance correct. And I think very, very focused leadership on that by somebody that has been in the data center infrastructure business for a long time and understands the dynamics of the architecture and comes in and looks at the industry with a fresh perspective is something I'm very excited about.

Our next question comes from Sidney Ho with Deutsche Bank. Your line is now open.

Great. Thanks for taking my question. So I have two questions. The first question is on hard drive. The unit number, the 1 million unit energy assist drive that you talked about, is that a production number or shipment number? And then how quickly does your production capacity go up in the next few quarters?

Yeah, that's a production number. We had an aspirational goal to ship that many. We didn't quite make it on the shipment side. We're probably several hundred thousand short of that. We still shipped a pretty fair number. We expect to ramp that number into many, many millions over the next two to three to four quarters. Like I said, this is the fastest ramping capacity point we've ever had. in the company that anybody can remember. I won't say in the history of the company because I haven't been here that long, but I talked to a lot of folks who've been here a long time. And the pace at which we've gone from 100,000 units to a million units is like a third of the time of the previous capacity point. And as we talked about, as we look into 21, we're hearing from our customers, you know, good demand trends that are going to drive adoption of that product. And, you know, we're We're happy where the product is. We're working through the qualifications on it at really big customers. And, you know, it will ramp quite quickly.

Our next question comes from Mitch Steeves with the RBC Capital. Your line is now open.

Hey, guys. Thanks for taking my question. So what I wanted to jump on really quick is just Intel divesting their NAND business. I realize it's new, but you guys probably had a chance to at least look at it and get an idea for what do you guys think. So how do you think this impacts Western Digital's NAND business going forward? Do you have any sort of comments you can make on what that divestiture does to the industry?

I guess what I'll say is, you know, we have a – I'm going to go back to what I a little bit talked about earlier. We have an unbelievably productive JV relationship with Keoksha, that makes us a scale producer in the industry. And I can imagine if I was in a position where I didn't have those scale benefits, I would be looking for how to get them. And so it doesn't surprise me at all. And I think we'll take it from there. It's pretty new, but it doesn't surprise me that there's some consolidation in the industry.

Our next question comes from Stephen Fox with Fox Advisors. Your line is open.

Thanks. Good afternoon. Two quick questions for me. First of all, on the FAB 7 launch, when that starts in terms of the grant process there, should we expect some extra costs to be run through your income statement? And then secondly, Dave, thinking about the new structure, you threw out a lot of, different benefits to it. If we look at like, say, 12 months, what would be the key things that you would like to accomplish or metrics that would say that you've had a success in terms of splitting up the business this way?

Thank you. It will be around execution and really clear roadmap fidelity that the roadmap we have in place and where we have our engineers focused is going to deliver the best value for our customers. and then that will in turn show up in our financial results. I'll let Bob talk a little bit about the cost. One thing I will say about Fab 7, it's very different than K1, first of all, in the fact that it's an expansion of an existing site. I'll also say it's something, in this industry, in this market, we have to continue to invest, and so it's in that vein. And it's also, you know, just starting to build the shell of the building, so I think it's going to be a while before we get to the details of spending. But, Bob, you want to say a little more?

Yeah, I think you hit the key points, Dave. I mean, we're still understanding the details of how it's going to evolve. It looks like the shell will be coming online somewhere in the spring of 22. From our standpoint, like Dave said, it's very different. It's an additional FAB on a major site, it will not be nearly the incremental cost that we saw in Kidakami. So it'll be pretty modest. And that's what we saw with PAB 6 there as well. So it won't be anything like what we've experienced with K1.

Our next question comes from Ananda Barua with Leeds Capital. You want to start with him.

Hi, good afternoon, you guys. Thanks for taking the question. Two quick ones, if I could. With K1 costs coming off, Bob, I think you mentioned this quarter, December quarter will be the final quarter. Is it as simple as for going forward, starting March quarter, just removing the $50 million from the P&L for the balance, well, I guess just sort of ongoing, which is about $200 million a year? And I'll actually ask my follow-up. It's pretty short, too. Okay. As in your prepared remarks made mention, I think just sort of, and I want the context on this, expect the 18 terabytes to be the sweet spot in the industry. Can you give us a timeframe on that? And really what I'm asking is if that's what you think for an indefinite period of time, I just want to be clear on that. So those two things.

Yeah. So on the second one, yeah, we do expect that probably a couple quarters out. You know, we see all of the big customers interested in that capacity point. I mean, obviously at different points in time, but, you know, we're engaged with lots of customers on that capacity point. But it'll be a quarter or two. Bob, on the K-1?

Yeah, on the K-1, I think most of the $50 million will either be going away as it'll go out as – as part of the COGS on products we're shipping, or it'll be in inventory. But you're going to have a lot of dynamics between here and the March quarter in terms of what goes on with cost of sales.

Our next question comes from Vijay Rakesh with Mizuho. Your line is now open.

Yeah, hi, David and Bob. Just a couple of questions here. When you look at the NAND site, I think you've seen the past BIX-5, 120 layer gives you a much better cost on the NAND side. So just wondering what the mix was on that side now, and how do you see that into first half?

You want me to take it? Yeah, VIX5 is still a very low percentage of the total. I mean, mostly shipping into retail right now. And that'll be the case through at least the first half of the calendar year, and then I think you'll start to see more VIX5.

Our next question comes from Nick Todorov with Longbow. Your line is open.

Yeah, good afternoon, Diggs. I would like to hear your thoughts on whether you need further HTT capacity footprint optimization. Essentially, I want to understand if near-line demand recovery and ramp-up of energy assist are the only two factors that preclude you from gross margin recovery on the HTT side. Thanks.

Yeah, I think, I mean, there's a couple of things. Bob talked about a couple of things. One is COVID expenses. We're still incurring some, you know, relatively significant COVID expenses. You know, I hope for all of us those are transitory and we get back to normal as soon as possible. We have some mixed issues in there. Retail has been strong. I think we started talking about retail being strong back in June and it's continued. And so that drives some demand and some mix, which is not as good as capacity enterprise. But then, and again, you know, but the big picture is there's a large shift going into capacity enterprise. And as that starts to be, as that continues to be more and more of the portfolio, it will drive the margins higher.

Our next question comes from Jim Suva with Citigroup Investment Research. Your line is open.

Thank you. And, Bob, it's probably a question for you, and I only have one question because I'm just a simple guy. But why aren't gross margins, you know, stronger in the quarter out? Is it due to K-1 or other things? Or why aren't margins stronger? What are the puts and takes?

When you say the quarter out, you mean the December quarter?

December.

Yeah. Yeah. Well, again, I tried to talk about it on the hard drive side. The mix is not that good right now. We're still seeing digestion with capacity enterprise, and we're seeing retail stronger, which tends to be lower margin business. So that's kind of the story on the hard drives. But I think we're getting ourselves very well positioned for next year there. And then on the flash side, again, we saw – some stabilization in pricing in the transactional markets, but we're seeing pressure this quarter from the OEM customers, and hopefully that'll start to get better from a price perspective as we move forward. But those are really the major dynamics for the December quarter.

The last question comes from Kevin Cassidy with Rosenblatt Securities. Your line's now open.

Thanks for squeezing me in. Just a simple question. With your new business unit structure, how does the customer see changes for Western Digital?

Primarily, our customers see our company through our go-to-market teams, and I think that's a part of, again, I've talked about this, the best of both worlds. The go-to-market team is still integrated. They represent the whole portfolio. So I think for the most part, the customers will see the company the same way. However, You know, really good general managers spend a lot of time talking to customers to make sure they really understand the market, they understand where the market is headed. So I think customers will see two very experienced, very talented general managers that are talking to them about where the portfolio is going and where their needs are going and making sure that we have those two things aligned.

Thank you. I would now like to turn the call back over to the CEO, David Deckler, for closing remarks.

Thank you. I'd like to take this opportunity to thank our shareholders, customers, and importantly our employees for your support of Western Digital. There has been a lot of developments over the last year, and we value your confidence and trust in us to deliver long-term success and value. One important component of our long-term success is promoting responsible and sustainable business practices, We recently released our 2020 Sustainability Report and are proud to share all of the progress we have made. Please visit our website to see this report and to stay up to date on upcoming events. Thank you for joining us today.

Thanks, everyone.

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