Western Digital Corporation

Q1 2022 Earnings Conference Call

10/28/2021

spk10: Thank you for standing by, and welcome to the Western Digital's first quarter fiscal year 2022 conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your first speaker, Mr. Peter Andrew. Thank you. Please go ahead.
spk06: 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 and performance, 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 for his introductory remarks.
spk19: Thank you, Peter. Good afternoon, everyone, and thanks for joining the call to discuss our first quarter of fiscal year 2022 results. We reported revenue of $5.1 billion non-GAAP gross margin of 33.9% and non-GAAP earnings per share of $2.49, all within the guidance ranges we provided in August. This marks the sixth quarter in a row of meeting or exceeding guidance, a point that we are particularly proud of as we continue to navigate uncertainty and volatility in the market. Strong demand across diverse end markets, particularly for our cloud products, combined with Western Digital's strong innovation, broad routes to market, and sharpened execution, enabled us to deliver results within our guidance range despite significant COVID impacts and supply chain disruptions. While these disruptions are transitory, the long-term opportunities for Western Digital remain unchanged as the world's digital transformation continues to accelerate. During the quarter, we shipped a record level of exabytes, while also improving non-GAAP gross margins across both Flash and HDD and generating profitable growth. We saw strong demand for our latest generation hard drives and flash products in the cloud end market, as well as strong consumer demand for new 5G-based mobile phones incorporating our latest Bix 5 flash solutions. The strong demand for these products were partially offset by pressure in the commercial channel within the client end market and certain portions of the consumer end market, particularly retail. This was attributable to component issues impacting our customers' ability to ship product, greater component sourcing constraints within our own operations, and uneven geographic demand due to COVID lockdowns. Our continued focus on innovation and a more agile business unit structure enabled us to quickly adapt to these dynamics. When combined with an industry-leading portfolio and a strong go-to-market operation, I'm confident in Western Digital's ability to continue to generate improved operational performance for all of our stakeholders. Before I get into the business trends, I want to highlight a few changes we made to our end market breakdown, which we believe will help you understand why Western Digital is well positioned to capitalize on the opportunity presented by the increasing value and importance of data. We now split our end markets into cloud, client, and consumer. The cloud represents an incredibly large and growing end market for Western Digital, and we are uniquely positioned to address customer storage needs as the only provider of both hard drive and flash products. During the first quarter, cloud represented a record 44% of total revenue, led by record capacity enterprise hard drive revenue and nearly 30% sequential growth in enterprise SSD revenue. We believe the accelerated digital transformation will continue to drive growth in this end market and continue to shift our business mix towards the cloud. As we ramp our new innovative products and continue leveraging the benefits of the organization structure we put into place last September, I am confident we will capture opportunities to achieve a more stable and profitable growth profile over the long term. The client end market represented 37% of revenue in the first quarter. Here we are providing a broad array of high-performance flash and hard drive solutions to our OEM and channel customers across PC, mobile, gaming, automotive, VR headsets, at-home entertainment devices, and industrial spaces. Lastly, the consumer end market accounted for 19% of revenue in the first quarter. The highlight of this end market is the strength of our SanDisk brand of retail products and the WD Black brand of storage products for gaming enthusiasts, which is strong and growing. The brand recognition and infinity, combined with our unmatched reach with nearly 400,000 points of presence across the world, is a great setup for Western Digital as we enter a seasonally stronger part of the year. With that, I'll now provide a recap of our ACD and Flash businesses as it relates to our first quarter results. In HTD, continued strong demand for our latest generation energy-assisted drives among our cloud and enterprise customers drove record revenue in exabyte shipments in our cloud end market. In addition, we experienced strong revenue growth in our smart video product line and were unable to meet demand. During the quarter, we announced OptiNAND, a revolutionary technology that utilizes flash in the HGD control plane to further increase aerial density. With this leading architecture, we achieved 20 terabyte capacity using our field-proven 9-disc mechanical platform and ePMR technology. Next month, we'll commence volume shipments of our 20 terabyte CMR hard drives based on OptiNAND technology. In Flash, revenue grew in the quarter due to continued strong demand within the cloud and client end markets for our latest generation of our enterprise SSD products and the ramp of new 5G phones incorporating our latest Bix 5 node. Within enterprise SSD, we experienced continued success in the cloud with another successful quarter of qualifications. We are now qualified at three cloud titans and have made excellent progress working our way through the qualification process in the enterprise and distribution channels. We expect these qualifications to start to drive accelerated revenue growth in 2022 as our customers begin to deploy these products into their networks. The ramp of next generation 5G phones incorporating our latest generation of BIX5 products accelerated in the quarter. with revenue growing over 20% sequentially. We expect this migration to 5G, combined with a continued increase in the amount of storage per phone, to drive another strong quarter of revenue growth in the fiscal second quarter. Gaming was strong in the quarter with a solid lineup of products for game consoles, along with a growing brand recognition of WD Black-based products in the channel and retail. Heading into the second fiscal quarter, we are well positioned to take advantage of seasonal strength and grow in a wide variety of gaming channels. As I noted earlier, the client PC OEM's distribution channel in retail were impacted by our customers' ability to ship product, greater component sourcing constraints within our own operations, and uneven geographic demand due to COVID lockdowns. Demand was solid, but these transitory issues impacted our ability to realize this demand in our results. In total, bid growth accelerated to 30% year-over-year in the first quarter, as we ramped BICS 5 to 17% of flash revenue. This quarter, we expect year-over-year bid growth to further accelerate to the mid-30s range, with BICS 5 bid crossover to happen later in the quarter. Our long-term goal is to grow BITS in line with the market, taking advantage of our product and end market breadth to shift our BITS to optimize profitability. As we look into calendar year 2022, we are optimistic as our customers continue to indicate strong end demand across cloud, client, and consumer end markets. We have industry-leading technology, the right product portfolio and investments, and and the organizational agility to fundamentally drive improved profitability regardless of market condition. We have a great position in two large and growing markets in Flash and HGD, and we have proven our ability to drive innovation throughout our portfolio and deliver industry-leading products to a broad and loyal customer base. We believe that the migration to the cloud and demand for storage solutions throughout the client and consumer markets will drive a huge opportunity for Western Digital and our customers. I'll now turn the call over to Bob to share details on our financial results.
spk12: Thanks, Dave, and good afternoon, everyone. As Dave mentioned, overall results for the fiscal first quarter were within the guidance ranges provided in August, marking the sixth quarter in a row that we've met or exceeded guidance. Total revenue for the quarter was $5.1 billion, up 3% sequentially, and up 29% year-over-year. Non-GAAP earnings per share was $2.49. Please note that EPS included $56 million in total COVID-related costs, which was higher than we anticipated entering the quarter. I'll provide more details on these costs in a minute, but we are pleased to deliver such good results in the face of this unanticipated headwind and other supply chain issues. From a disclosure perspective, in addition to the change in our end market breakdown that Dave discussed, this quarter we moved to segment reporting for our flash and hard drive businesses. For more details, please refer to our earnings deck. Looking at our end markets, cloud represented 44% of revenue at $2.2 billion, up 12% sequentially and up 72% from a year ago. This represented the second quarter in a row of record revenue. What is encouraging about this cloud revenue growth is the strength and breadth of our revenue streams across product areas. There was growth on a sequential basis in both the flash and hard drive business units, as well as across every product category within the cloud, including capacity enterprise drives, enterprise SSDs, smart video, and platforms. As the cloud continues to grow as a percentage of our revenue, we see an opportunity to reduce volatility in revenue and profitability. Over the last three quarters, we have successfully ramped our 18-terabyte energy-assisted drive to our highest volume mainstream product within the cloud end market. Overall, cloud HDD exabyte shipments grew 9% sequentially and over 70% year-over-year. and comprised over 80% of total HDD Exabyte shipments. Client represented 37% of revenue at $1.9 billion, down 2% sequentially and up 6% year-over-year. A highlight within the client and market was growth within our Flash business unit, specifically in mobile, gaming, automotive, IoT, and industrial applications. Our strength here was more than offset by pressure in desktop and notebook hard drives due to supply disruptions at our customers and within our own operations. Finally, consumer represented 19% of revenue at $973 million, down 6% sequentially, but up 10% year over year. Both our flash and hard drive business units declined on a sequential basis due to similar supply disruptions. in addition to uneven geographic demand due to COVID lockdowns. Turning now to revenue by segment, we reported flash revenue of $2.5 billion, up 3% sequentially and up 20% year-over-year. On a blended basis, flash ASPs were down 3% sequentially, primarily due to mix in pricing within our transactional markets. On a like-for-like basis, flash ASPs were flat. Flash bit shipments increased 8% sequentially and 30% year-over-year. Hard drive revenue was $2.6 billion, up 2% sequentially and up 39% year-over-year. On a sequential basis, total hard drive exabyte shipments increased 4%, while the average price per hard drive increased 5% to $102.00. 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 first quarter was 33.9 percent, up one percentage point sequentially. As noted earlier, this included $56 million in COVID-related costs, or a 1.1 percentage point impact. These were the highest COVID-related costs in over a year. Our broad routes to market and ability to proactively shift bids to the most attractive end markets enabled us to expand our flash gross margin by 1.5 percentage points sequentially to 37%. Our hard drive gross margin was 30.9%, up 60 basis points sequentially. This included COVID-related impact of $51 million, or approximately 2 percentage points. Operating expenses were $761 million within our guidance range. Operating income was $952 million, representing a 15 percent increase from the prior quarter and tripling year over year, highlighting our profitable growth. With our improving profitability, our tax rate in the fiscal first quarter was 11 percent. Earnings per share was $2.49 toward the top of our guidance range. Operating cash flow for the first quarter was $521 million, and free cash flow was $224 million. Capital expenditures, which include the purchase of property, plant, and equipment, and activity related to our flash joint ventures on our cash flow statement, was a cash outflow of $297 million. We continue to expect gross capex for this fiscal year to be approximately $3 billion and cash capex to be around $2 billion. In the fiscal first quarter, we paid off $213 million in debt, including a discretionary debt repayment of $150 million. Our gross debt outstanding was $8.6 billion at the end of the fiscal quarter. In addition, as a result of our strong financial results and free cash flow generation, last week we repaid the remaining balance of our Term Loan B in the amount of $943 million, bringing total gross debt outstanding to $7.7 billion. Our adjusted EBITDA at the end of the first quarter, as defined in our credit agreement, was $4.2 billion. resulting in a gross leverage ratio of 2.0 times down from 2.7 a year ago and was the lowest in three years. As a reminder, our credit agreement includes $1 billion in depreciation ad back associated with the Flash 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 second quarter non-GAAP guidance is as follows. We expect revenue to be in the range of $4.7 to $4.9 billion, and we expect flash revenue to increase sequentially and hard drive revenue to decline sequentially. We expect gross margin to be between 32 and 34 percent. We expect operating expenses to be between $760 and $780 million. Interest and other expense is expected to be approximately $70 million. Our tax rate is expected to be approximately 11% in the second quarter and for the fiscal year. We expect earnings per share to be between $1.95 and $2.25 in the second quarter, assuming approximately 316 million fully diluted shares outstanding. I'll now turn the call back over to Dave.
spk19: Thanks, Bob. I want to conclude by thanking the Western Digital team for their hard work and commitment to our customers throughout a challenging quarter. Despite the transitory issues we have been able to successfully navigate, it is clearer than ever that Western Digital's innovative technology portfolio is foundational to the rapid digital transformation and transition to the cloud that the world is experiencing. With our deep roots in a broad range of end markets and a sharp focus on execution, I'm confident in Western Digital's ability to capture this massive opportunity and am looking forward to the rest of the fiscal year. Let's now begin the Q&A.
spk10: Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Aaron Rakers with Wells Fargo. Please go ahead.
spk06: Hey, Aaron.
spk05: Hey, sorry, guys. Can you hear me? No problem.
spk12: We hear you.
spk05: Hey, sorry about that. Yeah, so I got two quick questions if I can. Sure. I guess, first of all, it seems like there's a lot of moving parts. you know, in the quarter and more importantly into the guidance outlook for fiscal 2Q. You know, Bob, I'm just wondering if you can help quantify to your best estimate of how much impact you're carrying in the revenue expectations relative to some of these, quote, unquote, transitory effects.
spk12: It's difficult to quantify, right, because there's impact in terms of our own execution, which I think we worked our way through pretty well during the quarter. And then we have customers who have supply chain challenges as well where they're trying to get match sets and build out. their environments. And then, of course, we have supplier challenges as well where we're working, like everybody else, pretty hard to get components in. So it's difficult to give you a definitive answer in terms of what the impact was in the quarter we just closed or even, obviously, in the next quarter. But, you know, it's certainly somewhere in the couple hundred million dollar range and potentially a little worse in the December quarter.
spk19: Hey, Aaron, this is Dave. First of all, thanks for the question. I guess the one thing I would say as well is whereas maybe a quarter or two ago we were seeing it in maybe certain parts of the business, some of the OEMs, PC OEMs, now we're seeing it more broadly. Even the big data center players are having their demand impact. Our demand from them is being impacted by their ability to get other components So it's really become a much more broad-based issue across the portfolio.
spk05: Yep. And then if I can follow up real quickly, one of the things that stands out to me is that I think you reported a blended ASP decline of about 3% sequential in the flash business. So I believe the mix of enterprise actually went up to the positive. So when I look at that ASP erosion graph, relative to actually some of your peers in the NAN market, it seems to be a bit of a disconnect. Can you help me understand, you know, the pricing dynamics you're seeing in NAN right now?
spk12: Yeah, I can start, and then Dave can fill in. Yeah, I mean, the blended ASP, as we started the quarter, we indicated we expected it to be down, and it was based on the mix we were anticipating. The mix came in essentially the way we had expected, and it was – I don't want to get into every little detail of the mix, but one of the things we said at the beginning of the quarter was we expected more mobile volume in the September quarter, and that is what we saw. We actually think we'll see even more mobile as a percentage of the total in the December quarter. Mix is definitely a bit of a headwind for us, but really ASPs are not going down that much, and we're really pleased with the cost reductions we've been able to achieve both in the quarter we just finished as well as what we're expecting to do this quarter.
spk19: Yeah, I guess, Aaron, Bob right on the money on that. I guess the only thing I would add is, you know, a little bit of softness in some of the transactional and consumer markets. But we're already seeing that level out a little bit. And we're really seeing this bifurcation where, you know, the qualified bits in the market are strong and the unqualified are a little bit weaker. I guess that's not surprising given all the nodal transitions the industry is going through. But the primary issue, I would say that's the issue in mix, as Bob pointed out. And we expected that walking into the quarter.
spk04: Thank you, guys.
spk19: Thanks.
spk10: Thank you. Our next question will come from CJ Muse with Evercore. Please go ahead.
spk07: Yeah, good afternoon. Thanks for taking the question. I guess if I look at your revenue guide and kind of the commentary on man bets, it sounds like the implied HDD revenue guide is roughly down 15% sequentially. So I guess, you know, A is the math right there, and B, I guess what's causing – the severity of decline. Can you kind of help us understand what's digestion versus, you know, some of the transitory supply chain issues that you spoke to?
spk19: Yeah, I think that's probably a little – I mean, we don't guide each individual business, but I think your number is probably a little heavy. You hit on some of the issues. Some of it is mixed. We've actually got one of our very, very big customers that has their own supply chain issues that's pushing out some orders. So that's a bit of an idiosyncratic thing that's happening there. You know, there's some supply chain issues with especially in kind of mid-cap and the ability to build all of that supply we want. We talked about that even in this past quarter in the smart video market, which is strong. and there's some unmet demand there. And then we're seeing a little bit of an inventory issue, quite frankly, in China, where there's a lot of high-cap inventory there, and that's kind of pulling the number down a little bit for the next quarter. So we expect all those things are transitory issues. We're really happy about the portfolio. I think the fact that, you know, 18T was now the majority of the portfolio. We talked about shipping 20T on a nine-disc platform, and OptiNAND is out there and in customers' hands. So we feel really good about the innovation that was delivered in the quarter and about where the roadmap is going in the drive business. And the new technology has been very well received.
spk07: That's great. And I guess as my follow-up, Bob, could you speak to how we should be thinking about gross margins into the first half of 2022? Obviously, there's certain unknowns in terms of revenues and man pricing, but we'd love to hear perhaps some of the other puts and takes that we should be thinking about, as well as the timing of when you think some of the COVID-related costs may abate.
spk12: Yes, CJ, you're right. It's difficult to say exactly what's going to happen over the next few quarters. And as you know, we only give guidance one quarter at a time. Now, having said that, we're pretty optimistic on 2022. Again, we think a lot of the challenges in the quarter we closed and the quarter we're in now are really supply chain related. We think the underlying demand situation is very positive. We really believe, as I said, in our cost reduction plans, and we think we'll be able to deliver solid margins. So I don't want to get into giving guidance for next year, but we're definitely optimistic. Thank you. Sure.
spk10: Thank you. Our next question will come from Joe Moore with Morgan Stanley. Please go ahead.
spk15: Great, thank you. I wonder if you could update us on where you are with BICS-5 qualification. I assume saying you'll be mobile-heavy this quarter means you're kind of still getting qualified across the SSD markets, and I had a follow-up.
spk19: Yeah, I think that's right. I mean, it's early in the node. We were happy with the ramp this quarter. We ended at, I think, 17% BICS-5, and we expect to get crossover before we exit the year, but Like any new node, you're in more of the mobile or components market as the rest of the products get qualified. But that's all work underway, and, you know, our customers are definitely pulling us in that direction. They want Bix 5 on the SSD products, and the engineers are hard at work at getting that work done. So it will be an evolving story as we work through 22.
spk15: Great. Thank you. And then I think you referenced some of the segments in client SSD maybe. being a little weaker. Can you separate out, you know, is there a Chia effect there where it was good for a while and then it was less good versus just overall client SSD being oversupplied because of other issues in the supply chain? Like, you know, how do you sort that out and what do you see happening in the client SSD market?
spk19: I don't think we see it as a chia effect. I mean, I was just talking to our sales team this morning, and I think the channel is now kind of normalized and back on seasonality after the chia disruption. I think we just see this issue with people not able to get all the components they need to put together the full kit for what they want to ship, and that's causing some softness in the channel. So I think it's more related to that than it is anything chia related, at least in my view. Thank you very much. Thanks. Thanks, Joe.
spk10: Thank you. Ladies and gentlemen, as a reminder, we ask that you please limit yourself to one question due to time restraints. Our next question will come from Carl Ackerman with Cowan. Please go ahead.
spk16: Yes, thank you. Bob, earlier in response to a question, you had indicated some of the impact or challenge in your enterprise, I believe, HTV business and SSD business was a result of a push out by a customer. My question there is, if we isolate that customer, how do you see the demand trajectory of cloud and mass capacity markets, not just into the December quarter, but also into the second half of your fiscal year? Certainly as you begin to ramp up you know, some of these 20-terabyte drives and other higher-capacity drives in HEDs as well as some of these new design ones you have in Enterprise SSD. Thank you.
spk12: Do you want me to take that or you?
spk19: Well, I can start. Okay. Yeah, so I think as a general statement, we're seeing continued very strong demand from our data center customers, especially our very big data center customers. They're giving us good signals about next year. And what they plan to do, you know, it's hard to pin that down to a certain quarter right now. But, you know, we continue to see very strong demand there. Like I said, we're starting to see the supply chain impact show up there as well. But I'm sure that will all get worked through as we go through the year. But, you know, we look into 22 and we have our customers telling us it continues to be a strong demand environment.
spk12: Yeah, I don't think I have anything to add. I mean, we believe in the cloud demand. I think it's strong, and there just is a lot of supply chain dislocation right now.
spk10: Thank you. Our next question will come from Wamsi Mohan with Bank of America. Please go ahead.
spk08: Hi. Thank you for taking my question. This is actually John on behalf of Wamsi. Just curious, there hasn't been a lot of media focus on Wamsi, And in the past, Western Digital has expressed interest in the asset. Do you think that consolidation still makes sense? And do you still have an appetite for it? Thank you.
spk19: Well, I mean, I think I'll speak in general about Keoxia. They're a tremendous JV partner. And we've spoken a lot about the JV and what the benefits of that are. And, you know, I think one of the highlights of the quarter is, you know, the continued production of the Flash roadmap and Bix 5 and the cost situation that that's driving. I mean, I think it's always been a very big focus of the Western Digital and Keosha team to very focus on capital efficiency and, and cost downs in the portfolio. You know, the seeds for BICS5 performance that we're seeing now were sown many years ago. That continues to be a great focus of the joint teams. And I think the fact that we have a joint roadmap with another supplier as big as Keoksha gives us a lot of investment in our roadmap. And then, of course, we produce together as well and have a lot of synergies there as well. So, You know, it's a great partnership. It's been going for over 20 years now. It's going to go for, you know, we're signed up for at least another decade, and we always look at that as we continue to invest in FABs, and we're really happy with the partnership, and we're going to continue to get the best out of it.
spk10: Thank you. Our next question will come from Mehdi Hoseni with SIG. Please go ahead.
spk09: Yes, thank you. Two questions. The first one is for the team. Obviously, there is a long lead time associated with the equipment procurement. So at this point, I would think that you have a pretty good feel for NAND, the bid supply growth in calendar year 22. Is there any color you can share with us? And I have a follow-up.
spk12: Yeah, I mean, we do have good visibility, and you saw our big growth came back up again this quarter. We expect it to be a bit higher year over year next quarter. Our long-term goal continues to be to grow at the rate the market's growing, and we won't get that perfectly every quarter, but that's our objective. And we think that, again, with Kyoksha, we've got the right plans in place for next year.
spk09: But what is the target for next year, calendar year?
spk12: Good question. Yeah, I don't think we've put a specific number out there yet. Some of the industry analysts suggesting industry demand growth in the low 30% range.
spk09: Got it. Thank you. And given the fact that your enterprise and cloud customers are expressing good, solid demand in calendar year 22, have you determined how to allocate? And perhaps I'm trying to better understand how you're thinking about the mix between between cloud enterprise and client and consumer?
spk19: Yeah, I think we're certainly having those discussions with them. I mean, I think every quarter we discuss the current quarter and out many quarters, you know, several quarters in advance at least. I mean, we don't lock in per se on those numbers exactly, but we think about share of their particular – and what that's going to look like and what that means to demand for us. So, yeah, we're having those conversations, and we're factoring them into the mix of bits for next year and how we allocate across the portfolio. Of course, there's a nodal mix equation of that as well. It was kind of referred to in the previous question, when are different products available on different nodes out of the fab. So we're working through all that right now.
spk10: Thank you. Our next question will come from Timothy Arcuri with UBS. Please go ahead.
spk03: Hi, thanks. I want to go back to the HDD guidance and just maybe ask around what the normalized base of revenue is. I mean, obviously, you're peer-guided flat. You're down kind of like low teens. Sounds like something in the range of $2.25 billion, you know, in that range. It sounds like part of that's a push-out and some of that's some company-specific issues on the supply side. So, Can you help us bridge the gap there? Is 2.6 kind of flat like the normalized level if you adjust for all that? Or is it something that's slightly down Q on Q but not down low teens? Thanks.
spk12: Yeah, I mean, again, it's hard to quantify exactly what the supply chain impacts were, and we're actually not giving guidance by segment. But we definitely believe the hard drive business is a growth business, and it will continue to grow over the next few quarters. We think 2022 will be a strong year. And, yeah, this is a bit of an aberration in the December quarter, but it's, you know, the business is really solid. The underlying demand is very good, and you're right. I mean, we already commented that there are some supply chain issues that are impacting us right now.
spk10: Thank you. Our next question will come from Toshi Ahari with Goldman Sachs. Please go ahead.
spk18: Hi, guys. Thanks so much for taking the question. Dave, I wanted to ask about enterprise SSDs. You talked about now being qualified at three cloud titans, which is great. You also talked about some of these wins translating into revenue growth and potentially driving an acceleration in growth in 22. Can you help us kind of shape the ramp into 22? Could it be more first half weighted, second half weighted? I know these projects can move around a little bit, but any help there would be really, really helpful. And then related to that, the impact on profitability as you ramp that business, initially would it be a headwind and then eventually a tailwind or should it be fairly margin neutral from the get-go. Thank you.
spk19: Hey, Tashari. So first of all, yeah, we are really happy with the progress of the portfolio. I remember sitting here a year ago, and we were just trying to get over the hump on the first one, and now we're over three of them, and we continue to work at the OEMs, the enterprise OEMs, which tend to be longer qual cycles, and we're making good progress there as well. And you're right. We got the calls done. We'll start to see a little bit of deployment next quarter and then start to ramp it throughout 2022. So I think it's an evolving story as we go throughout the year. I think it's a very attractive TAM, I think, with good margins, and that's why we're investing in the products. And I think as we mix more into that and have more supply into that, it's a tailwind for the overall portfolio. that's definitely a true statement.
spk10: Thank you. Our next question will come from Ananda Barua with Loop Capital. Please go ahead.
spk13: Hey, thanks, guys. Good afternoon. Thanks for taking the question. Yeah, I guess my question would be, you know, for whatever it is that you guys consider to be the revenue impact to the December quarter guide, Could you just sort of anecdotally map out for us, you know, how much is from the Flash business relative to HDD? And then inside of HDD, how much would be from the impact of, you know, kind of the cloud type? It sounds like there's some component stuff on their side there. And then you had mentioned some channel dynamics and some WD dynamic as well on the PC business. That would be helpful. Thanks.
spk12: Yeah, I mean, this is – I'm trying to think how to answer this question differently. I mean, we're actually not giving guidance by segment. However, we did say we expect revenue to be down a bit on the hard drive side. We expect it to be up sequentially on the flash side. There are supply chain challenges with some cloud customers. There are supply chain challenges with some PCOEMs. We also mentioned that there seems to be a fair amount of inventory in China right now. So there definitely are some short-term challenges with respect to the hard drive business. But, again, long-term, the underlying growth is really good there.
spk10: Thank you. Our next question will come from Vijay Rakesh with Mizuho. Please go ahead.
spk14: Yeah, hi, guys. Just a couple of quick questions. On the client SSD side, as you look at next year, Just wondering how you're thinking, what the outlook was. I know server looks pretty strong for next year, but on the client SSD side and on mobile too, how you're looking at next year's demand? Thanks.
spk19: Yeah, we think the PCTM is good next year. I mean, we're obviously coming off of a blockbuster year with COVID. I mean, we see the pre-COVID baseline is around 265, 270 million units. That went up to 340 this year, expected around that number. And we see, you know, somewhere around 320 to 335 next year. So it's definitely been, you know, we're going to come off this year a little bit. But we see, you know, basically the baseline has been reset pre-COVID by a significant amount. So we feel good about that. You know, we're hearing that from our customers. We're talking to those customers now about, you know, 2022 plans and what they plan to do and how much supply they're going to need and share conversations with each of them, and those conversations are going well. The smartphone market, you know, again, we continue to see this past quarter and the quarter we're in, we're seeing really good strength in that market. So I think there's a larger point here about the flash market is that there are The number of end markets is just more diverse now, especially with enterprise SSD growing and getting to be such a big market that there's a much better mix of demand that we play across in the market. And so we see strength in PC. We see strength in smartphones. We see strength in data center. Like we said, the more transactional markets this past quarter, You know, as more nodal transitions going on, there was more bits available in those markets, and we definitely saw that. But we're heading into a seasonally strong quarter on retail. So as we go through the quarter, we'll get a very strong idea about how retail is going to play out as well as we go through the holiday season.
spk10: Thank you. Our next question will come from Sydney Ho with Deutsche Bank. Please go ahead.
spk11: Thanks for taking the question. Related to hard drive business, earlier you talked about inventory issues in China. Can you add a little color to that? How much excess inventory are there? Do you think that will get back to normalized levels exceeding the year? And any other geography you're watching out right now? Thanks.
spk19: That's the main geography we're watching, and it's mainly high capacity, and we think it will get worked through in the next quarter. But it's definitely in the channel and it's some of the big customers. So, you know, it's just something that's going to impact the amount of business that flows through that part of the market, which is a pretty big market for all of us. But we don't see it more than a quarter, maybe a little bit more of impact.
spk10: Thank you. Our next question will come from Patrick Ho with Stiefel. Please go ahead.
spk04: Thank you very much. Bob, on the prepared remarks, you talked about the different variables in terms of the supply chain, the constraints, the suppliers, your own manufacturing efficiencies, as well as the customers. Can you, for both September and December, give kind of a qualitative commentary on which were the biggest impacts in both September and December?
spk12: Yeah, I think what I said earlier is we're actually expecting December to be a little more challenging than what we saw in September, and the September quarter was not easy. And starting with our own teams, I think we did a really good job given what was going on with COVID in Southeast Asia. We did mention our COVID costs were up to $56 million this quarter. And we've done a really excellent job in terms of working with local governments to try and get as many employees vaccinated as possible and to really do the best we can to assure supply in terms of our own factories. Now, as we mentioned, like everyone else, we have challenges in terms of getting components as well, particularly, obviously, the controllers on both the hard drive and the flash side, and that has an impact on the business overall. I don't know quarter to quarter which quarter is worse, but it's a challenge in both of them. And it's a challenge that's not going to go away soon in terms of the semiconductor availability. I mean, we're getting some lead times of 50 weeks right now. So it's definitely a very real issue in terms of getting components in. And then we've already talked a fair amount about the customer challenges. And I would say, you know, it feels to me, and Dave can comment, like there are more customers impacted by the supply chain in the December quarter than there were in the September quarter. It seems a little more...
spk19: Yeah, I don't think there's any doubt about that. I think when we talk to our sales teams and we talk to our customers, I mean, it's I think just over the last month or so, the number of places where we're hearing they're not able to meet their own true demand or they can't pull the demand from us if they're building their own infrastructure because of supply chain components is definitely broadened. And I think it started in some of the PC makers. I think that's where we heard the most about it, if you go back a couple of quarters. And now, like I said, we're hearing more about it in other segments, including the big data center providers. So it's definitely an impact to the business, and we just navigate through it. I mean, I think when you talk to our customers and we talk to our own we talk to our own sales teams and we look at what everybody's telling us. The end demand continues to be very, very strong, and everybody is just trying to figure out how to meet that and how to get enough components and get the right components to build the right kit, whether it's for something they're going to sell or it's building their own infrastructure to build what they need. And as Bob said, we see that ourselves in our ability to get components and our ability to make sure our factories continue to run. And I I will say I'll be a little bit selfish here and compliment our own teams, but, you know, the Delta variant in Asia was a very big impact, and this quarter was probably one of the most difficult since COVID started. There were points where we had thousands of employees in quarantine and still kept everything going. So, you know, when you see what's happening on the ground and what the impact has been, it's not hard to understand how all the discussions around supply chain impacts have I think the good news is that we're working very, very hard, as Bob said, with governments to get vaccines distributed and get things back on track. And as we exit the quarter and we sit here today, things are in much, much better shape than they were a couple months ago. So it makes us optimistic as we go through 2022 that this will get worked out and that we'll all be able to meet the true demand that's out there.
spk10: Thank you. Our next question will come from Harlan Sir with JP Morgan. Please go ahead.
spk20: Good afternoon, guys. Thanks for taking my question. So on your client business, you guys talked about the PC market being weak in September due to supply disruptions at customers. We all know about the match set challenges on component shortages. That's been pretty well telegraphed. But you also mentioned the WD sort of specific supply chain disruptions on client HDD as well. Is the primary impact the shortage of HDD controllers and preamps, or is the primary impact on the COVID-19-related sort of operations, disruptions? And given your semiconductor supplier's lead times, when do you expect to see your client HDD-specific chip supply issues start to ease?
spk19: I'll take a crack at it, and Bob can add some color as well. I mean, it depends on how you look at it. I mean... You know, certainly our COVID costs are up significantly this quarter, I think nearly 50% or more, 60% on what they were last quarter. We had been steady state for probably three, four quarters in a row, and now we've bumped up significantly. So, you know, a lot of that is costs going into managing our own infrastructure and work that's going on with our own teams. Of course, a lot of it is logistics as well. That's always a big component of it. So those costs are going up. our own supply is mainly around controllers, I think it's fair to say. As Bob said, we're planning a year out on lead times and working with our own suppliers on how we, number one, make sure we get everything we need to meet our demand, which has been challenging, and then get it in a time frame that we need. But we're working through it, and like I said, I think that there's no doubt if you go back a couple quarters, we've been talking about this, about how we were not able to meet all the demand that we saw out there. I think the thing that we see different walking into this quarter is we're seeing even a greater impact across all of our customer base, and it's spreading to places where we hadn't seen it before, and that's both raising the uncertainty there, and also just depressing the demand because customers can't get all the pieces they need, so they don't need everything from us. So we're starting to see some hints in some markets. It's starting to clear up a little bit. Super early days, but again. If you look at what's going on in the ground in Asia, things are getting better, at least from our perspective, our narrow perspective, although we have, you know, 40,000, 50,000 people there. Things are getting better on the ground, and that gives us optimism that the situation will improve from here as we go through 22. Thank you.
spk10: Our next question will come from Tom O'Malley with Barclays. Please go ahead.
spk00: Hey, guys, thanks for taking my question. I have another one on the HCD business. You guys have done a really good job of improving profitability over the last year plus. My question is, as related to supply issues, clearly there's a revenue headwind here. Could you talk about the impact of gross margins? Do you expect that you see a greater impact there because of the supply issues, or is this more of a revenue issue with gross margins kind of hanging in? Any help there would be nice.
spk19: Let me start and then turn it over to Bob. I think there are some headwinds. One of them would be a little bit of mix, at least for a one-quarter impact, because we've got such a big customer pushing out some demand. Then you've got pricing going up on components, so you've got inflation in the supply chain is a bit of a headwind as well. All that said, we appreciate your comments. The team has worked extremely hard. You know, we've rolled out a lot of innovation in the drive business and driven the gross margins. You know, 30.9 this quarter we thought was a great result. And on top of that, we had a couple points of COVID headwind on top of it. So, you know, it all starts with making sure we deliver. a great product to our customers. It starts with innovation. You guys have heard me say this many, many times, and I think the innovation engine is alive and well. Another big step forward this quarter with OptiNAND, and I think as the team continues to drive innovation and we drive great products to our customers, we'll have the opportunity to continue to have a better conversation with our customers around profitability. All that said, there are some headwinds, I would say, in the near term.
spk12: Yeah, they're definitely headwinds, but like you said, the team's done a great job in terms of their product portfolio, and we think that gross margins will be down a little. We are going to have probably COVID costs in the same ballpark as we have this quarter, so that's a couple points, but I think we've got a really good chance of having gross margins above 30% again on the hard drive business.
spk10: Thank you. Our next question will come from Jim Subba with Citigroup. Please go ahead.
spk17: Thank you. I just have one question, and it sounds like the December outlook is truly an aberration. So, you know, the people will push back and say, well, why is it truly an aberration and not simply the new norm? So maybe if you can walk us through around why December is, you know, so unique? Because whether it be supply chain or shipping costs, they look quite prolonged. So if you could just kind of, you know, lay out the reasons about why December is so unique for such the aberration. Thank you so much.
spk19: Well, I mean, first of all, we're in a very unique time. I mean, we're still, I think, as we talked about, the supply chain chain disruptions that have been brought by COVID and especially the Delta variant that really pushed through Asia over the last quarter or more have been very, very significant and very severe. And to the people that were managing the situation on the ground there, they did a tremendous job. They had an enormous amount of work just to keep everything running. So I think that just leads to a very unique environment, Jim, that we're navigating through. Like I said, when we look at demand and we look at what our customers are telling us about demand in the market, we hear very good things. They're very positive and very bullish. You just have different customers in different states of their own ability to build what they need to build or want to build. And, you know, that's constantly shifting. And when you add it all up in any particular quarter, you're going to get a result, and that's what we got, and that's what we'll manage to. But we think that as the supply chain issues get worked out, the demand trends in the business are very, very strong, and we're on the right side of where the world is going from a technology point of view. Now, I thought it was significant this quarter that 44%, a record percent of our quarter, was in the cloud. And hopefully you guys... react positively to our simpler decomposition of our revenue across cloud, client, and consumer, but we expect to see more growth in cloud, you know, 72% year-over-year growth in that part of the business, and we continue to have the portfolio pivoting in that direction and expect to participate in that growth as it goes forward.
spk10: Thank you. Our next question will come from Steven Fox with Fox Advisors. Please go ahead.
spk02: Hi. Good afternoon. Thanks for taking my question. So I guess I'm just trying to understand the idea that none of the demand push-outs are perishable because this is the seasonally strongest quarter of the year. How do we get confidence around that maybe not necessarily that it's perishable but maybe – spending that would have occurred in December doesn't occur in March even if there's availability just because of timing around, you know, usual timing around spending. Thanks.
spk19: Well, again, I think it goes back to, you know, if you're talking to a very large cloud provider that's trying to build out their infrastructure, I think they're going to catch up on building it out to what their demand is. If they can't do it this quarter, they'll get the components in the next quarter. So Again, we see a very good demand environment, and I think that as our customers are able to get all the components they need, they will continue to come back to us and adjust their demand to us. That's what we see. We have very close relationships with them, and so I don't expect that – The demand from our customer's point of view is not like kind of a one-quarter thing. It's like it's just a demand curve that goes on, and I don't see it as being perishable demand. I see it as everybody's trying to figure out how they can get as many components as they can to build complete kits for what they need to do. And as they do that, they come back to us and change their demand signal. And we've seen that. You know, maybe a good example is on some of the PC manufacturers where one quarter they'll drop their demand significantly and the next quarter they'll come back and raise it significantly when they've got their own supply chain issues worked out. So, as I said, we've seen this in other parts of the market and we've dealt with it and we know how to deal with it. Now we're just seeing it across a broader cross-section of our business and, quite frankly, some really big customers across that are in that mix now. And we've been working through this now for the last several quarters, and we'll work through it this quarter.
spk12: Yeah, and the most seasonal business is the consumer business, and we are expecting to have a sequential increase in the consumer business. So I think that's probably where there might be perishable demand, but we think that will be pretty solid this quarter.
spk10: Thank you. And today's final question will come from Srini Pajuri with SMBC NECO Securities. Please go ahead. Thank you.
spk01: Thank you for squeezing me in. Dave, I have a question about your pricing strategy going forward, especially given the, you know, cost inflation we are seeing in the supply chain. I guess, you know, some of the cost increases are temporary and some may be permanent. I'm just curious as to hear your thoughts on, you know, in your conversations with your customers, what kind of feedback you're getting, you know, as you kind of look to pass through some of these, you cost to your customers? And also, I want to hear about what you think your ability is in terms of passing through some of these incremental costs if these costs continue to, I guess, remain permanent.
spk19: I think you hit on the answer in the first part of your question set up, which is these are broad and long relationships with our customers, and they don't go up and down quite so fast. So We certainly have conversations with our customers when our costs increase, but it's not as simple as just passing it along. It's got to persist for a while before we would have that conversation. And quite frankly, we participate in a market, and so it's more about the market price. I think the overwhelming issue with pricing is around innovation and making sure we continue to drive innovation across our portfolio. And as I look back on last quarter, The two really big things that stand out to me for last quarter is, one, it's just the execution of the team in a really, really difficult environment, especially as I've talked a lot about the factories in Asia. And two is the innovation roadmap and the fact that we're transitioning aggressively to BICS-5. We introduced OptiNAND. Those are the things. We introduced the 20-terabyte drive, and we're going to be shipping that in volume now here in the next month. You know, that's with our energy assist technology, nine platter, nine disk drive, 2.2 terabytes per platter. So that's the primary issue where it's going to drive an innovation-led discussion with our customers about pricing. In the cost side of it, of course, as if they're going to be very long-term, we're going to have those conversations. But I would say they're long and substantial relationships, and we manage through the quarter-to-quarter stuff really in both directions. But really the focus is on driving innovation. If you drive innovation, you're going to get a better return for it. And quite frankly, I think we've seen that over the last three or four quarters as we've brought Energy Assist in our Our 18-terabyte drive, the 30.9% gross margin this quarter in HGD is a multi-year high, so we feel very good about that.
spk10: And speakers, as that was our final question, I'll turn it over to you for any closing remarks.
spk19: All right, everyone, thanks for joining us. We really appreciate it. It's always good to talk to everyone. Thank you for all your questions, and we look forward to talking to all of you throughout the quarter. Take care. Thanks, everyone.
spk10: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.
Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

-

-