Western Digital Corporation

Good afternoon and thank you for standing by. Welcome to Western Digital's fiscal second quarter 2021 conference call. Presently, all participants are in a listen-only mode. Later, we will conduct a 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'll turn the call over to Mr. Peter Andrew. You may begin. Thank you 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 in 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-K 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.

Thanks, Peter, and thanks, everyone, for joining us today. To start, our second quarter results were at or above the upper end of guidance ranges we provided in October. We reported revenue of $3.9 billion and non-GAAP earnings per share of 69 cents. These results reflect continued growth in retail in what was a seasonally strong quarter. In addition, Stronger demand for our client SSD products, as well as our notebook and desktop hard drives, contributed to upside in revenue. We continue to work hard delivering for our shareholders, customers, partners, and communities. We adapted to changes in our business and continue to manage the ongoing challenges presented by the pandemic. Our results reflect the benefits of having such a diverse and deep product portfolio. fantastic franchises, a vast customer base, and now an optimized organizational structure. As a result, we have a solid foundation to capitalize on the significant growth opportunities in front of us. I'm excited about the progress we've made over the last few months in the recently established Flash and HDD business units. Both franchises are led by exceptional leaders who are highly focused on executing their respective strategies by establishing their teams, evaluating technology and product development, engaging with customers, and analyzing and effectively capturing target end markets. As we've highlighted in previous earnings calls, we are committed to delivering on our product roadmap, including advancing our product transitions, notably We are making great headway with the product transitions of our energy-assisted hard drives and enterprise SSDs. As you all know, these transitions are multi-quarter journeys, but I'm pleased with our progress, which I'll detail shortly. Although our progress to date is showing tangible results, there's still work to be done. We remain extremely focused on enhancing our ability to derive continued innovation and sustainable long-term shareholder value. Let me now provide a recap of our Flash and HDD businesses. Within Flash, we remain well positioned to address the digital transformation driven by businesses, schools, and consumers that continue to leverage technology as a daily necessity for work, learning, and a much-needed form of entertainment. The pandemic has has not only accelerated this transformation by the way we all use the cloud, but it has spurred technological innovation by driving the ability to access the cloud using very powerful and advanced end devices. The increasingly pervasive ability to access, store, and share data from anywhere on any device has resulted in robust storage demand, particularly in smaller form factors such as notebook, tablet, and Chromebook. The attach rate of client SSDs into notebooks now exceeds 80%, while desktop penetration of client SSDs is around 40%. Furthermore, tablets and Chromebooks, which are all flash-based, represent a growing percentage of total PC demand. Our leading position in client NVMe-based SSDs and our strong relationships with the major PC OEMs drove our client SSD business to a record level of exabyte shipments. Retail continued to perform well in a seasonally strong quarter, and we achieved a two-year high in revenue, supported by the strength of our brand and the breadth of our portfolio. We continued to make progress with our second-generation enterprise SSD products, completing nearly 150 qualifications. Importantly, We completed the qualification process at one Cloud Titan, which was an objective we committed to last quarter. We are shipping to this Cloud Titan in the fiscal third quarter. The second-generation Enterprise SSD qualification process is well underway with additional Cloud Titans and large OEMs. From a technology perspective, we began shipping our 112-layer BIX5 technology and client SSD products in the December quarter. Bix 5 remains the most capital-efficient technology node in the recent history of NAND going back to the 2D era, and we are preparing for a significant ramp of this node through 2021. Ultimately, customers want the best product that offers a blend of cost, performance, and power, and Western Digital provides that. Our focus on technological and architectural innovations, coupled with the benefits of size and scale that we have with our joint venture with Keoxia, has enabled us to deliver the industry's highest bit density per layer at the lowest cost per bit. As the result of our inherent advantages with the joint venture, particularly our scale and consistent track record of technological innovation, we are able to deliver the required bit growth and performance with the lowest capital intensity in the industry. We are highly confident in our ability to continue this momentum as we ramp BICS 5 through calendar year 2021 and begin BICS 6 productization. On the HDD side of the business, upside demand in PC, notebook, and smart video more than offset weakness in capacity enterprise. The persisting work-from-home and distance learning trends I touched upon earlier drove higher demand for both desktop and notebook PC hard drives and propelled retail hard drive revenue to a three-year high. The smart video business continued to recover, growing 30% sequentially. The biggest HD update is our solid progress against the initiative we outlined last quarter, completing the qualification process at the Cloud Titans with our mass market energy assisted hard drives. I'm pleased to share that we have now completed qualifications at three of the four U.S. Cloud Titans. While one now completed Cloud Titan qualification slipped beyond our anticipated timeline in the fiscal second quarter, another Cloud Titan qualification scheduled to complete in the fiscal third quarter was completed in the second quarter. With these significant milestones now behind us, we have staged products in anticipation of the ramp of these drives as we continue through 2021. With cloud digestion abating and the stabilization of OEM demand, we believe the demand and capacity enterprise bottomed in the fiscal second quarter and are anticipating a rebound in the fiscal third quarter. 18 terabyte is expected to be our leading capacity point as we head into the second half of the calendar year, which should propel nice growth in this segment going forward. As the volume of these drives continues to ramp through the calendar year, we expect our revenue and gross margin to recover. Before I turn it over to Bob, I'll quickly summarize our perspective on what's to come. We continue to deal with the far-reaching effects of the pandemic and no one can be certain of what the new normal will look like. However, there is no question the accelerated digital transformation has only increased the reliance on data and technology in both our professional and our personal lives, which we are confident will have a lasting impact for years to come. To this point, some industry analysts are raising the possibility that in certain portions of the market, such as the cloud, the storage industry will not be able to meet the extraordinary demand for both flash and hard drive solutions over the course of the next 10 years. Western Digital's unique ability to provide flash and hard drive storage solutions for customers spanning individual consumers to cloud titans highlights the value and importance of our broad portfolio and strong competitive position. I'll now turn the call over to Bob to share details on our financial results.

Thanks, Dave, and good afternoon, everyone. As Dave mentioned, overall, results for the fiscal second quarter were at or above the upper end of the guidance ranges we provided in October. Revenue was $3.9 billion, up slightly sequentially and down 7% year over year. Growth in client devices and client solutions was mostly offset by a decline in our data-centered devices and solutions end market. Looking at our end markets, client devices revenue was $2.1 billion, up 10% sequentially and 19% year-over-year. Work, school, and game-from-home trends continue to drive demand for both our flash and hard drive solutions for notebook and desktop applications. In notebook and desktop, our flash and hard drive revenue each grew over 20% sequentially, highlighting the power and value of our portfolio for our leading OEM customers. Demand for our smart video hard drive was much stronger than expected, growing 30% sequentially as demand continued to recover from the bottom set in fiscal fourth quarter of 2020 during the height of the COVID-related lockdowns. And lastly, mobile revenue was down sequentially with growth in recently introduced 5G phones offset by dynamics within China. Moving on to data center devices and solutions, revenue was $807 million, down 29% sequentially and 46% from a year ago. Revenue from both capacity enterprise hard drives and enterprise SSDs were down sequentially. As Dave mentioned, we had an unexpected delay in a qualification at a Cloud Titan. As a result, during the quarter, our capacity enterprise drive shipments were negatively impacted and inventory grew. We have since completed this qualification, and as Dave noted, given that a separate Cloud Titan qualification was completed ahead of schedule, we now have three of the four Cloud Titans qualified on our new energy-assisted drives. In addition, we are beginning to ramp our second-generation enterprise SSD products through calendar year 2021. Next, client solutions revenue was above expectations at $1 billion, up 19% sequentially and 6% from a year ago. 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. Turning to revenue by technology, Flash revenue was $2 billion, down 2% sequentially and up 11% 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 7% sequentially. Hard drive revenue was $1.9 billion, up 4% sequentially and down 20% year over year. On a sequential basis, total Exabyte shipments were up 2%, while the average price per hard drive decreased 8% to $73. As we move into cost and expenses, please note that all of my comments will be related to non-GAAP results unless stated otherwise. Gross margin for the second quarter was 26.4%, up slightly sequentially and above the upper end of the guidance range provided in October. Our flash gross margin was up 0.7 points from the last quarter to 27.1% as the mix shifted toward our client SSDs, and we experienced a strong seasonal quarter in client solutions. We continued to achieve solid cost reductions. Our hard drive gross margin was 25.6%, down 0.6 points sequentially. The mixed shift towards notebook and desktop hard drives and the early ramp of our energy-assisted drives pressured our gross margin. This includes COVID-related impact of approximately $32 million. Non-GAAP earnings per share was 69 cents above our guidance range. Operating cash flow for the second quarter was $425 million, and free cash flow was $149 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 $276 million. In the fiscal second quarter, we paid off $248 million in debt, including an optional debt pay down of $150 million and $35 million of the remaining SanDisk convertible notes. 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 $9.3 billion. Our debt to EBITDA ratio was 3.9 times in the second quarter. Our adjusted EBITDA, as defined in our credit agreement, was $3.5 billion, flat sequentially, resulting in a leverage ratio of 2.7 times. As a reminder, our credit agreement includes $1 billion 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, our fiscal third quarter guidance is as follows. We expect revenue to be in the range of $3.85 to $4.05 billion, and we expect both HDD and flash revenue to be in a similar range in the third quarter as they were in the second. This range is better than expected when you consider normal seasonality, which would have implied a 7% decrease sequentially in the third quarter. We expect non-GAAP gross margin to be between 25.5 and 27.5%. We expect flash gross margin to improve sequentially as we anticipate flash price declines will improve from the fiscal second quarter and cost reductions will continue. Hard drive gross margin is expected to be down sequentially primarily due to higher volumes of our 16 terabyte drive and a planned reduction in production volume. We expect the 18 terabyte drive to be the leading capacity point as we head into the second half of the calendar year, which should propel growth in this segment going forward. We expect operating expenses to be between $705 and $725 million. Interest and other expense is expected to be approximately $70 million. The tax rate is expected to be approximately 23% in the third quarter, and we expect non-GAAP earnings per share to be between 55 and 75 cents in the third quarter, assuming approximately 310 million fully diluted shares. Now, I'll turn it back over to Dave.

Thanks, Bob. As we discussed, Western Digital has worked hard to position ourselves to address this unabated growth in data and therefore storage technology. And thanks to these efforts, the market has aligned favorably for us. We're running two industry-leading technology franchises in end markets that will only continue to grow as the digital transformation further accelerates. We know that our HDD business is less encumbered by workload mix shifts today, and that our flash business is becoming more and more driven by applications. We also have made the right investments, and our joint ventures with Keoxia are a strategic, differentiating asset. This is an extremely exciting time for our company as we are focused on capitalizing on the tremendous opportunities in front of us. Accordingly, we will continue building momentum behind our business unit strategies company positioning, strong brand, and industry-leading portfolio. I'll now turn the call over to the operator to begin Q&A.

Thank you. Ladies and gentlemen, if you have a question at this time, please press star then 1 on your telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. We ask that you please limit yourself to one question. Our first question comes from the line of Aaron Rakers with Wells Fargo.

Yeah, thanks for taking the question. Just kind of on the Nearline hard disk drive market, I know that you talked about some puts and takes with regard to qualification cycles on the 80 terabytes. But I guess the question, first of all, is can you help us understand what capacity shipments did in the quarter for Nearline? And just help us understand kind of the shape of the ramp that you expect on near line as far as capacity shift over the next quarter or a couple of quarters, which, you know, however you want to kind of, you know, discuss your expectations on AT&T's ramping going forward. Thank you. Thank you.

Yeah, I would say – thanks, Aaron.

So I would say the mix last quarter was still 14-16 for the most part. Of course, there were so many teams mixed in there. But as we said, one of the big calls that we were working on kind of finished right in the first week of the following quarter. So we expect that now to start ramping. You know, I think, as I said in the remarks, I think cloud digestion is abating. So I think the different big players come out of it at different rates. And the first ones are already starting to come out. We expect other ones to pick up as we go through the year. So the big thing for us is we expect 18 to, as we get into the middle part of the year, that's where the transition will happen of it being the leading capacity point for us. And as that happens, that's good for our business. So that's basically how we see it. And what did capacity shipments do in the quarter?

Well, we don't split it out specifically, but you can see that on the data center devices and solutions, we were down quite a bit. And that was driven both by the capacity enterprise as well as the enterprise SSD. Okay.

Thank you.

Sure.

Thanks, Aaron.

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

Great. Thank you. Thanks for letting me ask the question. In terms of the NAND gross margins, the improvement that you saw in the December quarter sequentially with prices down 6% like for like and the improvement that you're seeing in Q1, where is that coming from? And can you remind us where you are with the startup expenses from the new FAB rolling off?

Yeah, so I'd say kind of as we started talking about last quarter, in the more transactional markets, we're seeing pricing get better. You know, we'll see how that flows through to the negotiated markets over the next couple of quarters. But basically, as we went through the quarter, we saw retail and parts of the channel improve. And as far as K1 costs,

Yeah, I can update you on K1. So I think I had originally guided to around $50 million in K1 startup costs this quarter, and we actually came in around $40 million. And this quarter, the quarter we're now in, will be a normal production volume. So we're not going to continue reporting startup costs because we're really not in startup mode anymore.

Great. Thank you. And then in terms of your inventory level, I think you said that the The inventory increase was mostly on the drive side. Where are you in terms of your internal manned inventory?

The flash inventory is pretty consistent with the last couple quarters. We haven't really built inventory on the flash side. We really, as we mentioned in our remarks, really built some inventory in anticipation of the new drive, the new capacity enterprise drive shipping, and that's going to start in higher and higher volumes as we go forward.

Great. Thanks so much.

Thanks, Jerry.

Thank you. And our next question comes from the line of 1C Mohan with Bank of America.

Hey there.

Yes, thank you. Thanks for the call on the data center side. I was wondering, just given your comments around the qualification timing, can this segment grow in fiscal second half versus fiscal second half of 2020, especially given that the comps sort of get tougher? by the end of the fiscal year. And your comments on HDD gross margins sort of worsening sequentially, is this basically, are we waiting for one more quarter, basically the end of the fiscal year, before we see HDD margins pick up as you get material pick up in 18 TB, or will these cloud sort of abatement plus the OEM pickup help by a fiscal fourth quarter? Thank you.

Okay, let me see if I can decompose that a little bit. So, yeah, we expect a pickup as we move throughout the year. I think your call on the Grow Smart, we see the revenue coming back as we move into the next quarter and then getting better throughout the year. We kind of guide one quarter at a time. I don't have the year-over-year number on the top of my head, but you're right on margin. We kind of expect one more quarter of maybe flat to slightly down margin on the drive side year. and then we'll start to see that accelerate, especially as we move through into higher percentage of 18Ts.

Okay, great. Thank you.

Thank you. And our next question comes from the line of Toshi Yahari with Goldman Sachs.

Hey, Toshi.

Hey, thanks so much for taking the question. I wanted to follow up on – gross margins in your HCD business. Um, David, so again, as you, as you mentioned, this quarter is going to be flat to down. Um, as you, as you move forward, um, with mix improving, hopefully COVID costs abating at some point, um, maybe some of the costs related to energy assist going away. Um, do you, do you think getting back to 30% over the next year or so is, is a reasonable target or, um, Is the margin profile structurally different today versus, you know, a year ago, two years ago? Thank you.

No, I think you hit on the issues there. I mean, first of all, COVID, last quarter was about 1.7% of a headwind in that business. In the mix, we talked about retail being, you know, multi-year high. But we believe as we go into 18, we have a path back to the kind of margin profile you're talking about. We just need to get the mix better. I mean, COVID is a bit of a wild card. How fast the – it's really the freight costs, how fast we can get freight costs to come down. It's been obviously pretty sticky about where it's been for the last couple of quarters. And then, as I said, as we move into 18 and we see the cloud – fully come out of cloud digestion, I think you'll see a path back to a more traditional margin structure.

Got it. Thank you.

Thank you. Our next question comes from the line of Matty Hussain with SIG.

Yes, thanks for taking my question. On the flash side, can you please provide some color as to what percentage of flash revenue were driven from gaming, and how do you see that trending for the rest of the year? And I'll have a follow-up.

Yeah, gaming is still, you know, I think it's not as significant as it was last quarter, given last quarter there was a lot of buy and anticipation of the initial builds. So I would say it's down a little bit sequentially, but it's still a great market for us because we can play the console side of it and the retail side with WD Black, which has been very, very well received in the retail channels. It is part of the reason the retail business is doing well and the margins are good as we're investing in brand in addition to just the product. So sequentially down a little bit, but still expected to be a good market as we move throughout the year.

Gotcha. And then one additional follow-up on the Flash side. Last earning conference call, you alluded to the fact that you are a couple of quarters away from finalizing contracts with OEMs. And as prices or supply demand tightens, do you see OEMs stepping up and signing longer-term contracts, or is this just going to be a guesswork as to how they plan for, especially like one or two quarters out?

I think what I talked about last quarter was actually a qualification at the OEMs, and that's a multi-quarter activity. The pricing is negotiated on a quarterly basis, and there's kind of a long-term agreement of, let's say, on a year timeframe of what the target share is, but that can move around a little bit. But that gives you a sense about kind of how the market works.

But how do you see that dynamics like today compared to like October conference call?

Of which part? The qual or the share or the pricing?

Well, the qualification and how I think as you look into the remainder of the year, do you see more of a pricing power coming back to the suppliers or is it still going to be a hard negotiation?

Well, I mean, so the qualification was all about our second-generation MBME enterprise SSD product, which is quite a mouthful. But that – I think last quarter I said we were scheduled to start a qualification. This quarter – well, I said in October we were scheduled to start a qualification in our fiscal second quarter, which did start and is underway. And that is a multi-quarter process, and – you know, assuming it's successful, will put us in a stronger position to ship that product into the OEM, into the big OEM. So, you know, it's underway. As I said in the prepared remarks, and I think I've been talking about now for a couple quarters, the qualification in my book is the last phase of the development process. It can move around a little bit, but the fact that it's underway is a good sign for, you know, We're working to expand the TAM of that product.

Got it. Thank you. Thank you. Our next question comes from the line of CJ News with Evercore.

Hey, Jack. Good afternoon. Thank you for taking the question. Question on the net side. Can you speak to what's driving the betterment seasonal demand in Q1 and then beyond March? How are you thinking about changes in your mix and what impact that will have on your gross margins? Thank you.

So I'll give you a perspective. I'm sure Bob has a perspective as well. So we've been talking about retail for several quarters now. It's been good. The team has been doing a great job launching new products. I talked about WD Black in the gaming segment, Armor Lock, security in Enterprise SSD. So a lot of really good work there. And so that continued, you know, we expect that, you know, there's momentum there, let me put it that way. PC notebook demand we still see as being strong. And, you know, we talked about what I think was a significant milestone for us this past quarter was finishing the qualification of our second generation MBME enterprise SSD product at one of the cloud titans. And that finished right at the end of the quarter, and we started shipping. So that's accretive as well.

Yeah, I don't have a lot to add. I mean, I think retail continues to be strong in this work-from-home environment, and the enterprise SSD business will just keep picking up.

And just to follow up on how you're thinking about mix beyond the current quarter and what the implications are for margins –

Well, I mean, say a little more. I mean, we still have a balance. I would say we're focused on a balance for portfolio. I mean, we're clearly working on improving our position on Enterprise SSD. That's been a big goal for the company for even before I got here. And, you know, our second generation product, Things are going well. I think 150 qualifications now, including one of the big cloud players, which is a good breakthrough. Client SSD is obviously a strength for the company and has been for a while. We talked about gaming last quarter. And then mobile, we still, you know, we still have a healthy mix into mobile. I think we're under indexed to the market, but we're still in that market because it's very, very important to be in that market. So I expect a balanced mix across that. And then, you know, you mix in some IoT and automotive and you get most of the portfolio.

Thank you.

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

Great. Thanks for taking my question. The question I have is on NAND. It's good to see NAND margins improving and price decline moderating. How do you see industry supply-to-man balance for the rest of the year, maybe compared to what you think a quarter ago? And how do you see your own bid shipment growth this calendar year and kind of the shape of that for the rest of this year? Thanks.

I guess what we would say about investment in the industry is we're pretty much where we've been, which we think the industry has been pretty good about this. I mean, there's a lot of variability on investment, on supplier by supplier. Capital cycles vary. Even node transitions within each supplier vary about how much capital is required. In our case, BIX 5 is a very capital-efficient node. BIX 6 will require a little more capital. We'll talk about that when we get there. So we still see a pretty good balance. We see strong demand drivers. I think we see BIT growth this year probably low 30s, low to mid 30s, and we see demand above that. So I think nothing we're seeing in the environment surprises us tremendously.

Okay, thanks.

Thank you. And our next question comes from the line of Patrick Ho with Stiegel.

Thank you very much. Dave, maybe qualitatively, now that you've been at the company for almost a year, without any, I guess, financial quantification, with the two businesses now separated, Where do you see the most improvement in the time that you've been here so far? Is it in the R&D side of things? Are you more efficient there, manufacturing, supply chain? Where have you seen the most gains? And where do you think, as you go into your second year, you see more opportunities to improve?

So I guess what I would say is, first of all, it's been an extraordinary 10 months, and especially to join the company at the beginning of a global pandemic. that hasn't happened in our lifetimes, at least not mine. And so I think it's just been extremely impressive to see how the company has responded to that and the evolution of that in the early days. A lot of issues on the supply side that have just been completely worked out and things are running extremely well. I think we've made a lot of progress on just what you said, really understanding where the synergies of this portfolio are, which are on the go-to-market side, and the fact that we bring a broader solution to our customers. And I think we understand our customers' requirements well, given that we can play in both the drive market and the – flash market, but that they're very different products and driving the roadmaps of them. I mean, the technology is extremely, you know, extremely important and to separate those in the EU, and I think we, you know, we're, it's still pretty early, but the impact of having two very accomplished leaders join an already strong team, it just has an immediate impact on clarifying the roadmap and understanding where we're investing our R&D dollars, engaging with customers in a way that can drive the portfolio. So I think we've made really good progress there, but I think it will continue to get better as we go when these leaders and the groups get more established. And then the other thing I'll say, which is not really something – that I expect to get better. I think it's something that I just always want to reinforce is the value of the partnership with Keoksha. And I've spent, you know, given I can't travel, we've still spent a lot of time with the leadership there. Obviously, our teams work together on a day-by-day basis. I'm not saying, I'm not pointing this out because it works extraordinarily well And it's just a tremendous strength of the company, and it's been really great for me to be a part of it over the last 10 months.

Great. Thank you.

Thank you. Our next question comes from the line of Mitch Thieves with RBC Capital Markets.

Hey, Mitch. Hey, how are you doing, sir? I have two questions. I'm actually going to focus a little bit more on the hard disk drive side. So first is just kind of on the margins. If I look at kind of the run rate of the business right now, and I compare it to 2018. Back then, it was kind of a 27% gross margin business on roughly $2 billion in revenue. So if I assume that COVID-related headwinds and kind of the supply chain issues are about 100 basis points of headwinded gross margin, am I roughly accurate there? So I'll start with that one, and I'll have a follow-up after that one.

Yeah, I think it's closer to 170 basis points of headwinds.

So the number would have been kind of 27.2, 27.3 in that reference? Yeah.

Yeah, that's correct.

Okay. And then secondly, you guys used to disclose a little bit more detail on the non-compute units. I think those are pretty significantly Q over Q, 8.2 going to 10.1. I'm just curious if you can give us any sort of, like, directionality and, you know, was it more consumer electronics or was it more your branded units or doing better for the quarter? Sure.

Yeah, I don't want to get too much into specifics, but one of the things we did mention was smart video was up quite a bit sequentially, and that's in the non-compute area. But, you know, we're just on the hard drive side, on client and notebook, we did really well.

Thank you. And our next question comes from the line of Tom O'Malley with Barclays.

Hey, guys, thanks for taking my question. My question is really centered around the transition of the two cloud titans with the HGT qualifications. You said one slipped, but a little one came in a bit earlier. Can you talk about, you know, what the mix of those transitions kind of nets? You talked about, obviously, the gross margin slipping into the next quarter, but then kind of recovering, so we're seeing a bottom there. Do you think that the out quarter is better? benefiting from this with the one coming in earlier, or do you think it's a net negative transaction in the near term? I just want to get a little bit more color about how it affects the business into March.

Yeah, I think – so if you look in last quarter, there was some business we expected to ship on 18 that we didn't because the qualification wasn't done, and it actually wrapped up, I think, the first week of January. So some of that business – mixes into other capacity points, and some of it goes to other suppliers. And then in the other qualification that we didn't expect to finish until – it wasn't – we didn't – and the schedule was the end of the – towards the end of this quarter we're in. That actually finished sometime last quarter very smooth. So – You know, what it says is looking backwards that things, you know, could have been a little better if the one would have finished on time. But now they're both behind us. So going forward, we're in a position to start to shift 18s to both of those customers as they ramp the capacity point. Does that help?

Thank you. And our next question comes from the line of Harlan Serner with J.B. Morgan.

Hey, Harley. Good afternoon. Thanks for taking my question. On the gross margins on the flat side of the business, you know, good to see the inflection in gross margins in December. As you guys mentioned, startup costs are coming out here in the March quarter. So that's about 150, 175 basis points gross margin tailwind to NAND. And then on top of that, you're seeing better pricing trends and maybe getting a little bit of benefit from the higher the margin trends from your initial shipments of your Gen 2 NVME products. So are gross margins approaching 30% here in the March quarter? Or maybe if you could just help me understand some of the puts and takes on gross margins for NAND.

Yeah. So, Harlan, I mean, you talked about a number of the moving parts. And we're definitely, as I said earlier, expecting gross margins to improve on the flash side. We saw in the last quarter, you know, I'd say very good pricing trends in the transactional markets. In the OEM markets, we negotiate one quarter at a time. So, you know, and we did that obviously in the middle of last quarter. So it's a little hard to say how much we'll see there. And then we're continuing to do a good job on the other part of the equation, which is cost reduction. We still think we're very confident in our 15% year-over-year cost decline. So I think it's just a question of how pricing plays out as we move forward. But I think we're in a very good place.

Yep, absolutely. And just a follow-up. So many of the suppliers of your HDD and SSD controller chips are seeing tightness in wafer supply, assembly and test capacity. Are your shipments here in the March quarter potentially being somewhat held back because of lack of controller availability from some of your merchant or ASIC controller chip suppliers?

Yeah, there's no doubt things are tight, and we're not immune from that. I mean, clearly we have our financial plan covered with components, but, you know, when you do go looking for things from the semiconductor supply chain, it is tight right now. So we'll see how it plays out during the quarter.

Thank you. And our next question comes from the line of Nick Todorov with Longbow Research.

Yeah, thanks, guys. Good afternoon. I understand, David, I think you talked about seeing continued momentum in retail and PCs, but maybe we can extend a little bit. I would like to hear your thoughts about how you see those trends persisting as we look forward. I know visibility is probably not as Good, but I just want to hear your thoughts. How are you thinking as we go into the following quarters, the demand from PCs and retail and work from home specifically?

Yeah, I mean, it's obviously a very dynamic environment with the pandemic and, you know, seeing resurgence in certain parts of the world and more lockdowns in parts of the world and So it's hard to call it more than one quarter of time. We guide one quarter of time, but I understand your question a little bit broader. I guess what I would say is in retail, we've really just dialed in how to deal with this environment we're in and the dynamic nature of it. And I think that the new products that we've been launching have been well-received. Again, the WD Black Gaming product, we're doing co-branding. with other folks. You know, we introduced a product around security and storage that I think is going to be, you know, good for us. So, a lot of investment in the brands, which are strong, making sure we keep share of voice high. And, you know, it has been an area where we've been able to get some momentum and keep some momentum, I think, going a couple quarters back. So, But it is, to your point, it's very dynamic given the COVID situation and the lockdown. So, you know, we'll see above seasonality performance. Q1 is a seasonally weak quarter for retail, but we're planning to do a little bit better than that.

Thank you. And our next question comes from the line of Ananda Barua with Loop Capital. Hey there.

Hey, good afternoon. Thanks for taking the question. Yeah, I guess if I could just go back to the gross margins on the flat side. Longer term, intermediate term to longer term view, do you guys see a path to sustainably greater than 30% margins? I think you've talked about it in the past. And, you know, if so, you know, what are the kind of signposts or mechanisms that need to manifest to have that be the case? Appreciate it.

I guess I can start with that. And, again, as we all know, a lot of this depends on the supply and demand and what's going on with the industry. We've been encouraged, as we said, about the pricing in the transactional markets over the last few months. As we move forward, we're pretty confident on the demand side for the year. I mean, there's just obviously a big demand on the mobile side. We think we're going to see very good demand on the enterprise SSDs. We've already had a strong position on client SSDs. So we feel pretty confident on the demand side. And we think the supply side appears to be pretty rational. And I think if that's the case, we should see margins improve from here. But I don't want to put a particular milestone or a particular goal out there. But I think it's going to be a pretty good market in 2021.

Yeah, I think we've been signaling that about 2021 for a couple quarters now. Now, again, we don't want to get ahead of ourselves. We do have more exposure to the transactional markets, which helps when things start going in a positive direction. But it's got to flow through to the negotiated markets still. And, you know, we'll see how that plays out over the next couple quarters. The other thing I'll highlight on this is really important, Bob touched on earlier, is just make sure we maintain our cost positions. And as I've highlighted a couple times in the prepared remarks and what I said earlier, with our partner, Keoxia, we're the largest provider of NAND flash memory in the industry. We jointly develop our technology roadmap, so we're heavily invested in that. We believe we've got tremendous technology that allows us to deliver the power, performance, bits we need, you see our technology is, you know, lower layer count than others. That means it's a more efficient process. So we feel good about that that sets us up to continue to drive the 15% year-over-year cost decline. So we've got to make sure we keep our eye on that side of the equation as well.

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

Hey, Jim. Thank you. Hello. And you have implemented, you know, a more tightly focused on your two different segments, the FLASH and HDD segment, and kind of have been at it for a little bit now. Have they, those leaders, done the work to where we're actually seeing the fruit of all their efforts now, or are they still kind of implementing a lot of those and the fruit still has to be rolled out of their efforts? Because it seems like, you know, prior to this Western Digital has been very much known for a company that sometimes executes very well and other times has a few slip-ups. So I'm just trying to figure out, are we at the midpoint of them implementing all their changes or the early innings, or are we actually at the point now where what they found and discovered and wanted to align that we should expect going forward? Thank you.

Yeah, Jim, I think that – so first of all, I think we see benefits of – anytime you add two – leaders to your business that have run, you know, multi $10 billion portfolios in the technology space, you're going to get an immediate benefit from that. You just have two more very, very senior business leaders that are looking at the portfolio every day, that are engaging with customers every day, reviewing engineering products every day, and providing a level of perspective that is highly developed and, you know, their main job is to integrate all the different pieces together into a business. So you're going to see an immediate benefit of that, and we have. But then they're going to start working on, okay, you'll start looking at the roadmap of our products and make sure I've got the right fit, I'm investing in the right places. To me, your technology roadmap is kind of like an articulation of the future value of your company. What markets are you going to be in? Where are you going to invest? And the timeline for those payouts are different. There's different time horizons to that. So if you come into a technology franchise and you own it and you're in the middle of a big engagement with a customer, for example, you now have another person that can get involved in that process and understands immediately how to engage in that in a very senior way, how to communicate information. how to guide their teams. And so I think you'll see an immediate benefit. There's other parts of it where we're making decisions on what products are going to come to market in two years from now or three years from now. And so their job is to really integrate over all of those time horizons and get the best result given the investment we put in the business. So, you know, we've seen benefits already, but there will be more to come. and I think you will see a crisper execution, and you'll see that the portfolio is optimized to give us the best return for the investment we're making.

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

Yes, good afternoon, gentlemen. Thank you for letting me ask a question. Hi. I had a question just on, I guess, your hard drive business. You know, your peer... spoke about a recovery in data center in the first half of the year. And I'm curious if that resonates with you, such that you could achieve 35% exit by growth for your near-line business in fiscal 2021. And I was also hoping you could juxtapose what you're seeing across on-prem and cloud within that near-line business And then I guess thirdly, if I may, I was hoping if you can achieve that 35% exit by growth, can you do that with your existing capacity today or if you could touch on your capacity expansion plans as well? Thank you.

So I think the first part of the question was about what are we seeing when you say enterprise on-prem market. So... Nearline specifically. Yeah, nearline. I would say it's, you know, I think that term I used in the prepared market was stabilization of the enterprise of the OEM market. And I think that's kind of how we're seeing it. You know, it's on or above forecast of what our customers are telling us. So it looks better. I wouldn't, it's certainly not pre-COVID yet. And I, you know, it's easier to judge going forward, but not back to where it was. And that's not surprising given the environment we're in. As far as the cloud, we talked about different cloud providers come out of digestion at different rates throughout the year. And then as far as exabyte growth, we see that 32%, 35% in that range, exabyte growth. I think that's been the long-term growth of the industry. We see that going forward. Again, I think coming out of the pandemic, we'll see Does that line tilt up or not, given the dependence on technology and the cloud that we all see? But we have yet to see that. So we see good growth in the capacity enterprise business as we move through the year.

Thank you. And our next question comes from the line of Srini Pajuri with SMBC NICO.

Thank you. Hi, guys. First, I have a clarification for Bob. Bob, on the client devices growing 10%, you said desktop and notebook grew 20% and video grew 30%. There was an issue in China. Just trying to understand what that was in mobile in China that you were referring to.

Yeah, it was actually Huawei, which we talked about last quarter. And so we're not shipping to Huawei either on the flash side or on the hard drive side.

Thank you. And our next question comes from the line of Shannon Cross with Cross Research.

Thank you very much. I just had a question on CapEx. It seems as if you've shifted a little bit more, I think, from cash CapEx into the flash ventures. And I'm just curious how we should think about that. Is there anything there? And then also, you know, what are your thoughts on that? the amount of CapEx that's going to be needed over the next few years as you look at, you know, hopefully an improving market? Thank you.

Yeah, it's a good question. And first of all, what I would say is in terms of gross CapEx, which we define as our portion of the investments that are made in the flash joint ventures, as well as investments we make on our own balance sheet for the back end of the flash business as well as the hard drive business, We expect gross capex of around $3 billion this year, and that's been what I've said the last couple quarters. What's a little different this year relative to last year is we are investing more on the hard drive side. As we look out over the next few years, the first priority is always going to be reinvest in the business. And so we'll see how the growth goes over the next few years and make sure that we're investing to support the growth in the market. But, you know, I – Yeah, I think probably where we're at right now is about what I would think about for the future.

Great. Thank you.

Thank you. And our last question comes from the line of Stephen Fox with Fox Advisors.

Hi. Good afternoon. Thanks for squeezing me in. Can you just maybe broadly talk about your thinking around edge cloud compute for 2021 and It seems like, based on what the service providers are talking about, that this could be a year where it starts to pick up noticeably. And so where do you think you're going to play with NVMe drives versus HDDs, and how do you think you're positioned competitively? Thank you.

Yeah, I mean, I think that's potentially a very deep conversation. So how are we positioned? I think we're positioned actually quite well because we can play in if it's, you know, A lot of the heavy lifting of big-time storage is HDDs and will be for a long time, but obviously Enterprise SSD is going to be a big growing market there as well. That's why we're so focused on our NVMe Enterprise SSD. As far as how the architecture of the cloud plays out, I mean, clearly as we have more devices that are enabled at the edge, I think you're going to see more points of compute and storage that get closer to that. I agree with you. This could be, you know, it could be getting closer. It's been talked about for a while. But, you know, I think this is something that's so exciting about our business. I mean, the whole world is more technology enabled. I think the pandemic accelerated that. I think the architectures to support that are going to continue to evolve. And I think we have the portfolio that's well positioned. No matter how that plays out, we can play on the edge all the way to the device. and clearly we play at the foundation of the cloud as well. So it's a fun place to be.

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

All right, everybody. Thanks for joining us today. We appreciate it. We will see you during the quarter. Take care.

All right. Thank you. This concludes today's conference call. Thank you for joining, and you may now disconnect.