Q2 2022 Western Digital Corp Earnings Call

January 27, 2022

Yes.

Good afternoon, and thank you for standing by welcome to Western Digital's fiscal second quarter 2022 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 one on your phone.

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 <unk>, Chief Executive Officer, and Bob <unk>, Chief Financial Officer.

Before we begin let me remind everyone that today's discussion contains forward looking statements, including product portfolio expectations.

<unk> 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.

Certainties that could cause actual results to differ materially.

We will also make references to non-GAAP financial measures today reconciliations between the non-GAAP and comparable GAAP financial measures are included in the press release and other materials that are being posted in the Investor Relations section of our website.

With that I will now turn the call over to David for introductory remarks.

Thank you Peter good afternoon, everyone and thanks for joining the call to discuss our second quarter of fiscal 2022 results.

We delivered strong results for the fiscal second quarter with revenue of $4 8 billion and non-GAAP gross margin of 33, 6%.

Both of which are within the guidance range, we provided last quarter.

Additionally, we reported non-GAAP earnings per share of $2 30.

Which was ahead of our expectations I am proud of the team as this marks the seventh consecutive quarter of meeting or exceeding guidance amid a continuously increasingly challenged supply chain.

Before I go over the detailed results and business trends I wanted to offer some important key takeaways coming out of calendar year 2021.

First we have made significant progress in strengthening our product portfolio.

We delivered on our goals of qualifying our enterprise SSD products at three cloud Titans into Oems commercializing energy assisted hard drives as well as commencing shipments of 20 terabyte hard drives based on <unk> NAND technologies.

These products address the large and fast growing opportunities within the cloud for storage.

Second demand for western digital storage solutions across cloud client and consumer end markets remains consistently strong we are optimistic about our outlook for calendar year 2022, as our customers continue to indicate solid demand across the end markets we serve.

I'll share more about that demand and other macro factors later.

Third.

We are continuing to navigate an increasingly complex supply chain, which is impacting both our customers' ability to ship products as well as our ability to build products.

In order to meet our end customers' demand we are incurring additional costs that will weigh primarily on our hard drive gross margins through the first half of calendar year 2022.

These issues are transitory in nature affecting both revenue and gross margin and we expect them to subside as the supply chain normalizes, we remain confident that the long term growth and profitability opportunity in front of us has not changed.

Lastly, we received an investment grade corporate rating from Fitch in December which represents western Digital's second investment grade corporate rating.

This marks an important milestone as we have worked hard over the last 18 months to strengthen our financial position, providing us with greater financial flexibility in the future as we approach our targeted debt levels. We look forward to re engaging in a capital return program in fiscal year <unk>.

23.

Turning to our results.

This past quarter demand remains strong across our end markets and our customers in the western digital teams continue to work diligently to mitigate the impact of supply chain disruptions.

In particular cloud revenue for the fiscal second quarter increased by 89% from the same period last year.

We continue to anticipate strength in storage demand, which is bolstered by our ability to continue to bring innovative new products to market to meet the needs of the digital economy.

The potential of what can be accomplished through the creation of content and the ability to access digital information easily has never been greater with our technology, we are enabling businesses creators and innovators to think bigger and push their limits even further.

Western digital has built a great position in the large and growing storage markets, our proven ability to innovate and develop a balanced portfolio coupled with our broad routes to market puts western digital in a strong position to capitalize on the many growth opportunities ahead of us.

I'll now recap, our HDD and flash businesses.

In HDD overall cloud end market product demand remained high with revenue increasing 50% year over year led by capacity enterprise hard drives.

Although we were up strongly year over year capacity enterprise hard drives declined sequentially. After two quarters of strong shipments partly due to some of our customers supply chain challenges.

As both western digital Orange customers continue to face supply chain challenges, we will experience some near term visibility issues. However, our overall demand signals continued to be very good as we move through the calendar year, and we will be in a stronger position once these headwinds subside.

During the fiscal second quarter, we commenced volume shipments of our 20 terabyte CMI hard drives based on <unk> NAND technologies. We are very excited about <unk> NAND, a revolutionary technology that utilizes flash in the control plane to further increase aerial density. Additionally.

We are seeing an increase in customer interest in adopting SMS technology and expect multiple cloud Titans to deploy SME drives and high volume later in this calendar year.

In flash revenue grew in the second fiscal quarter due to seasonal strength in mobile and consumer.

Within mobile shipments of our <unk> five products into leading <unk> smartphones increased over 60% sequentially and 50% year over year led by strong content growth.

<unk> five shipments represented over 40% of total revenue and <unk> five production crossover took place during the quarter as expected the successful ramp of <unk> five helped accelerate our overall year over year bit shipment growth to 37% in the quarter.

Our WD black premium SSD product line optimized for the best gaming experience continues to gain momentum with revenue, increasing about 50% sequentially and doubling in calendar year 2021.

Along with flash products for gaming consoles revenue has grown from zero to over 10% of our flash portfolio over the last two years.

As consumers demand more ways to access generate and store content, whether by a gaming or the now emerging meta versus our strong and growing flash portfolio will be integral to enable all of these applications.

In line with the guidance, we provided last quarter.

Our client SSD business declined sequentially due to supply chain disruptions at some of our PC customers and pricing pressure in the more transactional markets. So.

So far within the current quarter, we are starting to see pricing in the more transactional markets stabilize.

As I mentioned earlier, our enterprise SSD products are qualified at three cloud Titans in two major storage Oems, marking significant progress compared to one cloud Titan a year ago.

As you know this has been one of my top priorities.

Building upon the early success of ramping <unk> five into mobile and gaming consoles. We are further strengthening our product portfolio as we move through calendar year 2022.

In client SSD, the bedrock of Western Digital's Flash portfolio, we have launched and are ramping <unk> five based products in the fiscal third quarter with fixed five enterprise SSD products later in the year.

For our next generation <unk> Flash, we began initial commercial shipment of consumer flash devices based on our 162 layer <unk> six.

Furthermore, we qualified and commence revenue shipment of client Ssds based on Q, ELC and <unk> five technology in the fiscal second quarter.

While it's still early in its evolution, we are starting to pave the way for the industry's adoption of <unk> in the future in our next generation <unk> six node will play an important role in that evolution.

Let me now offer a few observations on the demand environment.

The accelerated digital transformation in the last two years has created a world that is more technology enabled and technology dependent than ever before.

We anticipate these trends will continue to drive data storage growth across each end market, we serve cloud client and consumer our customers remain optimistic about demand trends in calendar 2022, driven by capital investment for the cloud build out continued recovery in enterprise spending.

Growth in smart video applications increased adoption of <unk> phones, consumer gaming and emerging trends such as VR AR devices.

In cloud our customers have announced a 36% year over year increase in capital investment for the cloud Buildout.

This coupled with an increase in enterprise spending and continued growth in smart video applications is expected to drive growth for our flash and HDD products into this growing end market.

In client PC end demand has remained strong our customers are driving more consistent demand than the past several quarters and we see continued stabilization in 2022.

PC unit shipment forecast continue to be robust and significantly ahead of pre pandemic levels. In addition, we anticipate an eventual return to site to drive a mix shift towards commercial Pcs, which tend to offer Richard client SSD content versus consumer oriented Pcs.

In mobile the latest <unk> phones have doubled NAND content from prior generation smartphones, we expect mobile device content to benefit.

As ongoing <unk> adoption and new <unk> enabled applications are expected to drive the storage demand in both endpoints and the cloud.

In consumer the highlight of this end market as our WD Black SSD line of products optimized for gaming enthusiasts revenue more than doubled in calendar year 2021.

The consumer recognition of the strength and value of WD black along with the Sandisk and Sandoz professional brands drove a 34% year over year growth and average capacity per unit and consumer flash.

While end customer demand in calendar 2022 looks promising supply chain challenges are increasing.

This both limits our ability to source components to meet customer demand and increases component costs.

These costs are on top of the ongoing elevated logistics and health and safety Covid costs. While we believe these incremental costs are transitory and will subside as the supply chain conditions normalize they will impact our results through the first half of this calendar year.

Let me now turn the call over to Bob who will discuss our fiscal second quarter results and provide a more detailed outlook for calendar year 2022.

Thanks, Dave and good afternoon, everyone as Dave mentioned overall results for the fiscal second quarter were better than our expectations, marking the seventh consecutive quarter that we've met or exceeded guidance.

Total revenue for the quarter was $4 8 billion.

Down, 4% sequentially and up 23% year over year.

non-GAAP earnings per share was $2 30.

Which exceeded the high end of our guidance range.

Please note that this figure includes $70 million in total COVID-19 related costs, which was higher than we anticipated entering the quarter.

Provide more details on these costs in a minute, but we are pleased to have delivered such strong results in the face of ongoing supply chain issues and COVID-19 related challenges.

In addition to the solid financial performance, we hit a major milestone this quarter and receiving an investment grade corporate rating from Fitch.

This marks the company's second investment grade corporate rating.

We're pleased to see that our work to build a stronger financial foundation is being recognized and is providing us with greater financial flexibility for the future.

Additionally, we closed a public debt offering last December and amended our loan agreement with lenders in January bringing the maturity of over 85% of our debt balance to 2026 and beyond.

For more details please refer to our earnings presentation.

Turning to our end markets cloud represented 40% of total revenue at $1 $9 billion down.

Down, 14% sequentially and up 89% from a year ago.

Supply chain disruptions impacted cloud hard drive deployments at certain customers, which led to a sequential decline in exabyte shipments in the fiscal second quarter.

However, healthy overall demand for capacity enterprise drives along with Western Digital's leadership position at the 18 terabyte capacity point drove a greater than 50% year over year increase and expedite shipments.

The client end market represented 38% of total revenue at $1 9 billion.

That sequentially and down 1% year over year.

The continued ramp of <unk> phones helped offset decline in both client SSD and client hard drive revenue, enabling total client revenue to stay flat.

Client hard drives represent less than 15% of our HDD revenue.

Lastly, consumer represented 22% of revenue at $1 1 billion.

Up 9% sequentially and flat year over year.

With a strong holiday season retail flash led to sequential growth in consumer on a year over year basis growth in consumer flash was offset by a decline in consumer HDD.

Turning now to revenue by segment.

Reported flash revenue of $2 6 billion up 5% sequentially and up 29% year over year.

On a blended basis flash asps were down 6% sequentially due to a seasonal increase in shipments to mobile and retail.

On a like for like basis Flash Asps were down 3% sequentially.

Flash bit shipments increased by 13% sequentially and 37% year over year.

Hard drive revenue was $2 2 billion.

Down, 14% sequentially and up 16% year over year.

On a sequential basis total hard drive exabyte shipments decreased by 14%, while the average price per hard drive decreased by 5% to $97.

On a year over year basis, total hard drive exabyte shipments increased by 27%.

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 second quarter was 33, 6% down <unk> three percentage points sequentially.

As noted earlier, the Covid related impact was $10 million higher than we anticipated at $78 million.

Our flash gross margin was 36, 1% down <unk> nine percentage points sequentially.

This included Covid related impact of $10 million or approximately <unk> four percentage points.

Our hard drive gross margin was 36% down three percentage points sequentially.

This included Covid related impact of $60 million or approximately two seven percentage points.

Operating expenses of $741 million were below our guidance range due to prudent cost control and lower variable compensation expense.

Operating income was $882 million, representing a 7% decrease from the prior quarter and 157% increase year over year, highlighting our ability to drive profitable growth.

Earnings per share was $2 30.

Which exceeded the high end of our guidance range.

Operating cash flow for the second quarter was $666 million.

And free cash flow was $407 million.

Despite a slight increase in inventory due to supply chain disruption, we've maintained strong cash flow generation in the quarter.

Capital expenditures, which include the purchase of property plant and equipment and activity related to our flash joint ventures on our cash flow statement.

The cash outflow of $259 million.

We remain prudent and investing in manufacturing capacity and continue to expect gross capex for the current fiscal year to be around $3 billion.

We now expect cash capex to be around $1 $5 billion as we actively manage our overall spending.

As we mentioned on our last earnings call, we fully repaid our term loan b and the amount of $943 million last October .

In addition last December we closed a public offering of $1 billion in senior unsecured notes and repaid $1 $3 billion on our term loan a bringing our gross debt outstanding to seven 4 billion at the end of the fiscal second quarter.

On top of that earlier this month, we entered into an agreement with our lenders to revise the terms of our loan agreement to reflect our improved credit ratings and to extend the maturity of our term loan and revolving credit facility from 2023 to 2027.

Our trailing 12 month adjusted EBITDA at the end of the second quarter as defined in our credit agreement was $4 8 billion.

Resulting in a gross leverage ratio of one five times this.

This compares to 3.0 times in the third fiscal quarter of 2020, when we announced the plan to focus on debt repayment to achieve greater financial flexibility.

As a reminder, our credit agreement includes $1 billion in depreciation add back associated with the Flash ventures. This is not reflected in our cash flow statement.

Please refer to our earnings presentation on the Investor Relations website for further details.

Considering the transitory supply chain challenges, we discussed earlier I would like to provide a bit more color on our view of both hard drive and flash businesses in calendar 2022.

Within our hard drive segment, we expect hard drive revenue to decrease on a sequential basis in the third fiscal quarter.

While the supply chain disruptions at some of our customers are expected to remain the larger issue of late has been our ability to source components to meet customer demand.

We expect revenue to return to sequential growth in the fiscal fourth quarter.

While overall hard drive pricing is expected to remain relatively stable, we expect gross margins to decline, 2% to three percentage points from the fiscal second quarter through the fiscal fourth quarter due primarily to component cost inflation.

Within our Flash segment, we expect flash revenue to decrease on a sequential basis in the fiscal third quarter driven by ASP.

We expect flash revenues to return to growth in the second half of calendar year 2022.

Furthermore, we anticipate downward pressure on gross margins for the first half of this calendar year as cost reductions revert towards our long term target of 15%.

In regard to our fiscal third quarter, our non-GAAP guidance is as follows.

We expect revenue to be in the range of $4 45 to $4 65 billion.

With a sequential revenue decline for both flash and hard drive businesses.

We expect gross margin to be between 30% and 32%.

We expect operating expenses to be between $750 and $770 million.

Interest and other expenses are expected to be approximately $70 million.

Our tax rate is expected to be approximately 11% in the third quarter and for the fiscal year.

We expect earnings per share to be between $1 50, and $1 80 in the third quarter, assuming approximately $318 million fully diluted shares outstanding.

I'll now turn the call back over to Dave.

Thanks, Bob looking ahead, we remain optimistic about our business outlook in calendar year 2022, as our customers continue to indicate strong and demand across cloud client and consumer end markets. Despite the transitory issues, we discussed earlier.

Clearer than ever that we have the right foundation for long term growth and the right technology portfolio in place to ensure that we are successful in scaling our business over the last couple of years, we have made significant changes necessary to improve our focus sharpen execution and set strategic goals to place.

Western digital in the position of greater strength and I am excited that we are starting to see the fruits of those changes.

Before I finish today I'd like to take a moment to comment on the CFO transition, we announced earlier this afternoon.

You may have seen we announced that with some job ray will be joining western digital is chief financial officer effective the week of February seven.

We saw him was most recently chief financial Officer dialog semiconductor. In addition to his deep financial and semiconductor expertise. We saw also has technical expertise and importantly shares western digital's values of collaboration and innovation.

Can read more about his background in the press release issued today.

Like to extend my sincere thanks on behalf of the entire board and management team to Bob for his.

<unk> hard work at the service of Western digital.

During my tenure as CEO I have greatly benefited from his friendship and expertise. He has been an essential part of our leadership team guiding key aspects of our strategy.

Among many other contributions Bob drove our capital allocation strategy that has led to significant repayment of our debt Mark this quarter by Western Digital's second investment grade corporate rating.

Bob's insight was also instrumental in helping us navigate COVID-19 uncertainty and execute other strategic changes at the company to position us for growth and value creation.

Next quarter, you'll have an opportunity to hear from us. Some I know he is looking forward to it with that Peter let's begin the Q&A.

Thank you ladies and gentlemen, we will now begin the question and answer portion of today's call. If you have a question. Please press star one on your phone if you will.

To withdraw your question please press the pound.

One moment please for the first question.

Our first question will come from Aaron Rakers with Wells Fargo. Please go ahead.

Yes, thanks for taking the question I guess I wanted to dive into obviously the hard disk drive results I mean by my math it looks like you.

The shift in near line declined by about high teens, or even 20% sequential can you help.

The impact of your larger cloud customers, having their own supply constraints relative to the comment of your own component availability.

And then on top of that.

Gross margin in this next quarter I know you alluded to but how much COVID-19 costs are you factoring into the gross margin expectation with 2% to three percentage points decline. Thank you.

I'll take a crack detection Erin thanks for the question and thanks for joining us as always.

I think it was quite down quite quite as much as you said I think we're kind of like mid teens.

A big piece of that is we've talked about it last quarter. We had one very very large customer that's going through.

Some challenges of their own.

And now we have issues with our own supply chain. So I would say in the last quarter it.

It was primarily on the customer side and as we went through the quarter. It started to creep in on on our own components and as we move into the next quarter.

It's much more of a component issue is as the rest of the market normalizes out or the customer normalizes out.

On the Covid costs, you saw there theyre going up and I'll, let Bob comment on this in more detail.

But.

The health and safety and logistics costs continue to go up we've seen that over the last couple of quarters and now we're seeing.

Seeing component costs that are almost approaching that same level.

<unk> spend as far as increases so that'll give you some idea of sizing it that Bob do you want to.

Yes, I can add a little more detail I think the COVID-19 costs, we've been reporting which are the logistics costs.

Costs in the factory associated with keeping our employees safe probably peaked in the second fiscal quarter at $270 million I think it will come down some.

In the third quarter, and hopefully continuing to come down from there the logistics costs as you know have been elevated for probably at least six quarters now.

The thing Thats different is as we look at the next quarter or two are the component costs and we're seeing a lot of inflationary pressures on the component costs. We think those are transitory or opex, but I'd fees a lot of a lot of expense associated with trying to get the parts and so we can get the products built and delivered so I think that's really what's.

As we look forward the next quarter or two.

The other thing Erinn I'll, just wrap up by saying I mean, as we look forward into the next quarter, we're expecting right about on seasonality for our hard drive business.

I would say earlier.

Midway through last quarter, we are hoping to do better than that because we saw the demand there.

But there's a significant amount of unmet demand that we just can't meet given the component constraints, but even with all of that included we believe we're back on back on a more seasonal number.

Okay. Thank you.

Sure thing.

Thank you. Our next question will come from C. J Muse with Evercore. Please go ahead, yes.

Yes. Good afternoon. Thanks for taking the question I guess to follow up on Aaron's question.

Can you speak to when you expect these constraints.

Two.

To no longer be a headwind and as part of the higher component costs.

Is there a point in time, where you can where contracts can be renegotiated and you can.

The increase there was higher input costs in terms of your pricing.

Yes, so there is.

First of all thanks for the question and thanks for joining US again, there is a lot to unpack or that question. Let me let me take a.

A bit of a crack at it so.

The component constraints are not necessarily new we have been dealing with them for a long time I think early in the pandemic, we were able to qualify additional component suppliers diversify.

And then as things went on we would always remix and do what we could to get the most out of the components we could get.

It's just gotten to the point now where it's getting even more constrained.

And quite frankly, a little bit more surprises that orders that we thought were going to show up get either delayed or canceled. So we continue to work through that so.

To your point, there's a number of dynamics about why it gets better one.

We stay very close to our suppliers and we obviously work many quarters into the future.

And we can see as we get through the first half of the year things get better.

We also the technology moves forward it in some cases, we just move on to different nodes.

In the semiconductor business that have more availability on them. So we know as the portfolio shifts things are going to free up and then to your point.

The longer it goes we can negotiate longer contracts and kind of look at the relationship with all of our suppliers to get back to a position where we have more predictability both on the supply side and on the pricing side of it.

That's very helpful. As my follow up on the NAND side of things I think you've historically talked about the transactional market kind of as a leading indicator and so curious as you look into March.

Are you thinking about.

Pricing and I know you don't.

Pricing, but curious.

Is there a larger headwind like for like or on a blended basis as you sit here today and consider.

The likely mix.

I would say pricing is.

Look I mean, I said it in the script pricing has stabilized in the more transactional markets. I think there was a little bit I think the narrative in the industry given some of the shutdowns that are going on with it flow through immediately.

We haven't seen that.

But we do we did see a stabilization.

Also it's worth noting that.

Majority of the portfolio is price before we go into the quarter and that happened before any of the events of the shutdowns in China. So.

That's not going to show up for another quarter or two.

But.

I would say, we're seeing more stabilization our view I think has been that we will see.

We'll see better pricing in the second half.

And that's pretty much the way, it's playing out.

Depending on kind of the.

The impacts of some of the shutdowns that may move forward, a little bit, but I think mainly the impacts of what we've seen impact on NAND pricing is going to be more second half favorable including some of the stuff. We're seeing now on uneven the tool vendors. The component issue is heading them. So we're watching that very closely I would say right now we've got.

We've got a more stable environment over the last two to three weeks.

Thank you.

Yep.

<unk>.

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

Great. Thank you just following up on the NIM question.

You guys have been going through this big five transition and I know part of that.

Sort of as you're waiting for controllers and qualifications that you end up in those more transactional markets where are you from a mix standpoint is that still a negative impact in the March quarter and do you see that at some point reversing as you start to get traction in other markets with X five.

Hey, Joe Thanks for the question so definitely as we go through the year the mix gets better on VIX five it starts out in more transactional markets consumer moves into mobile it's moved into gaming.

This quarter, we will start to ramp client and then.

More of that as we go through the year and then in the second half of the year, well, we'll ramp <unk> five into enterprise SSD.

And that's really where the whole enterprise SSD story comes together we've got this.

This year, we went through all the qualifications.

That's <unk> for material right now which is in shorter supply.

And then as we ramp that into <unk> five throughout the year the mix the mix gets better as we go throughout the year. So it's a really important point and one of the reasons why.

When we talk about the setup for 2022 as.

As we go forward the portfolio gets stronger.

Great and then.

And then I don't know if you mentioned because of been on multiple calls.

Have you had constraints from SSD controllers, as well as HDD and power management anything else, that's constraining on the NAND side of the business.

Yes, I would say the NAND business, we're leaving on the table in the NAND business is higher than the drive business. It is significant and the drive business on the order of $100 million to $150 million in the third quarter, there, but in the in the flash business.

It's it's.

Basically twice that so yes, its controllers its power Ics, it's a number of different parts on enterprise ssds and embedded as well.

Great. Thank you.

Sure thing.

Thank you. Our next question will come from Karl Ackerman with Cowen. Please go ahead.

Yes. Thank you two questions if I may.

It's great to see crossover of <unk>, 5% this quarter.

Can you discuss the timing of ramping <unk> six I ask given your plans to reduce to reduce cash capex and expectations for a moderation.

And cost declines.

A follow up please.

So we expect so first of all let me talk about how we think about ramping different nodes I mean, the main thing. We're looking at is the cost side of it so.

The cost numbers are good.

Good again this quarter.

We expect that to revert closer to the 15 that we always talk about modeling it's been above that I think for nine quarters in a row now.

But still the nodes are producing.

And we're getting the cost we needs as we as we go forward. We fixed four was a great node for us on yields at record yields we expect big five to six five is the most capital efficient node the team has ever built.

So at this point, we expect <unk> to be in FY 'twenty three type of ramp.

We've got we've got lots of runway on <unk> five.

I appreciate that.

For my follow up there have been some investor concerns that channel inventory has been increasing for non enterprise hard drives and retail areas of the NAND market.

I am curious whether thats the case for you it doesn't appear that way given the constraints you are seeing from a component perspective, but if you could just discuss the.

That level of visibility and the amount of channel inventory, you see or the leanness of that that would be very helpful. Thank you.

I don't think its anything noteworthy that's particularly out of the norm across the portfolio.

We talked a little bit about some stuff last quarter Thats normalized.

Yeah.

So theres really nothing to call out I don't know Bob has anything come to mind from your perspective, I think quarter within normal ranges in every every region.

Thank you thank you Kyle.

Thank you. Our next question will come from Mehdi Hosseini with ethane.

Yes, thanks for taking my questions two follow ups.

Wanted to go back to the supply chain dynamics for HDD and.

Now that.

Two.

Follow ups here.

Now that Youre.

Actually the impacted by component shortages.

Yes.

Is that.

If you were willing to pay a higher premium would you actually be able to procure the components you need or is it just.

Hoarding going on in the supply chain.

Or just.

The parts are available no matter, how much you are willing to pay and I have a follow up.

Well I think there is.

There is a premium to get.

So we have good contracts with our suppliers.

So, but there are premiums to get the pieces.

But like I said, there is just more variability on timing, especially in the Factset.

Orders that had been placed many many many quarters in advance then we get push outs.

I think your question is are we just not paying forum are they available and I think it's a mix I mean, we're definitely we definitely have to pay more to get what we need and there is some pieces that are just getting delayed and especially later in the planning cycle, where it's more difficult to mitigate.

The impacts.

Thank you.

So up to that.

When I look at your December quarter, you were impacted by one particular customer now to supply chain issue does that mean that we should expect.

Step function in your HDD shipments.

Especially leading into the September quarter or is the recovery in recouping. These lost shipment and revenues going to be more gradual.

Yes, let's talk about I mean, I think we're back on seasonality as we go into Q1.

We obviously have a margin impact we expect the revenue Q3 to be the bottom on the revenue in that business I think the margin will probably hit the bottom in the next quarter, but we'll see some sequential growth.

What I can say is when we look at it.

Calendar Q2 calendar Q3 through the end of the year the demand signals from our customers are very strong so.

Assuming we get the parts and like I said, especially on the drive business as the portfolio transitions, we move on to different nodes that are free year as far as getting the controllers.

That's why we have more confidence in the second half of the year.

Got it thank you and Bob.

Best of luck in your next endeavor.

Alright, Thanks, Mary Thanks Mehdi.

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

Good afternoon. Thanks, so much for taking the question I've got two as well.

Dave I guess, you've been focused on.

I guess shifting your ACD business from a more transactional business to one that's more perhaps a little bit more strategic and longer term in terms of how you how are you.

Engagement with your customers any progress on the LTA front over the past couple of quarters.

Yes, I think.

The business is definitely changing I mean, we've talked about this for a couple of years and let me just frame it up is that kind of.

Where we were when we walked into 2021 and where are we when we walk into 2022.

And so as we go into 'twenty, two where clearly we clearly have strong customer demand in the first quarter, we have more demand than we can meet we have customers asking us for upsides.

And we we get good <unk>.

Hand signals as we move through the year.

The LTA percentage to your point, our multi quarter agreements.

Im starting to say a little more precise.

On the drive business when we walked into 'twenty. One we had we knew where maybe a low to mid single percent of our extra bytes, we're going to go through agreements and as we walk into 'twenty. Two that's more like a third of the portfolio. So <unk> seen a dramatic we've seen a dramatic difference in.

What we understand about how much our customers are going to take especially the biggest of the big customers. What their demand is going to look like what are they committing to that obviously helps us plan that helps us work on pricing. So it's a very very different situation.

From a portfolio point of view.

We walked into calendar year 'twenty, one when we were talking about commercializing energy assist we walk into 'twenty two.

Not only having commercialized energy assist and got the areal density gains from it. We've also launched opt in NAND.

We got back on our front foot with 18 and ramp that and now we're ramping 20.

Something we talked about in the script, which has evolved over the year as we are seeing much more interest now from the big customers and SME that's.

Something we've been investing in for many years, we've always thought it's been good technology.

<unk> NAND helps deliver a better <unk> drive in better areal density and we expect by the end of the year, we're going to have multiple cloud Titans deploying.

<unk> at scale.

On the flash side of the business, we talked about <unk>, five and kind of where we are there and how that portfolio gets stronger throughout the year and then I think as we go through 'twenty. Two we're just in a better financial situation than we were before.

And as we talked about on the call getting too.

Getting to is back to a shareholder return policy, which we're all very much looking forward to as we move into FY 'twenty three so maybe a little broader than your question <unk>.

LTA is in the drive business have become a meaningful increase in the percent of our expedites and where theyre going to be placed.

Throughout the year.

Got it that's super helpful. Thank you and then as my follow up Dave You mentioned at the very end of your response on the shareholder return aspect of the business.

So its next fiscal year, which is which is great what sort of internal debate when you think about dividend versus share repurchases.

Just just given the evolving macro backdrop and sort of the rate backdrop any change in how you think about and how you approach capital allocation at a high level. Thank you, yes, I think I think we will have more to say about that.

As we get a little bit closer I mean, one of the things. We can do is talk to our shareholders and get their input on that question and then we'll have more to say about it. So I don't know if its an internal debate just yet, but we're just really looking forward.

To getting to that point, we've spent 18 months now paying down well over $2 billion worth of debt.

We have the ability we've made a lot of changes in our execution and the portfolio to generate more cash and we're looking forward to returning that to our shareholders.

Thank you.

Thank you, ladies and gentlemen, due to time, we strain we ask that you. Please limit yourself to one question.

Next question will come from Timothy Arcuri with UBS. Please go ahead.

Hi, Thanks, a lot this is Jason park on for Terry.

Okay.

Question.

Question is on our HDD.

So.

Just wanted to ask how Youre 20, terabyte as Brad Pitt.

Wonder year.

As you guys know you've got your competitor I provided some color on this last night thing.

Terabyte will be one of the fastest ramp ever so if you guys.

You could provide any details on how your 18, then pointed out with a recommendation.

Thank you.

Yes, 20 years, but I guess, what I would say is 'twenty is ramping going to ramp it as ramping I mean, if I look at units shipped in the last quarter, we're up to a high single digit percent already of units that are going out at <unk>.

And like I said, we see high interest because we have some very very large customers going to <unk> and.

And so youre going to get more more bang for your Buck there.

The gains you get on <unk> and <unk> NAND as a as a technology that makes that even more efficient so.

We feel really good about where 20 is we feel good about where the technology is.

And we think it's going to be a very successful ramp.

I'll just leave it at that.

Thank you. Our next question will come from Vijay Rakesh with Mizuho. Please go ahead.

Dave and Bob just a question here on your March quarter Flash Guide I think you talked about price.

It might be a little bit of pricing that would be little bit softer.

The mix should be more positive for you guys, because mobile probably comes in and better mix.

Good evening.

Enterprise.

Modest wouldn't be more stable in the flash site into the March quarter, and also I think you mentioned.

<unk> cost inflation.

This is actual component costs and logistics costs.

What exactly the company and cost inflation.

So on the second one is actual component costs like what the supply what the suppliers mix of courses is a different quite different thing I mean, obviously wafers are going up but for us. It's just the cost of the component itself on your mix question, Yes mix gets better as we go forward because we go more into to <unk> five and more.

Parts of the portfolio I guess, what I'll say is the component.

Impact on the portfolio I mean, one of the places of component impact on flash is hitting the portfolios on enterprise HDD, which is.

Enterprise SSD.

So Steve Thank you Peter Enterprise SSD.

So anyway.

The component impact on the portfolio is.

Component shortage impact on the portfolio as part of the equation there as well.

Got it thanks.

Thank you.

Thank you. Our next question will come from Tom O'malley with Barclays. Please go ahead, Hey, good afternoon, guys and thanks for taking my question I just had two on the HDD business.

<unk>.

David you've talked about seasonality or a more seasonal March you've obviously see some margins over the past two years that I would classify as less seasonal could you remind us what seasonality traditionally looks like in that business and then the second one is you talked about gross margins over the next few quarters going down 200 to 300 basis points in the ACG business could you.

Any color on the cadence there do you see a sharp fall off in March and a flattening in June or is it a step function for both quarters. Thank you.

First question.

Margins by season seasonality.

About 4%.

The company overall, but were years, usually down about 4% in the March quarter.

And then Rob you want to comment on gross margin, but it looks like an HP and HDD Q fiscal Q3 fiscal Q4, yes.

Mentioned.

We have two big headwinds right now the one we've had for a while which of the COVID-19 costs and we hope they peaked in the December quarter. We think they peaked in the December quarter at about $70 million and it'll come down some from there.

So logistics costs.

Have been persistent for quite a while so I think it really comes down to what are we going to see more passenger traffic coming out of Asia, which we'll be able to get the cargo rates down. So so thats one headwind we continue to have and then on the component costs.

We're really expecting those to persist through the fourth quarter, and we expect them to get better as we go through the year as Dave mentioned as some of the controllers get on different nodes and we're able to see more supply available.

I think through that through the fourth quarter, we will continue to have a challenge.

Thank you for the color.

Sure.

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

Probably a question for Bob, but when you talk about those COVID-19 costs.

Kind of peaking I think you said December quarter, peaking can they come off pretty quickly if the COVID-19 pandemic ends up for spring and summer kind of going away and critical mass of people overcome it just kind of curious about how quick they can go away or or is that too optimistic to think.

They could go away.

Hopefully as fast as warmer temperatures come around.

Yes, I mean, I think that as I mentioned the real driver is there's very little passenger traffic coming out of Asia right now and so there's a lot of cargo on those flights in normal times. So yes.

Obviously, we're seeing good indications a lot of the countries are starting to open up I'd say theyre going to open up in the spring then you have to see the passenger travel will come back and then obviously you have to negotiate with the carriers and see the rates come down. So I don't know its going to be Super quick, but I think that it will come down over the course of the year.

Great. Thanks, so much sure thanks, Jim.

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

Hi, just a basic one from me I.

I understand how.

Different nodes on the controller side can help and some things are out of your control in terms of freight costs. As you just mentioned, but I am just struggling to.

With the idea that in a couple of quarters you feel that.

Some of these supply chain issues will be more manageable is there anything else you guys are doing to.

Control.

Your own destiny that makes it sort of a little bit different in terms of your outlook.

Let's say September December and Bob Congratulations.

Always appreciate working with you. Thanks.

Yes, so I think we're doing everything we can I mean, we're I mean, we always look to diversify our supply chain, especially in this kind of environment.

We're staying very close to our suppliers to understand it.

Exactly.

They understand what we need and we understand what they can they can provide like I said, there's been more variability in that lately, where we're redoubling our efforts there to get close to it.

And I think when we look we plan many many quarters in the future and so when we look at.

We look at where we're at if we can get the surprises out of there, which we think will get better as more.

More of the nodes in the fab start to free up will we will be able to be in a better position and like I said theres. Some theres some big issues. When you when you roll the portfolio forward.

If you change the bomb the product and that that gives you a different set of components that you are using so when you look at that planning is what gives us confidence on the second half.

That's really helpful. Thank you very much.

Thanks, Dave I appreciate your comments.

Thank you. Our next question will come from Ananda Baruah with loop capital. Please go ahead.

Hey, good afternoon, guys and appreciate you guys taking the question.

Bob Yes, it really enjoy working with you as well.

Thank you.

Yes, you got it I guess my question is sticking with 20 terabyte.

The component constraints.

The velocity of the ramp through the year and I believe in the past you had talked about maybe reaching 2000 TV crossover sometime sometime mid year and that's still the case. Thanks a lot.

Yes.

The components situation is better on 'twenty.

Maybe a better way of saying what I said earlier.

But so I mean at.

At this point, there's no impeding of that that roadmap right in that ramp.

Where we are we're running into problems as controllers on <unk>, because that's where that's where 75% to 80% of the portfolio is right now and that's that's the sweet spot of what customers are deploying so.

I think as we move through the year and we move into 'twenty.

We'll get things to free up it will get closer to our suppliers and get more capacity.

On the current products as well, but as we move forward. We also have some other dynamics that help us.

That's super helpful. Okay, great. Thank you.

Thank you. Our next question will come from Stephanie <unk> with SMB Nikko Securities. Please go ahead.

Thank you just a follow up to one of the previous questions on I guess the cost side of things.

Obviously some of the costs are transitory when it comes to sublet chain, but it's no secret that the semiconductor pricing IC pricing has gone up.

Perhaps on a permanent basis so.

I am just curious Dave as you kind of talk to your customers and what sort of conversations are you, having with your customers and I'm trying to understand your ability to pass through some of these permanent cost increases.

As we go through the next few quarters.

Yes, so we work I mean.

This goes back to the conversation we had earlier on multi quarter agreements I mean, we've been working with our customers quite a bit on what their future looks like and what Theyre planning that gives us more certainty in the process.

And quite frankly, that's helped stabilize pricing in the <unk>.

In this environment.

The first order of business is to be as close to our customers and mitigate these costs.

Through staying aligned with them.

If it gets to the point, where there is.

Think theyre going to be long term and of course well.

Economics of the industry will have to reset to drive the continued investment to drive the exabyte growth. So.

So a little bit how we're thinking about right now.

We see them.

Subsiding as the supply chain loosens up and we drive the technology forward.

If our calculation is off on that and we'll we'll look at all the other levers we have in the business.

Got it and Bob Thank you for all your help and good luck.

Thank you I appreciate it.

And our final question will come from Nik Todorov with Longbow Research. Please go ahead.

Yes, Thanks for squeezing me in and thanks for taking my question.

We talked about the Otas on the HDD side I Wonder what does that guide the customers were doing lta's on the NAND side, particularly on the enterprise business and then maybe on the client SSD side.

Supply is obviously open banking.

I would say.

Definitely LTA as are the routine way the NAND market works with with with Oems and anybody that's buying on a consistent basis. So that's been a part of the market for a long time I think it's we're borrowing some of those ideas and moving over to the to the drive business.

Again, I talked about earlier why I'm more confident in 'twenty, two as we walk into the year and as we go forward.

On the NAND side.

<unk> of the portfolio under LTA has gone up as well.

We walked into last year.

It was over it was already over half the portfolio, we walk into this year, it's more like two thirds.

And realize we have a big percentage of our portfolio and consumer markets and the channel. So so those are not things, where you think about multi quarter agreements with your customers, but in the NAND market.

It's just the way business is done is to negotiate share for.

For different products with customers.

And then of course on a quarterly basis negotiate price.

Within that share envelope.

Then there's always the opportunity for upsides beyond that share amount and we're seeing a fair amount of that right now in the NAND business. There is theres a lot of customers coming to SPC customers enterprise SSD customers.

Looking for upside.

And so again that makes us optimistic when we talk about strong demand signals.

That's one of them that that gives us.

It gives us confidence in the year, we'll manage through the component issues and we feel super good about where the roadmap is where the technology. That's underpinning this is.

We feel good about the customer relationships and demand signals and again to wrap it all up we spent a year and a half getting the company in a much stronger financial position and we look forward to getting back to a shareholder return policy. So.

But again to summarize your question LTA is much much more prevalent in the NAND business.

Got it thanks.

Thank you.

Alright.

Peter Alright.

Alright, thanks, everyone. We really appreciate you joining us today.

We will be talking throughout the quarter.

And we'll look forward to engaging them. Thank you very much thanks everybody.

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

[music].

Yes.

[music].

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 <unk>, Chief Executive Officer, and Bob <unk>, 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.

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.

With that I will now turn the call over to David for introductory remarks.

Thank you Peter good afternoon, everyone and thanks for joining our call to discuss our second quarter of fiscal 2022 results.

We delivered strong results for the fiscal second quarter with revenue of $4 8 billion and non-GAAP gross margin of 33, 6%.

Both of which are within the guidance range, we provided last quarter.

Additionally, we reported non-GAAP earnings per share of $2.30, which was ahead of our expectations.

I'm proud of the team as this marks the seventh consecutive quarter of meeting or exceeding guidance amid a continuously increasingly challenged supply chain.

Before I go over the detailed results and business trends I wanted to offer some important key takeaways coming out of calendar year 2021.

First we have made significant progress in strengthening our product portfolio.

These products address the large and fast growing opportunities within the cloud for storage.

I'll share more about that demand and other macro factors later.

Third.

We are continuing to navigate an increasingly complex supply chain, which is impacting both our customers' ability to ship products as well as our ability to build products.

In order to meet our end customers' demand we are incurring additional costs that will weigh primarily on our hard drive gross margins through the first half of calendar year 2022.

Lastly, we received an investment grade corporate rating from Fitch in December which represents western Digital's second investment grade corporate rating.

23.

Turning to our results.

This past quarter demand remains strong across our end markets and our customers in the western digital teams continue to work diligently to mitigate the impact of supply chain disruptions.

In particular cloud revenue for the fiscal second quarter increased by 89% from the same period last year.

We continue to anticipate strength in storage demand, which is bolstered by our ability to continue to bring innovative new products to market to meet the needs of the digital economy.

I'll now recap, our HDD and flash businesses.

In HDD overall cloud end market product demand remained high with revenue increasing 50% year over year led by capacity enterprise hard drives.

Although we were up strongly year over year capacity enterprise hard drives declined sequentially. After two quarters of strong shipments partly due to some of our customers supply chain challenges.

As both western digital Orange customers continue to face supply chain challenges, we will experience some near term visibility issues. However, our overall demand signals continue to be very good as we move through the calendar year, and we will be in a stronger position once these headwinds subside.

During the fiscal second quarter, we commenced volume shipments of our 20 terabyte <unk> hard drives based on <unk> NAND technologies. We are very excited about <unk> NAND, a revolutionary technology that utilizes flash in the control plane to further increase aerial density. Additionally.

Additionally, we are seeing an increase in customer interest in adopting SMS technology and expect multiple cloud Titans to deploy SME drives and high volume later in this calendar year.

In flash revenue grew in the second fiscal quarter due to seasonal strength in mobile and consumer.

Within mobile shipments of our <unk> five products into leading <unk> smartphones increased over 60% sequentially and 50% year over year led by strong content growth fixed.

Our WD black premium SSD product line optimized for the best gaming experience continues to gain momentum with revenue, increasing about 50% sequentially and doubling in calendar year 2021.

Along with flash products for gaming consoles revenue has grown from zero to over 10% of our flash portfolio over the last two years.

In line with the guidance, we provided last quarter.

Our client SSD business declined sequentially due to supply chain disruptions at some of our PC customers and pricing pressure in the more transactional markets. So.

So far within the current quarter, we are starting to see pricing in the more transactional markets stabilize.

As I mentioned earlier, our enterprise SSD products are qualified at three cloud Titans in two major storage Oems, marking significant progress compared to one cloud Titan a year ago.

As you know this has been one of my top priorities.

Building upon the early success of ramping <unk> five into mobile and gaming consoles. We are further strengthening our product portfolio as we move through calendar year 2022.

In client SSD, the bedrock of Western Digital's Flash portfolio, we have launched and are ramping <unk> five based products in the fiscal third quarter with <unk> five enterprise SSD products later in the year.

For our next generation <unk> Flash, we began initial commercial shipment of consumer flash devices based on our 162 layer <unk> six.

Furthermore, we qualified and commence revenue shipment of client Ssds based on Q, ELC and <unk> five technology in the fiscal second quarter.

Let me now offer a few observations on the demand environment.

The accelerated digital transformation in the last two years has created a world that is more technology enabled and technology dependent than ever before.

Growth in smart video applications increased adoption of <unk> phones, consumer gaming and emerging trends such as VR AR devices.

In cloud our customers have announced a 36% year over year increase in capital investment for the cloud build out.

This coupled with an increase in enterprise spending and continued growth in smart video applications is expected to drive growth for our flash and HDD products into this growing end market.

And client PC end demand has remained strong our customers are driving more consistent demand than the past several quarters and we see continued stabilization in 2022.

PC unit shipment forecast continued to be robust and significantly ahead of pre pandemic levels. In addition, we anticipate an eventual return to site to drive a mix shift towards commercial Pcs, which tend to offer Richard client SSD content versus consumer oriented Pcs.

In mobile the latest <unk> phones have doubled NAND content from prior generation smartphones, we expect mobile device content to benefit.

As ongoing <unk> adoption and new <unk> enabled applications are expected to drive the storage demand in both endpoints and the cloud.

In consumer the highlight of this end market as our WD Black SSD line of products optimized for gaming enthusiasts revenue more than doubled in calendar year 2021.

While end customer demand in calendar 2022 looks promising supply chain challenges are increasing.

This both limits our ability to source components to meet customer demand and increases component costs.

Let me now turn the call over to Bob who will discuss our fiscal second quarter results and provide a more detailed outlook for calendar year 2022.

Thanks, Dave and good afternoon, everyone.

I've mentioned overall results for the fiscal second quarter or better than our expectations, marking the seventh consecutive quarter that we've met or exceeded guidance.

Total revenue for the quarter was $4 8 billion.

Down, 4% sequentially and up 23% year over year.

non-GAAP earnings per share was $2 30.

Which exceeded the high end of our guidance range.

Please note that this figure includes $70 million in total COVID-19 related costs, which was higher than we anticipated entering the quarter.

<unk> provide more details on these costs in a minute, but we are pleased to have delivered such strong results in the face of ongoing supply chain issues and COVID-19 related challenges.

In addition to the solid financial performance, we hit a major milestone this quarter and receiving an investment grade corporate rating from Fitch.

This marks the company's second investment grade corporate rating.

We are pleased to see that our work to build a stronger financial foundation is being recognized and is providing us with greater financial flexibility for the future.

Additionally, we closed a public debt offering last December and amended our loan agreement with lenders in January bringing the maturity of over 85% of our debt balance to 2026 and beyond.

For more details please refer to our earnings presentation.

Turning to our end markets cloud represented 40% of total revenue at $1 $9 billion down.

<unk>, 14% sequentially and up 89% from a year ago.

Supply chain disruptions impacted cloud hard drive deployments of certain customers.

Led to a sequential decline in exabyte shipments in the fiscal second quarter.

The client end market represented 38% of total revenue at $1 $9 billion.

<unk> sequentially and down 1% year over year.

The continued ramp of <unk> phones helped offset decline in both client SSD and client hard drive revenue, enabling total client revenue to stay flat.

Client hard drives represent less than 15% of our HDD revenue.

Lastly, consumer represented 22% of revenue at $1 $1 billion.

Up 9% sequentially and flat year over year.

With a strong holiday season retail flash led to sequential growth in consumer on a year over year basis growth in consumer flash was offset by a decline in consumer HDD.

Turning now to revenue by segment.

Reported flash revenue of $2 6 billion.

5% sequentially and up 29% year over year.

On a blended basis flash asps were down 6% sequentially due to a seasonal increase in shipments to mobile and retail.

On a like for like basis Flash Asps were down 3% sequentially.

Flash bit shipments increased by 13% sequentially and 37% year over year.

Hard drive revenue was $2 2 billion.

Down, 14% sequentially and up 16% year over year.

On a sequential basis total hard drive exabyte shipments decreased by 14%, while the average price per hard drive decreased by 5% to $97.

On a year over year basis, total hard drive exabyte shipments increased by 27%.

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 second quarter was 33, 6% down three percentage points sequentially.

As noted earlier, the Covid related impact was $10 million higher than we anticipated at $78 million.

Our flash gross margin was 36, 1% down <unk> nine percentage points sequentially.

This included Covid related impact of $10 million or approximately <unk> four percentage points.

Our hard drive gross margin was 36% down three eight percentage points sequentially.

This included Covid related impact of $60 million or approximately two seven percentage points.

Operating expenses of $741 million were below our guidance range due to prudent cost control and lower variable compensation expense.

Operating income was $882 million, representing a 7% decrease from the prior quarter and 157% increase year over year, highlighting our ability to drive profitable growth.

Earnings per share was $2 30.

Which exceeded the high end of our guidance range.

Operating cash flow for the second quarter was $666 million and free cash flow was $407 million.

Despite a slight increase in inventory due to supply chain disruption, we maintained strong cash flow generation in the quarter.

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 $259 million.

We remain prudent and investing in manufacturing capacity and continue to expect gross capex for the current fiscal year to be around $3 billion.

We now expect cash capex to be around $1 $5 billion as we actively manage our overall spending.

As we mentioned on our last earnings call, we fully repaid our term loan b and the amount of $943 million last October .

Our trailing 12 months adjusted EBITDA at the end of the second quarter as defined in our credit agreement was $4 8 billion.

Resulting in a gross leverage ratio of one five times.