Western Digital Corporation

Good afternoon, and thank you for standing by. Welcome to Western Digital's fiscal third 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 telephone. As a reminder, this call is being recorded. Now, I will 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, 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 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.

Thank you, Peter. Good afternoon, everyone, and thanks for joining the call today. We reported solid third-quarter results above the guidance range provided in January with revenue of $4.1 billion, non-GAAP gross margin of 27.7 percent, and non-GAAP earnings per share of $1.02. Sequential revenue growth was driven by increasing momentum of our high-capacity energy-assisted drives and our second generation MVME enterprise SSDs, improving NAND flash pricing trends, along with the continued accelerated digital transformation across end markets. As we continue to manage the impact of the pandemic, we know that the world is not only more technology enabled, but also more technology dependent than ever before. From the intelligent edge to the cloud, Data storage is a fundamental component underpinning the global technology architecture. Western digital strengths in technology and cost leadership, expansive product portfolio, and broad routes to market are providing a foundation upon which we are solidifying our position as an essential building block of the digital economy. These strengths combined with our increased operational and strategic focus enabled by our new business unit structure are driving results. As we continue to face a dynamic environment, we are seeing the benefits of the synergistic value in the breadth of Western Digital's portfolio in our unique ability to deliver both hard drives and flash solutions to our diverse end markets and customer base. Let me now provide a recap of our flash and HDD businesses. Within flash, the depth and breadth of our product line, distribution channels, cost leadership, and customer base are significant differentiators. Our ability to act swiftly and shift bits to meet customer demand in various end markets, ranging from data centers to retail, enabled us to grow both revenue and gross margin in the third quarter. Within data center devices and solutions, we experienced significant growth in the quarter with our second generation NVMe Enterprise SSD at a Cloud Titan. In addition, we are seeing many cloud customers also utilize NAND Flash for their consumer product lines. This creates many opportunities for us as a strategic partner as we continue to diversify and balance the end markets we serve. We are already achieving significant progress in VR headsets, game consoles, and other at-home entertainment devices, where we have experienced over 10 times bid growth last calendar year, and expect to double again this calendar year. In client devices, continued strength in PC demand along with the new game console ramps drove sequential revenue growth above typical seasonal trends. Retail remained a high-performing end market as our brand recognition, broad product portfolio, and extensive distribution channels continued to distinguish Western Digital from our competitors. In particular, It was a solid quarter for gaming, with our WD Black product line having maintained strong levels of interest as gamers have gravitated towards more customized solutions. By delivering reliable performance, expansive storage capabilities, and a hyper-realistic gaming experience, our industry-leading WD Black portfolio is trusted by gamers to perform their best. We are also excited about the future, as Western Digital's technology roadmap and cost leadership will continue to drive our ability to meet customers' needs. BIX 5 is in the midst of a significant ramp, exceeding customers' expectations and delivering the reliability and performance our customers depend upon. Moreover, the technology advancements we made with BIX 5 have allowed us to achieve the scale, efficiency, and bit growth needed while using a lower number of layers, resulting in lower costs, and lower capital intensity. We continue to expect BICS 5 bit crossover later in 2021. Finally, in February, we revealed BICS 6, our next generation flash device based on 162 layer and CUA technology. Developed in partnership with Kyoksha as part of our longstanding successful joint venture, BICS 6 features numerous architectural advancements including improved lateral scaling, which allows us to deliver this high-performing product at an optimal cost. This marks another major milestone in our 20-year relationship with Kyoksha, and together we will continue to drive innovation to meet the needs of our respective customers in their diverse applications. In HDD, revenue growth was led by capacity enterprise drives. a trend that tilts the overall HDD market to growth as demand for capacity enterprise drives will more than offset the decline in client drives. Meanwhile, retail HDD demand was better than expected, supported by continued work-from-home, distance learning, and at-home entertainment trends. We continue to see enterprise demand stabilizing and expect a pickup as employees return to work. We have completed qualifications for our energy-assisted drives with nearly all our cloud and enterprise customers, including all the cloud titans, and expect an aggressive ramp of our 18 terabyte hard drives. Building on this success, we've entered into long-term agreements with a number of our cloud titans for 18 terabyte drives. These commitments underscore our product leadership in the importance of capacity enterprise drives to our data center customers. As we continue to navigate challenges brought on by COVID-19, we know that the world is not only more technology enabled, but also more technology dependent. We believe this is a fundamental and sustainable trend highlighting the importance of Western Digital's broad portfolio of storage solutions, and we're encouraged by what's ahead. In flash, improving pricing trends in the retail and transactional portions of the market are translating to better pricing in the negotiated portions of the market. And we expect this trend to continue in the fiscal fourth quarter. Our unique ability to provide high volumes of flash and hard drive solutions through extensive distribution channels and to diversified end markets provides us with broad demand visibility, enabling our team to optimize product mix and profitability. In the cloud, we remain uniquely positioned to benefit from the strong growth in this sector, where NAND flash and hard drives are complementary solutions. We expect the strength to build as we progress through the calendar year, led by the ramp of our 18 terabyte hard drives, as well as broad-based growth in flash. And while we are excited about these drivers, we are also keeping close watch on some headwinds. To date, we have been able to largely mitigate the impact of the industry-wide semiconductor component shortages through proactive supply chain management. We are, however, experiencing tightness in controllers as well as flash, which could limit potential upside in the future. We also recognize that while the pandemic effects are lessening in some regions, others are unfortunately experiencing another wave of cases. We are actively managing through this environment which continues to have ongoing impacts to our business. 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 third fiscal quarter were above the upper end of the guidance ranges provided in January. Flash revenue and gross margin improvement were the primary contributors to the upside versus guidance Total revenue was $4.1 billion, up 5% sequentially and down 1% year over year. Looking at our end markets, client devices revenue was $2 billion, down 6% sequentially and up 10% year over year. On a sequential basis, client SSD revenue was flat and notebook and desktop PC hard drive revenue was down. though it decreased less than what we're used to seeing based on typical seasonality. Gaming revenue grew while mobile revenue was down on a sequential basis. Moving on to data center devices and solutions. Revenue was $1.2 billion, up 53% sequentially, but down 19% from a year ago. Revenue from both capacity enterprise hard drives and enterprise SSDs grew sequentially. We were encouraged to see the sequential growth driven by our new energy-assisted hard drives at the 16 and 18 terabyte capacity points and our second-generation NVMe enterprise SSD products, both targeted for the cloud and large-scale enterprise OEMs. Lastly, client solutions revenue was $888 million, down 12% sequentially and up 8% from a year ago. Turning to revenue by technology, flash revenue was $2.2 billion, up 7% sequentially and up 6% year-over-year. Flash ASPs were down 2% sequentially on a blended basis and flat on a like-for-like basis. Flashbit shipments increased 8% sequentially. Hard drive revenue was $2 billion, up 3% sequentially and down 7% year-over-year. On a sequential basis, total hard drive exabyte shipments increased by 7%, while the average price per hard drive increased 14% to $82.00. As we move to costs and expenses, please note that my comments will be related to non-GAAP results unless stated otherwise. Gross margin for the third quarter was 27.7 percent, up 1.3 percentage points sequentially. This was above the upper end of the guidance range provided in January. Continued success in driving down costs coupled with an improving pricing environment And our ability to shift bits to more attractive end markets drove our flash gross margin up 2.9 percentage points sequentially to 30.0%. Our hard drive gross margin was 25%, down 0.5 percentage points sequentially. As noted last quarter, production ramped costs of our new energy-assisted drives and a planned reduction in overall unit shift pressured gross margins. This also includes COVID-19 related impact of $31 million or approximately 1.6 percentage points. Operating expenses of $732 million were higher than guidance due to a larger than expected variable compensation accrual tied to our improved profitability. With our improving profitability, our tax rate in the fiscal third quarter was 8%. which was well below our prior expectations and directly resulted in a 17-cent benefit to our earnings per share. We now expect our tax rate to be 17 percent for fiscal year 2021. Earnings per share was $1.02. Excluding the tax benefit, earnings per share was still well above guidance. Operating cash flow for the third quarter was $116 million, and free cash flow was negative $11 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 $127 million. In the fiscal third quarter, we paid off $212 million in debt, including an optional debt pay down of $150 million. We'll also be making an additional optional debt payment of $150 million this Friday, highlighting the confidence we have in our cash flow generation for the fourth quarter. Our liquidity position continues to be strong. At the end of the quarter, we had $2.7 billion in cash and cash equivalents, and our gross debt outstanding was $9 billion. Our adjusted EBITDA, as defined in our credit agreement, was $3.5 billion, resulting in a growth leverage of 2.6 times. As a reminder, our credit agreement includes a $1 billion add-back of depreciation 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 fourth quarter non-GAAP guidance is as follows. We expect revenue to be in the range of $4.4 to $4.6 billion, and we expect both hard drive and flash revenue to be up sequentially. We expect gross margin to be between 30% and 32%. We expect both flash and hard drive gross margin to improve sequentially as well. We expect operating expenses to be between $760 and $790 million. Interest and other expense is expected to be between $68 and $73 million. The tax rate is expected to be approximately 17 percent in the fourth quarter and the fiscal year. We expect earnings per share to be between $1.30 and $1.60 in the fourth quarter. assuming approximately 317 million fully diluted shares outstanding. Now I'll turn it back over to Dave.

Thanks, Bob. As technology continues to advance, our powerful portfolio will remain centered on developing solutions to our customers' evolving storage needs. Western Digital's unique ability to offer complementary flash and hard drive products benefits the industry, our customers, and our company as a whole. While market conditions continue improving, I believe the organization and leadership changes made over the last year are now delivering more agility, better execution, and a stronger portfolio, and collectively are driving results and unlocking the underlying strengths of Western Digital. We are in a unique leadership position and feel confident that we can continue to drive innovation while delivering value for all of our stakeholders. We will now begin the Q&A session.

Thank you. Ladies and gentlemen, as a reminder, to ask a question, you will need to press star 1 on your telephone. We ask that you please limit yourself to one question and one follow-up question. To withdraw your question, please press the pound key. Please stand by while we compile the Q&A roster. Our first question will come from Aaron Rakers with Wells Fargo. Please go ahead.

Yeah, thanks for letting me ask the questions and congratulations on the execution in the quarter. I guess the first question I have is you mentioned in your prepared remarks about establishing long-term purchase agreements with some of the cloud customers or cloud titans. Can you help us appreciate that a little bit more? Can you give us any context of how those agreements are structured? Are they volume related? Are they take and pay, just any kind of clarity on that and how that would compare to kind of prior engagements with those customers on product cycles.

Yeah. Hey, Aaron, thank you. You know, it's something we've been working on, you know, for a while, I guess. I mean, when I got here a year ago, it kind of struck me that it was a big business and it was very transactional. And the more certainty we could put around it would be better for all of us, you know, especially going into a, a world where we're going to be investing capital in this business and we're trying to judge supply and demand and get that right as the market shifts to capacity enterprise. So, you know, they're multi-quarter agreements, as you would imagine, and we talk about the amount of demand they're going to have and we set a price for that period. So as opposed to just going quarter by quarter, we're extending that out to multi-quarter agreements to give us both more visibility around the business.

Okay.

And I guess maybe somewhat related to that, you know, just thinking about the hard disk drive business as my follow-up is, you know, I guess a simple question is how do we go from a 25% gross margin back to, you know, what I think is still probably the target of at least 30%, if not higher, gross margin and hard disk drives? How do we think about the variables to bring us back to that 30% plus level?

Well, I think, I mean, so the first part is getting out of COVID. I think we had a 1.6% impact on gross margin due to COVID. So that continues to be an issue. And we're all hoping things continue to get better there. Obviously, mix is a question or an issue as we get more client in the work from home. That's not necessarily a bad thing, but it's definitely a different margin profile. And then getting to scale on the capacity points where we can continue to drive the costs down. And we can't control the pricing in the market, but continuing to deliver a strong TCO proposition for our customers. And that's what we're continuing to do. We believe we have a long roadmap of continued density and aerial density improvements on HDDs. They're the foundational storage element in the cloud, which I think is a very good place to be. And so we're working on it from all of those angles.

Okay. Thank you. Thank you. Thanks, Aaron. Thanks, Aaron.

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

Yeah, good afternoon. Thank you for taking the question. I guess first question was hoping to discuss just overall gross margins. So very nice uplift there. And in particular, your cost sales on the NAND side in the March quarter were fairly spectacular and clearly better than what we saw across most other NAND players. So, you know, can that 20% improvement year on year continue as we go through the year? And what other kind of drivers should we be thinking about impacting gross margins into June?

Yeah, so we're happy where the technology is. I mean, I think we're going to, you know, we're still at our, you know, we target 15%. Some quarters we do better. Some quarters maybe we do a little worse than that. We're in a good spot. You know, a lot of the portfolio is on BICS4, which is a very high-performing node for us. So, you know, we're very happy with the cost downs. Hopefully you tuned in to Dr. Siva Sivaram's discussion of NAND technology and kind of what's driving it. All of this, we do believe very strongly in our technology roadmap with Keoksha. Between us, we're the biggest investor in NAND, and so we have a lot of confidence in our roadmap and to be able to sustain that. As we look into the next quarter, we talked about it, we continue to see a good pricing environment. You know, we expect to continue to get good cost downs in the portfolio and in a rising price environment that puts us in a good spot to drive gross margin.

Okay, very helpful. And we are beginning to ramp our fixed 512-layer technology as well, which will continue to help bring the costs down.

Great, thank you. And then I guess, can you speak a bit to the rebound you saw in the enterprise market? HCD side, pretty strong, up 16% sequential units. Can you share with us how to think about 16, 18 terabyte ramp and the prospect for faster growth as we go through the year? Thank you.

Yeah, we expect sequential growth in that market. I think this quarter we had basically a balanced shipment of capacity enterprise across 14, 16, and 18 terabytes. And we see that shifting strongly to 18 sequentially. And we expect that to drive, we see sequential exabyte growth and also sequential gross margin improvement in the portfolio as we move forward as well.

Great, thanks.

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

Great, thank you. Also on the enterprise side, if you could talk about the enterprise NVMe progress that you've had. You know, you're citing a CloudTitan customer there. Are there, you know, prospects for more, and where would you say – I know you had a late start with enterprise NVMe. Where would you say your share is, and can you kind of get to where your share in the enterprise is similar to your share overall in the end?

Yeah. So we're working on quals with the big enterprise OEM, so that's still in process. As I talked about last time, that's a multi-quarter process. It's going along fine. We're seeing good demand in the channel for that product, so that's a good indication. As far as where we're going to land on share, I mean, I think one of the things to... We're really running a balanced portfolio across a whole bunch of different markets we're in, from client SSD to mobility. I think the big thing for us is to get the enterprise SSD qualified and now start to ship at scale. But we're still going to run a balanced portfolio across the big markets we have, which is client SSD, mobility, enterprise SSD, and of course, retail. and then with things like gaming coming up quickly as well. So we feel good about where the product is. We think it was a major milestone for us last quarter when we got the call done at a Cloud Titan, and we saw the benefits of that this past quarter.

Great. Thank you. And then if I follow up, 330 base points of gross margin improvement is pretty significant. Can you give us a qualitative sense of how much of that is coming from NAND versus DRIVE's?

Well, gross margins were up in both. I'm sorry. Gross margins were up on the flash side. They're actually down sequentially.

Yeah, I meant more in the June quarter, your guidance. In the June quarter.

Yeah, sequentially it would be up in both businesses, probably driven a little bit more on the flash side. Okay.

All right. Great. Thank you.

Sure. Thank you.

Thank you. Our next question will come from Toshi Ahari with Goldman Sachs. Please go ahead.

Hi, guys. Thanks for taking the question, and congrats on the strong results and outlook. David, you talked about shortages in your NAND business as it relates to controllers and perhaps raw NAND as well. Can you talk a little bit about the actual impact you saw in the quarter, what's embedded in your June quarter guidance, and when you'd expect some of these issues to be resolved?

Yeah, so we're working on, I mean, obviously we're working to get as much supply as we can. I mean, this past quarter we did see shortages in controllers, let's say in places like Chromebooks, where we probably couldn't get as many controllers as we would have liked and could have shipped a little more into that. But in general, what we're able to do is, with the supply we have, is shift the portfolio around to where we get the biggest return for that, whether it's moving those controllers to products in the channel or from retail into the channel and vice versa where we're going to get the highest return. So the agility I think that the team is implementing on all of our different go-to-market routes has been very beneficial over the last couple of quarters, and I expect it to be going forward as well. So we're able to mitigate it a little bit. We're not able to completely escape it, but we're going to continue working to get all the supply we can. And, you know, we definitely know what the forecast, it's matched to the supply we have. So we don't expect any surprises from that regard.

Got it. And then as a quick follow-up, I just wanted to get your thoughts on NAN supply demand going forward. Clearly, the near term is looking really good, and you spoke to that in your prepared remarks. But as you start to plan for fiscal 22, what are your thoughts on the overall market supply-demand and your intentions from a CapEx perspective? You obviously want to make the transitions and maintain share, but at the same time, you don't want to flood the market with too much supply. So what's sort of the debate internally? Thank you.

Yeah, so you got it right. I mean, we're going to invest to maintain share. We feel good about the demand situation. I mean, 22 is pretty far out. As you know, of course, we guide one quarter at a time. I have to say that. But we continue to see demand is strong into the second half of this year, certainly. I mean, whether it's in the PC market or in the cloud infrastructure market, we're pretty bullish. So You know, we'll manage it through the end of the year and be disciplined with our CapEx investments and go one quarter time.

Thank you.

Thank you. Our next question will come from Wamsi Mohan with Bank of America. Please go ahead.

Yes, thank you. Dave, I want to go back to the long-term agreements on 18TB. Is there any share basis for those agreements? And if not, how much share are you targeting at these customers?

Yeah, we don't go into that. We don't go into that much detail on a customer-by-customer basis. I mean, it's fair to say with these customers, we have longstanding and very deep relationships given our position in their data centers and given that 90% of the storage in the cloud is on hard drives. it's just about getting more visibility of what their plans are and getting it aligned with where we're going and making sure that our business is aligned with where their business is headed. It's kind of as simple as that to give us more visibility and try and move the market, as I said, from this transactional quarter to time to allow us both to plan for what the next several quarters look like.

Okay, thank you. And as a follow-up, on the HDD gross margins improving in the June quarter, is that more mix-related or lower-cost headwinds? Can you just help us think through what you think are more transitory, maybe in the cost headwind side versus an improving mix here? Thank you.

A big part of it is mix. I think we've been talking for a long time that the 18 capacity point is a better point for us. As I said, this quarter we shipped a pretty balanced number of 14s, 16s, and 18s, and we'll see that tilt strongly to 18s next quarter.

I think the cost will get better quarter to quarter as well. We slowed down production a little bit in the March quarter, and we're back at full production here in the June quarter.

Thank you.

Thank you. Our next question will come from Mehdi Hosseini with SAFE. Please go ahead.

Yes, thanks for taking my question. David, it's been about a year or so since you joined the company. And I remember when you first joined, you were doing somewhere around 250 of annualized earning. And fast forward 12 months, you're almost at a $6 annualized earning. Great improvement, but it's still well below 2017, 2018, when the company was doing north of $10 of earning. And I'm not asking you to give me a forecast or a guide for one or two years out, but I think it would be very helpful if you could articulate your views as to how earnings are going to improve here assuming that you just continue to execute and I have a follow-up.

Yeah. I mean, I think it's what, I think you're starting to see the better execution and build, you know, on the flash side, build out the portfolio across a number of end markets, which I think that enterprise SSD was, you know, a big piece of getting that established with the cloud Titans. We clearly have a very strong client SSD portfolio. We have a, I think a, very strong retail portfolio. You know, mobility we've talked about. We stay qualified with all the top vendors. We're very much participate in that market, maybe less than, definitely less than some others. And then we have a lot of, you know, new products coming around gaming and smart home devices where because of our strong relationships with those big cloud customers that also drive that portfolio gives us kind of a front row seat as those are developed. So, I think it's build out the portfolio and then use our routes to market to deliver the best return we can given the pricing environment in the market. I think we were able to do that in Flash this quarter and balance the portfolio across all the markets and put the agility in the system to make sure that we're doing that. I would say from a year ago to where we are now and the way we executed the last quarter, there's just much more agility in the system and to be able to react and get the best outcome we can. On the hard drive side, it's continue to drive aerial density and leadership. Return to a leadership position as we did with 18, and then continue that forward. It's a good market. I think we've had a longstanding position there. And then, you know, I think there's – we've seen this synergy between the two portfolios in the client space. We have a great client SSD portfolio where these technologies were substitutes for each other. We had longstanding relationships with those customers where we could manage that transition. And in the data center, there are more complementary technologies, and I think the ability to execute that synergy is in front of us.

Okay, thank you. And just a quick follow-up on HDD. I believe you still are restricted with shipment to certain customers, but your primary competitor has continued to ship. How do you see that geography and specific customers there playing to your disadvantage? And I'm assuming that you're still restricted.

Yeah, we've been, you know, since the commerce rules came out, I think back in September, we stopped shipping per the rules. We talk to commerce frequently. We have our own attorneys and outside firms. We know that that's the right position, and that's the position we continue to be in. You know, the licenses are pending with commerce, and we'll see how that plays out. I don't think there's been any, there hasn't been any movement there recently. As far as what our competitors do, and I can't speak to what they're doing, so I only have insight into our position, and we are clearly not shipping to places where we're not supposed to per Commerce Department regulation.

Thank you.

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

Thanks for taking my question. My first question is on the 18-terabyte drives. First of all, congrats on all the qualifications. But in terms of the RAMP, do you expect your 18-terabyte drives to cross over the 14-terabyte drives existing this calendar year? And will 18-terabyte be margin accretive right off the bat? Maybe follow-up to that is how are you thinking about strategy in terms of RAMPing 16 versus 18?

Yeah, so we expect 18 to be the primary, the highest volume we ship this quarter. So yes to the first question, and yes, we expect it to be margin accretive. We expect sequential improvement in HDD gross margin. The second question again.

The second question, it's 16 versus 18. Are you putting all your eggs into the 18-terabyte basket and 16 is just whatever the customers are asking for?

Well, I mean, I think it's always whatever the customer is asking for. So every customer is at a different point in the evolution of their data center of what they're deploying. Some are still deploying 14 at scale. Some went to 18 as quickly as possible, and others are at different points of deploying 16 or 18. And so we meet the customers where they are in that process. But we expect 18 to be the predominant point going forward. It's just a better TCO equation. So you would expect the customers to go there when they can, given their own internal architectural evolution.

Got it. Maybe a follow-up to the Neoline side of things. Given the improvement in the enterprise side that you're seeing, and obviously the cloud has been strong, What is your expectation for the industry-wide exabyte growth for Neoline Drive this year, and how do you think you'll stack up against that this year? Thanks.

Yeah, we see a quarter of strong growth coming up. I think we're still in that around 35% exabyte growth for the year. And as the market shifts to 18, I think that we're in a – we're in an incrementally stronger position, so that's how I expect the rest of the year to play out.

Thank you.

Thank you. Our next question will come from Tom O'Malley with Barclays. Please go ahead.

Good evening, guys, and congrats on the really nice results. My first question was around end markets. You guys gave some helpful color on the HGD and Flash side. Could you talk to what you guys see client devices, data center devices, and client solutions kind of doing into the June quarter? Just any general color would be helpful there.

I mean, I think in data center we expect improvement. I mean, I'm trying to think here around modular seasonality here. I mean, look, I mean, devices are very strong. I mean, we saw a lot of strength in PC and client, and I think we continue to see, we saw, you know, this past quarter we saw decline, but way better than seasonal decline. So, and we expect that to continue. We think that market is strong. Our customers are telling us that market is strong. The number of units shipped is up. So that continues to be a good market. I think data center, With 18 ramping stronger, you're going to see growth there. And I think in the retail space, we'll see sequential growth, but probably a little smaller than the others. But still very good performance.

That's helpful. My follow-up was really around the cadence of gross margins. You guys indicated that you should see some HED gross margins that are improving sequentially. Can you talk to the cadence for the year? I think that the target longer term is 30 and even above that, but obviously with near-line drives becoming a bigger part of the mix and some of this COVID headwinds coming off, can you talk to the progression that you guys are expecting internally and just kind of the progression from here to the 30s?

Yeah, I mean, I think, you know, we're going to forecast it one quarter at a time, but we're working, you know, the teams are working very hard to do what that they're gonna do in any storage market, which is continue to bring down the costs. And as you scale the products, you'll bring down the cost. So I think the whole industry is driving back to 30% gross margins. I think we're gonna get there one step at a time, but we're gonna work on both sides of it, is make sure we've got good supply-demand matching on kind of what the demand is in the market. And then we talked about multi-quarter supply agreements i think which helps give some certainty and then work on the cost side of it so we're every quarter we're focused on on all those elements and we'll continue to drive it now that starts with delivering a great value proposition for our customers and continuing to drive a better tco equation as we drive higher and higher aerial densities and you know we've got a long road map on aerial density improvement a big piece of that was us implementing or introducing energy assist. And that's the big thing with our 16-18. As we're now just starting to ramp to 18, we've got energy assist in the market. There's well over a decade of research behind that, and we've now commercialized it. And so that gives us many generations on that technology to continue to improve aerial density, which is going to improve the TCO equation for our customers.

Great.

Thanks again, guys.

Thank you. Our next question will come from Shannon Cross with Cross Research. Please go ahead.

Thank you very much for taking my question. I'm just curious with regard to your cloud customers, if you believe they're pretty much through the adjusting period of the excess capacity. I know we've seen from a couple we cover that they're starting to ramp up CapEx again, but I'm curious what you're hearing from them. And then I have a follow-up. Thanks.

Yeah, I think the word I used last time was cloud digestion abating when we talked about this, but they're all in a slightly different spot, but we're into an ingestion phase for the most part.

Okay, and then I was curious in terms of the tightness and components and overall market, what kind of impact is that having on your working capital? We're looking at some of the movements in AP and inventory. Thank you.

Yeah, no, it's a good question, and we definitely are carrying a little more inventory than we normally would, particularly on the hard drive side because of the tightness on controllers. And also, frankly, because of the logistics costs associated with COVID-19, we're putting more products on the ocean and not in the air. So it's definitely having an impact in terms of working capital in that respect. Our accounts payable did go down this quarter. I mean, that really was a result of us slowing down the production in the March quarter, and I think it'll come back up again this quarter.

Thank you. Our next question will come from Tristan Guerra with Bayer. Please go ahead.

Hi. Good afternoon. Just following up on the earlier question about supply-demand, we've had some peers talk about their concern around I see some excess capacity coming in NAND. I know it's too early to provide an outlook for the next fiscal year, but is capacity in NAND industry-wide a concern in your view, or do you see a path that ultimately could get you back to the type of peak gross margin that you reported in NAND back in the 2018 timeframe?

Yeah, it's not something we're overly worried about at this point. I think the industry has been pretty disciplined for the last several years. And I think there's now pretty strong demand in the market. So, I mean, we feel pretty good about the balance of supply and demand in the market going forward. I mean, again, there's even the Well, let me just leave it at that. We're pretty happy with where supply-demand balance is. I mean, I think everybody is trying to figure out what's the long-term demand for technology coming out of a pandemic. It's kind of a unique situation. But, you know, we're staying very close to it. And, you know, our view is the industry has been pretty balanced on the whole topic.

Thank you. Our next question will come from Jim Suva with Citigroup Investments. Please go ahead.

Thank you. And I'll ask both my questions at the same time, and you can answer them in any order you want. But the data center softness, is the visibility there getting better, the digestion phase? And, you know, are we a long ways to go or kind of mostly through the worst part, or is demand coming back for that kind of on the data center? And then you mentioned longer-term relationships and contracts with – cloud Titans and hyperscalers, do they allow for flexibility and pricing? The reason why I ask is recent NAND pricing came out and it was quite positive. And we just want to make sure that you're not missing the opportunity for, you know, better economics from pricing. And so just kind of wondering without even specifics of your relationships of quantity and volumes and pricing is, are there some abilities to adjust it or do you get locked in and, Maybe pricing will or won't help you. Thank you.

I think your second issue is, without going into all the details, is not a concern for us. On the first issue, I think we saw, first of all, very strong sequential growth in data center for us this quarter, 53%, although it was down, get your point, year over year. It was a very strong compare a year ago on exabyte shipment, but we expect sequential growth there in exabyte shipments on the drive side. And I think up on flash as well, maybe not as strong as the exabyte growth we expect in hard drives as 18 really starts to be the major point in the industry. But we see sequential improvement there, Jim.

Thank you. Our next question will come from Ananda Guru with Loop Capital. Please go ahead.

Hey, thanks, guys, for taking the question. And congrats on the strong results. I guess just going back to just the flash gross margin and the balance that you guys are seeing right now, do you feel like you're sort of to 30% sooner than expected, which is a positive thing? If so, you know, how would you like us to think about if supply demand remains balanced on the flash side, how to think about margins going through the second half of the calendar year? And then I have a quick follow-up. Thanks.

Yeah, I guess one way to think about that is we, you know, we delivered above what we guided, so I think we're ahead of where we thought the market would be when we walked into it. And, you know, a lot of that is the We have really strong exposure to a lot of transactional markets in the channel and in retail. And as price tightens, it allows us to move pricing in those big markets much faster than other markets, OEM markets, which are a quarter-by-quarter negotiation. Yeah, I mean, I think the market was good for us. And as I said, the go-to-market teams and the BU teams were very agile as far as shifting our supply around on where we could get the best return for it in the quarter. As far as going forward, I mean, we're guiding for sequential improvement in flash gross margin. We're seeing that. We saw the pricing strength or firmness that we saw in the transactional markets translate into negotiated markets. I think last quarter we were waiting to see if that was going to happen. We see that going into Q4. And so, you know, we're definitely forecasting incrementally stronger flash margins in this current quarter.

Okay. And it sounds like just structurally it feels like maybe that could actually follow through, you know, just because it feels like the dynamics are more at the beginning as well. And I guess my follow-up is it seems like on your CapEx, it seems like you've lowered the CapEx expectation just slightly for fiscal year 21, if I'm seeing that accurately. And I was just wondering if there's any direct reason for that and what would be underpinning that if there is. Thanks. And that's it for me.

Yeah, no, that's a good observation. And we expected CapEx to be around $3 billion this year, pretty much all year. The main delta is we actually sold some real estate this past quarter to the tune of about $100 million.

Thank you. Our next question will come from Nick Todorov with Longbow Research. Please go ahead.

Thanks. Yeah, good afternoon, everyone. David, if I heard correctly, you talked about seeing cloud titans also starting to use your client SSD products for their consumer-based businesses. I think that's the first time you hear about that. So can you maybe unpack that a little bit? How should we think about that opportunity? And are you addressing that opportunity with your existing portfolio?

No, not necessarily our client products. There is some of that because I think the easiest way to think about it is a lot of these big cloud titans also have big consumer portfolios, whether it's gaming, tablets, VR headsets. That's what I'm talking about, us participating in those builds and those parts of the market as well. It's part of that go-to-market synergy we talked about. I think we tend to only think of it as HTDs and enterprise SSDs, but it's much broader than that given the relationship we have from the HTD business with these customers and the depth of the relationship. Most of them also have big consumer portfolios as well, whether it's home automation or the kind of things I talked about. So our ability to participate in those parts of the market for flash is just what we were talking about.

Got it. Got it. Okay.

And thank you. Our next question will come from Srini Pajuri with SMBC MECO Securities. Please go ahead.

On the non-gross margins, As well, I didn't hear you talk about K1 costs. I'm guessing they came down pretty meaningfully. But I guess my question is, as we look through the next few quarters, you do have additional FABs coming online, either it's K2 or Y7. I'm just wondering how we should think about any potential incremental costs from those new factories.

Yeah, I don't think we heard. quite at the beginning of your comment, but you're correct that the K1 period expenses are immaterial now. We've ramped there to normal volume levels, and so those costs are getting inventoried. So I think we're kind of in a normal state. As newer FABs come on, it's not going to have as big an impact from a startup cost standpoint as the greenfield that we did with K1. Definitely you're bringing on some fixed costs, but we'll also be bringing the production volumes up and amortizing those costs over a bigger base because we have multiple FABs on a given campus.

Thank you.

Sure.

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

Hi. Good afternoon. Two questions real quick. First of all, on the taxes, Bob, Is the 17% tax rate kind of here to stay? Do you think it can go a little bit lower? And then secondly, I apologize if I missed this, but have you talked about sort of the recent trends in high-capacity video HDDs and what you're expecting going forward?

I'll do taxes and talk about video. So, yeah, and this has come up in prior calls. I mean, we've been in a situation over the last couple of years where our operating profits have been below what we expected, and we have minimum taxes that we have to pay around the world, and so our rate was higher than what we would consider normal the last couple years. Now, as we're forecasting the rest of this fiscal year with the profitability we're expecting, we're very confident in the rate at 17%, and it'll be, you know, as we look to future years, it'll be a function of how profitable we are in those years, but Right now, I think a good planning number is 17%.

Yeah, Steve, we haven't talked about high-definition video in particular, but, I mean, one way to think about it is just driving more demand for storage. I think all the devices we carry have more and more capability to store higher-definition video, which is just driving the need for more storage per device. So if you have something more specific than that, happy to follow up on it.

Yeah, I just was... If you could just maybe expand on what you're seeing in the June quarter, like I think there was some seasonality last quarter, you know, how you have availability to ship to that market. Thanks.

Oh, you said smart video, the smart video market. I'm sorry. I misinterpreted. Yeah, sorry about that. The smart video market and the HDD market. That market's been pretty stable. I think we see some improvement in it. But, I mean, I don't think there's anything that's particularly noteworthy except that it's a good market for us and continues to move forward.

Yeah, it's a growing market. Great.

Thank you. Great.

Thank you. All right, everyone. Look, we really appreciate you spending time with us. We'll follow up with you throughout the quarter. And, again, thanks for joining us. Take care.

Yeah, thanks, everyone.

Ladies and gentlemen this concludes today's conference call. Thank you for your participation. You may now disconnect and have a wonderful day.