Q3 2022 Western Digital Corp Earnings Call

April 28, 2022

Okay.

Good afternoon, and thank you for standing by welcome to Western Digital's fiscal third 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.

A reminder, this call is being recorded now I will turn the call over to Mr. Peter Andrew Vice President financial planning and analysis and Investor Relations you may begin.

Thank you and good afternoon, everyone. Joining me today are David <unk>, Chief Executive Officer, and we some job rate Chief Financial Officer before we begin let me remind everyone that today's discussion contains forward looking.

<unk>, including product portfolio expectations.

<unk> plans and performance demand and market trends and financial outlook based on management's current assumptions and expectations.

And as such does include risks and uncertainties.

We assume no obligation to update these statements. Please refer to our most recent financial report on Form 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 introductory remarks.

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

We delivered excellent performance in the quarter with revenue of $4 4 billion and non-GAAP gross margin of 31, 7% both of which are at the higher end of our updated guidance ranges. We provided in early March.

Additionally, we reported non-GAAP earnings per share.

$1.65, which exceeded our revised guidance.

I am proud of the team's execution as we navigated dynamic geopolitical and macroeconomic environment as well as ongoing supply challenges on top of that we successfully managed through a fab contamination event that is now fully resolved.

Overall, the western digital team did an amazing job of meeting our customers' growing and evolving storage needs.

This has all been made possible by the operational and technological improvements we have made over the last couple of years that enable us to unlock the true earnings power of the Western digital model.

Looking ahead, we are optimistic about the business outlook for calendar year 2022.

We believe the secular demand for storage and our new product ramps in HDD and flash combined with the seasonally stronger second half of the calendar year will drive growth across our end markets.

With 40% of the world's data stored on western digital products, our innovation powers, the global technology ecosystem from consumer devices to the edge to the heart of the cloud.

Our vision is to create breakthrough innovation inspired by the convergence of human potential and digital transformation that enables the world to actualize its aspirations.

At Western digital we have established an admirable position as a large and growing storage markets, our proven ability to develop a diversified portfolio of industry, leading products, coupled with our broad routes to market puts western digital in a unique position to capitalize on the promising growth opportunities ahead.

Of us.

I'll now turn to an update on our HDD and flash businesses.

Our HDD revenue was as forecast and in line with typical March quarter seasonality led by growth in capacity enterprise drives.

Robust demand in the cloud end market for 2018, and 20 terabyte drives generated a nearly 40% increase in near line revenue from the same period last year.

No our 20 terabyte drive exabyte shipments approached high single digit percentage of total capacity enterprise shipments.

During the quarter qualification of <unk> NAND based hard drives progressed as planned across multiple cloud and OEM customers.

Mining opting in with our SLR leadership uniquely positions western digital in the marketplace.

Adding it all together, we have positioned our innovations in <unk>, NAND and SLR to drive business results and our capacity enterprise business for the rest of this calendar year and into the future.

Our largest cloud customers are aligned with this strategy and are accelerating adoption of SMA products within data centers. Later. This year, we are laser focused on bringing new cutting edge features and functions to our products for cloud storage we.

We will provide more details around these exciting innovations at our Investor day on May 10.

Turning to flash or overall business was impacted by our ability to ship product due to the fab excursion.

In light of this event, coupled with the supply chain challenges facing all companies across the industry I would like to thank our customers and the western digital teams for working together diligently to mitigate the impact of supply chain disruptions.

From a product perspective clients SSD demand improved in the quarter as our PC OEM customers successfully worked through their own supply chain issues.

<unk> is another growth market for us where we continue to have success with exabyte shipment nearly doubling year over year.

We have a leading position in the marketplace with our brands, including WD Black Sandisk and Sandisk professional recognized globally for cutting edge innovation performance and quality.

An example of this is our WD black SL, 770, SSD product, which leverages, our cutting edge fixed five technology and in house DRAM less controller architecture. This SSD product is one of the fastest and best drives available in the market. We have received excellent reviews from <unk>.

Journalists, which is a great Testament to the company's strength in both our <unk> technology leadership, and our ability to develop innovative solutions, enabling our customers to unlock the potential of the Pcs.

Qualifications are fixed five based products for client and consumer end markets were largely completed and.

And we're making great progress in qualifying qualifying our next generation <unk> five enterprise SSD products. We expect these products to drive revenue growth and mix improvements into the future.

Lastly, fixed five represented nearly half of the flash revenue up from 41% in the previous quarter.

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

In cloud, we see continued strength in calendar year 2022, the increase in cloud capital investment for datacenter build outs expected to propel growth for our HDD and flash products in this growing end market.

Client PC end demand growth has been solid for the last two years and we are starting to see some normalization in the PC market.

We expect PC unit demand to remain significantly above pre pandemic levels with the return to site trend driving a mix shift towards commercial and enterprise Pcs with richer client SSD content versus consumer oriented Pcs.

In mobile we have a strong position in <unk> and we see demand for the latest five flagship phones remaining solid.

With NAND content doubling from prior generation smartphones.

In other emerging applications demand from gaming and VR AR devices remains robust industry analysts expect VR headset sales to grow at a 47% CAGR over the next couple of years.

In consumer we are experiencing short term demand weakness outside the U S tied to the geopolitical events in Europe as well as Covid related Lockdowns in China. However, we are confident in the strength of the business as we are entering a seasonally stronger second half of the calendar year with a number of new innovative.

<unk>.

We feel good about the overall demand in calendar year 2022, we are continuing to navigate the macroeconomic and geopolitical factors I mentioned earlier.

While these transitory issues are affecting both revenue and gross margin in the near term, we expect them to subside over time.

Confident that the growth our growth and profit profitability opportunities in front of us have not changed.

In closing I want to acknowledge the hard work and unrelenting spirit of our employees that goes into creating our game changing products in particular I want to thank our employees in China for their efforts to work through all the supply chain and logistics challenges during the Lockdowns.

Before turning the call over to we saw I wanted to make a quick announcement that western digital in the IRS have reached a tentative agreement to resolve our long running tax matter covering the fiscal years 2008 through 2015.

With offsetting tax benefits, we expect the ultimate net amount will be in the range of $500 million to $600 million.

While this settlement will result in a previously and forecasted cash payment in fiscal year 2023.

It does highlight the work that I and the rest of the western digital team have undertaken in the last two years to instill strong financial discipline and provide greater financial flexibility upon which we are building a foundation for future growth for the company, we saw and we will go into more detail in a minute.

Let me now turn the call over to we some who will discuss our fiscal third quarter results and provide a more detailed outlook for the fiscal fourth quarter, we saw.

Thanks, David and good afternoon, everyone.

As David mentioned.

Overall results for the fiscal third quarter were better than our revised expectations.

Despite the incredibly dynamic macro environment and David discussed our results reflected the resilience of our business and our ability to continually deliver solid financial performance.

In addition, we completed the debt restructuring with our lenders in the March quarter.

Mark and continued success in paying down debt and providing increased financial flexibility and stability.

Total revenue for the quarter was $4 $4 billion down, 9% sequentially and up 6% year over year.

non-GAAP earnings per share was $1 65.

Above the revised guidance range of $1 30 to $1 60.

We provided in early March.

We are pleased to have delivered such strong results in the face of the challenging environment.

Turning to our end markets.

<unk> represented 40% of total revenue at $1 8 billion down 8% sequentially.

25% from a year ago.

Within cloud.

Western digital leadership position and the 18 terabyte capacity point.

And ramp of 20 terabyte drives.

Drove a nearly 40% year over year increase in near line revenue.

This growth was partially offset by lower enterprise SSD and smart video hard drive revenues.

The client end market represented 40% of total revenue at $1 $7 billion down, 7% sequentially and 2% year over year.

The sequential decrease was primarily due to typical seasonality in both flash for mobile.

Client hard drives.

On a year over year basis growth in flash was offset by decline in hard drive.

Lastly.

Consumer represented 20% of revenue at zero point $9 billion down.

Down, 17% sequentially and 8% year over year.

On a sequential basis, the decline was primarily due to lower ethane flash shipments.

The year over year decrease was roughly evenly split between hard drives and flash products.

Turning now to revenue by segment.

We reported flash revenue of $2 $2 billion down, 14% sequentially and up 3% year over year.

On a blended basis flash asps were down 1% sequentially.

On a like for like basis Flash Asps were down 2% sequentially.

Flash bit shipments decreased 14% sequentially and increased 9% year over year.

During the quarter, we recognized the majority of the bit supply impact caused by the fab contamination.

Hard drive revenue was $2 1 billion down, 3% sequentially and up 9% year over year.

Sequentially total hard drive exabyte shipments increased 1%, while the average price per hard drive increased by 4% to $101.

On a year over year basis, total hard drive shipments and average price per hard drive increased by 20% and 22% respectively.

As we move to costs and expenses my comments will be related to non-GAAP results unless stated otherwise.

In the March quarter, total fad contamination charges of $203 million.

Were excluded from our non-GAAP results.

Gross margin for the third quarter was 31, 7% down 190 basis points sequentially.

Up 400 basis points year over year.

Including approximately $59 million in Covid related expenses.

Our flash gross margin was 35, 6% down 50 basis points sequentially and up 560 basis points year over year.

Our hard drive gross margin was 27, 7% down 290 basis points sequentially.

And up 270 basis points year over year.

Hard drive gross margin included Covid related impact of approximately $51 million.

Or 240 basis points.

Operating expenses of $740 million were below our guidance range as we tightly managed our expenses.

Operating income was $650 million.

Presenting at 26% decrease from the prior quarter and 58% increase year over year.

Earnings per share was $1 65.

Up from $1 <unk> in the year ago quarter.

Operating cash flow for the third quarter was $398 million.

And free cash flow was $148 million.

Cash and capital expenditures, which include the purchase of property plant and equipment and activity related to our flash joint ventures on our cash flow statement represented a cash outflow of $250 million.

We remain disciplined in investing in manufacturing capacity and expect gross capex for the current fiscal year to be around $2 9 billion.

We expect cash capex to be around $1 $3 billion as we actively manage our overall spending.

Yes.

In the fiscal third quarter, we made a discretionary debt repayment of $150 million.

Our gross debt outstanding was $7 $25 billion at the end of the fiscal quarter.

We ended the quarter with $2 $51 billion of total cash and cash equivalents.

Our trailing 12 months adjusted EBITDA at the end of the third quarter.

As defined in our credit agreement was $5 billion.

Resulting in a gross leverage ratio of one four times compare compared to two six times a year ago.

As a reminder.

The 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.

Before discussing our outlook.

I wanted to provide some more details on the settlement with the IRS that David mentioned.

As previously disclosed in our quarterly SEC filings.

The company has been a significant long run things situation with the IRS.

Taxes for fiscal years 2008 through 2015.

As you can see in our GAAP statements, we took a tax charge in the fiscal third quarter, primarily based on our latest assessment of the situation.

In the last few days, we reached a tentative agreement to settle the transfer pricing issues in dispute.

The actual amount western digital will have to pay and exact timing of the payments have not been determined yet. However, we currently expect to make a cash payment in the range of $600 million to $700 million.

Sometime in the first half of fiscal 2023.

Please note that this is the cash out number.

We currently expect that the ultimate net amount will be in the range of $500 million to $600 million.

After accounting for certain offsetting tax benefits expected to be recouped over the next three years.

Finally in.

In the fourth quarter, we will make a GAAP only adjustment to the reserve associated with this settlement.

You will find additional details in our 10-Q, which we plan to file next week.

I will now provide our view of both hard drive and flash businesses for the fiscal fourth quarter.

As we indicated on our last earnings call.

We continue to expect hard drive revenue to increase.

By growth in near line hard drives.

We also expect flash revenue to increase sequentially in the fourth.

Fiscal quarter as our flash supply improves.

For our fiscal fourth quarter, our non-GAAP guidance is as follows.

We expect revenue to be in the range of four five to $4 7 billion.

With sequential revenue growth for both hard drive and flash businesses.

We expect gross margin to be between 31% and 33%.

We expect operating expenses to be between 770 and $790 million.

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

Our tax rate is expected to be approximately 11% in the fourth quarter.

We expect earnings per share to be between $1 60, and $1 90 in the fourth quarter, assuming approximately 317 million fully diluted shares outstanding.

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

Thanks.

Looking ahead, we remain optimistic about our business outlook for the calendar year as customer demand across our end markets continues to be generally strong.

Despite the supply chain challenges and macroeconomic factors, we discussed earlier it is evidenced that we have the right foundation for long term growth the right technology portfolio in place to meet evolving customer needs and the broad routes to market necessary to scale our business over the last couple of years, we have planned and executed.

Significant changes to improve our focus sharpen execution.

Our strategic goals to place western digital in a position of greater strength.

We are excited that we are witnessing the positive impacts of those changes.

Before I wrap up I want to remind everyone. We have investor day coming up on May 10th and I look forward to seeing you all there let's start the Q&A.

Thank you.

Finder to ask a question you will need to press star one on your telephone.

Jim restraints, we ask that you. Please limit yourself to one question. So withdraw your question. Please press the pound key please.

Please standby, while we compile the Q&A roster. Our first question will come from C. J Muse with Evercore. Please go ahead.

Hey, good afternoon, and thank you for taking the question I guess the question relates to your June quarter outlook.

And we'd love to hear.

How you're thinking about.

Any any kind of ongoing implications both demand contamination issue.

Kind of impact that might have on your.

Availability.

And then secondly in terms of the China Lockdown.

Impact on your HDD media side, and whether that's pushing out any shipments beyond the June quarter.

Hey, C J thanks for the question.

Yeah on the plus side. So first of all as we said the flash contamination issues behind us in the fab.

We expect bit growth next quarter.

We wont be all the way back, but we will.

We expect to accelerate from where we were this quarter.

As far as the situation in <unk> in China, We did we did have that facility.

<unk> shut down for a couple of weeks at the end of last quarter, we've mostly recovered that as far as the as being able to meet demand for this quarter I would say as a general statement.

I think it's very difficult for everybody to meet what true demand is right now in the market. So between component shortages and the situation in China. It makes it makes it really tough, but I think we were able to navigate through the situation quite well quite frankly the team there did a fantastic job.

Recovered.

Some incremental costs as we saw in the HDD margin line that we didn't expect but.

All in all I think.

<unk> navigated through the situation fairly well.

The coming quarter.

<unk>.

Yes, we're still we're still dealing with the situations in China, but we think we'll be able to navigate through although it is it is very very dynamic, but we factored in all of the risks and so the guide and we're comfortable with where the numbers up.

We saw anything to add.

Not much David.

I think you've covered it well.

Thank you guys appreciate it.

Yes.

Thank you. Our next question will come from Aaron Rakers with Wells Fargo. Please go ahead.

Yes, thanks for taking the question I'll stick to one as well I just kind of thinking about the gross margin guidance into this next quarter I think it was 31% to 33% I was curious if you could help kind of unpack the variables maybe give us some color on how youre thinking about the flash gross margin relative to the hard disk drive gross margin.

And I guess with it hard disk drives how much COVID-19 related expenses are you still embedding.

Or just any other variables you can help us appreciate on both those two segments.

So it will take us.

I'll start on it and we found can add so on.

The drive business last quarter, we talked about.

The two to 300 basis point impact that we're expecting I think we took a little more of that in this quarter than we had expected some of that with some cost we didn't expect like I just talked about in <unk>.

<unk> earlier, but Shenzhen.

And.

So if that business looking forward I think we see it as pretty much we pretty much hit the bottom basically see it flat going forward in the flash business, we expect some acceleration of.

Gross margin given given the.

The supply demand balance situation. So we'll.

<unk> anything to add to that.

David just maybe to follow on on the comments.

Aaron's question with respect to Covid.

Where we see the.

Corporate costs going into next quarter are expected to be a little bit less than what we experienced in the fiscal third quarter.

Thank you.

Thanks Sharon.

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

Great. Thank you.

Just following up on the contamination issue.

Is seven exabyte number that you guys talked about still the right kind of number to think about the loss production and how does that split across the March and June quarters.

Hey, Joe.

That's still the right number I mean, the team will always work in kind of an evolving situation to see what they can do with the material that we had to take out but.

I don't think it will be super material to the numbers of seven is good good place to work from.

And we haven't split it up over over the quarters, but.

The majority of it we took in.

Previous quarter.

Okay and your joint venture partner.

I won't speak for them, but like just in terms of assessing the industry situation would have lost proportionately the same amount.

Yes, im not going to speak for them, but we have we have joint manufacturing.

Facilities for sure.

Great. Thank you.

Thanks, Joe.

Thank you. Our next question will come from Patrick Ho with Stifel. Please go ahead.

Hey, Patrick are you there.

Hey, Sherri why don't we skip over I'm trying to get Patrick backend.

Okay. Our next question, we'll go to Tom O'malley with Barclays. Please go ahead.

Afternoon, guys. Thanks for taking my question Youre seeing really.

Youre seeing a really strong trend in the HDD pricing side is that entirely related to the mix more towards near line or are you seeing any underlying trends in other parts of the business as well anything helpful. There will be really good. Thank you.

I'll put a much larger frame on it.

I think what is happening and we see it show up in a number of ways and there's a lot of COVID-19 implications and cost in it too but.

I think we're just seeing the industry change from <unk>.

The World, where there was always.

Capacity enterprise drives available.

Hard drives for available it was about.

Putting as many as you could in places where you can fill up factories and get good absorption and not have to pay incremental cost for that.

That's.

So kind of decline of the client era and the rise of the cloud era, we're pretty much through that we are in the last legs of it and I just think youre seeing a lot of industry dynamics change.

Youre seeing long term agreements come in much more something that last year was kind of a new concept that we were working through now it's becoming much more mainstream with our big customers just to give us visibility.

Making investments in this business essentially we don't have a lot of capacity anymore to shift from client to to enterprise and the cloud and we're having to invest in that and thats, causing.

The whole industry to shift the way it thinks about this technology in my point of view I think it starts with we're still driving a strong <unk>.

Model for our customers, that's where it all starts every generation of technology, we're able to bring down the tcl for our customers in the past I think as we did that of the reward for the for our side of it was more volume to soak up that capacity well that specification.

Now we have to invest in new volume. So the industry has to change. So we're bringing a lot of <unk> value and I think youre seeing the industry move to providing more visibility.

Thinking about value based pricing more and how do we how do we move that value equation in a way that we can continue to drive the <unk> down and rates.

A better pricing environment.

That's the Big picture and then of course, there is theres a lot of costs in the system right now in inflation of input.

Input costs are going up and we're working through pricing.

We can if we can mitigate parts of that.

Happening as well.

Helpful. If I could just sneak just another quick one in on the.

On the flash side, obviously, you have a lot of disruptions during the quarter. It looks like the implied cost was relatively flat.

When youre looking into the out quarter Youre, obviously say gross margins are up you should see some pricing tailwind given the industry, but Tom maybe any any sort of color on the cost versus pricing impacting the awkward I know you don't like to get specific but obviously given the situation anything would be helpful. Here to kind of move on the moving pieces. Thank you.

Yes.

Okay.

Yes.

Go ahead, yes of course, yes, Tom so.

We do it we do expect that.

Our long term to continue to reach our long term.

Cost reduction, which is a 15% year on year.

We did see a bit of a headwind.

Headwind in the current quarter, but it's impacted by a few factors.

We expect will dissipate.

Next.

A couple of quarters. So we saw for instance, we continue to.

Ryan power mixed five technology.

As well as just like everybody we're seeing.

Some inflationary pressure.

As well as the <unk>.

Start up of our <unk>.

Five seven but.

We still expect for this fiscal year 'twenty two to be at least 15% year on year in terms of cost reduction and as I start to dwindle, we do expect to continue to.

I mean that target going forward.

Very helpful. Thank you.

Thanks, Tom.

Thank you. Our next question, we'll go to Timothy Arcuri with UBS. Please go ahead.

Hi, Thanks, a lot this is Jason on for Pam.

So could you. Please provide any color on the trajectory of your HDD gross margins through the second half of this year Im asking because.

We expecting some benefit that will get.

Stronger likely a stronger pricing environment second half first half. Thank you.

Yes, we do expect.

As we talked about last quarter, we're pretty much in the same place, which is we expected the decline we saw this quarter.

We actually expected gross margin will be a little lower next quarter now we think that will be flat and then we expect that to improve in the second half for a number of reasons mix input costs that are changing a bit.

And also some pricing benefit so yes, we expect.

We expect next quarter to be the low and then we expect to improve from there.

Thank you.

Thank you. Our next question will come from Patrick Ho with Stifel. Please go ahead.

Thank you very much I apologize before.

Dave maybe you could give a little bit of color you gave some very encouraging commentary regarding the data center and cloud spending.

Into the second half of the year what are these because of the long term agreements.

Signing with customers and maybe secondly.

Along with that question.

How do you see the customer base in terms of the transition from 18 to 20 is it a new set of customers or are your customers quickly transitioning over 20 terabytes.

Yes, So let me unpack that a little bit I can thanks Patrick.

So.

<unk>.

The.

It's largely the same customers that will move from 18 to 20, I mean, I think as I said earlier, the Tcl equation improves as you go issue as you keep driving forward. So.

It's a very important part of what we do I mean, this is I talked about innovation a lot around here and the innovation, we've driven around <unk> now opt in NAND in SME.

Those are all things that we layer into our products and allow our customers every time they move a generation forward they get better Tcl equation. So there's there's reasons to keep moving forward. So that's kind of the way.

That's kind of a way that works a little bit by the way, we'll come back and talk about SMA are a little bit more we're continuing to see more momentum towards <unk> that is the future of the cloud HDD businesses SLR all the big players are now moving down that path, which is in technology, we've been investing in for quite some time.

On your other question on let's say <unk> don't drive the spending of the LTA helps smooth out the spending I think the whole idea with the LTA has to give.

We have a strong relationship with our big customers to give better visibility to three quarters out what I've talked about this a lot in the past the business used to be if I think back a year ago or two years ago. When I came into the business. The business was just transact it quarter to quarter and even within the quarter.

Clearly given the investments we need to make to continue to drive investments in heads and media to fund to fuel the exabyte growth, we're going to need more visibility than that and so.

Lta's have been adopted.

And we strike those with our big customers on multi quarter Timeframes and then we stick to them and that's been very good as far as smoothing out any ups and downs and builds on their side.

And so.

Yes.

As far as the second half environment.

Our big cloud customers continue to tell us and signal a strong demand environment in the second half of the year. So.

We will be excited about driving to that with starting with 2018, and then transitioning to 'twenty as we move through the year.

Thank you.

Thank you. Our next question will come from Chris <unk> with Cowen. Please go ahead.

Hey, Hello, guys, Hi, Chris Thanks for taking my question core HDD when do you expect the crossover between 'twenty thorough by 18.

<unk> talked about.

And can you.

Please tell us if you did see a slowdown in.

Market for HIV over the quarter. Thank you.

Yes.

I would imagine the 'twenty crossover will be in the second half of the year.

We're deep into the 18 right now I mean, 18 is probably 80% of the portfolio, but shipping so it's the sweet spot of the market as we move through the year, we'll start to ramp.

We will start to ramp 20, so towards the end of the year early next year, we can circle back on a specific date, but that's the way we're thinking about it.

The surveillance market smart video market.

That's been us Ben been soft all year so.

We continue to see that with the Lockdowns in China.

We expect that once that ends there'll be some some snapback in some recovery of pushed out demand there, but right now given the COVID-19 situation.

I think that that market is not going to change until the COVID-19 situation changes.

And if I can squeeze one in surveillance margin accretive.

Is it margin I don't think we breakout at that level, we certainly have a comment on that or Peter.

Yes, David we don't break out down to that level of detail.

Alright, great. Thank you.

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

Yeah.

Thanks for taking my questions a couple of short ones on Slashdot.

How are you thinking about your full year bit shipment growth for calendar 'twenty. Two I know you don't want a quarter by quarter, but for the full year and then as a follow up question is gross margin fell flashing and just talk about maybe up a little bit for next quarter are you actually expecting much price increase.

How much how much is mix a factor and maybe talk about.

With Alan can you talk about the <unk> startup costs can you kind of quantify what that number. Thanks.

Alright.

We saw him handle the gross margin question the bit growth look our bit growth will be down. This year, we're not going to put a number out there right now, but given the fab excursion will be down this year and then we'll make it up over the next year or so year plus it will take a while to fully come back to our our fair share of bps. Our strategy has been very consistent for us.

A long time, we invest to maintain share.

And you see us doing that.

Including the recent fab announcements with <unk>.

We signed me when I'm talking about gross margin a little bit in <unk>.

In flash.

Of course, David So Sidney Thanks for the question when we think of the.

Flash business I think to address maybe the.

Part of the question around the UK.

Startup cost then theyre not.

Significant and actually much lower than the.

Okay.

Nicky one fab.

Startup.

We're talking about really in brownfield expansion here versus a greenfield expansion.

So the part of your question with respect to.

Flash.

Gross margin, that's sort of embedded in the guidance and of course mix always plays a part in any gross margin.

So whether it's an actual or projected so but as I said earlier, we're still expecting too.

And to meet that 15% plus.

Year on year cost reduction for flash in the fiscal year 2022, I hope this helps.

Thank you.

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

Yes, Thanks for taking my question and just as a follow up to the previous question, how should I think about the impact of.

FX exchange rate on our flash gross margin.

So maybe.

<unk> for the question and then maybe I'll just.

Talking about the <unk>.

In general our approach as we do we use.

Layered hedging.

Our approach which means.

There is so much more coverage in hedge in the on the shorter term versus the longer term.

So that smooths out the impact of FX over time.

And the way also to think of it is.

Any incurred cost within the quarter.

Typically will not try to impact the P&L.

Approximately 90 to 120 days later, given the manufacturing cycle times and lead time for delivery of product and so.

Whatever we see.

At least in the past short term in terms of.

Currency fluctuations will not be.

That impactful to the numbers.

We saw and why.

We're sort of expecting.

Actually what we saw in this quarter and what we're anticipating for.

On the system.

Fourth quarter is.

Less than 1% impact on all of our cost of goods sold.

That basically talks about the cost of goods sold mainly not only the flash.

Okay.

Can I ask a question.

It was more of a quick clarification.

Okay.

Hi, Chris.

Just back to David.

Given your LTA then you sound.

Confident that the cloud demand is going to sustain into the second half how should I think about near line exabyte growth prospect in calendar year 'twenty two versus 21.

Supply growth in 'twenty two versus 20.

I can get you.

When I look this up real quick.

Yes.

If I have a look.

Look I mean, if I look at it over looking at over we.

We keep coming back to 35% growth in the.

Sure.

In exabyte in the cloud.

That's been a pretty consistent number I'd have to go back and put it in I tend to look at it more in fiscal years in calendar years, but I can follow up with you on a calendar year number. Okay. Thank you and I look forward to meeting you at the analyst day I look forward to it so refunds.

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

Yes, thanks for the question and good afternoon.

David you talked about <unk> quite a bit on this call maybe can you unpack how should we think about the impact on <unk> on mix pricing and margins in HDD, maybe can you touch on what kind of workloads are the cloud guys looking to deploy a similar initially.

I'll defer the workloads, one until our Investor day, we'll go into a little more detail there, but look I think big picture, we see this last quarter I think.

No I said, we had two big cloud Titans that we're working on SLR and we expected significant shipments towards the end of the year.

Within the quarter, we had another one and another one come to us about adopting <unk>. So.

I think that.

Yes.

I think that.

It's very it's very clear to me that that.

The capacity gains that can be achieved with <unk>, we've been investing in this technology for a long time and this idea that you can get an extra 10.

Percent or more and again, we will talk about that next week and a couple of weeks as well.

As very attractive, especially given the size of the of the drives now and how big they are you're talking big numbers multiple terabytes that are being added through changes now.

And the thing that gives me a lot of conviction on this is because it requires the on the host side you have to do some software work and nobody wants to do software work.

If they can avoid it.

If the return is not good enough and the fact that.

The big players are coming in they're saying look we're going to invest in this and we're going to we're going to pull <unk> into our data centers.

Tells me that this is the next leg of growth in this industry. So.

Again, we'll get to our Investor day to talk about what it means on the portfolio, but I get back to just another way that allows us using innovation to drive a better <unk> equation for our customers and where we can drive better <unk> and then we can leverage that into a conversation about value based pricing.

And that's exactly what we're doing and that's exactly where the industry is going and like I said Lta's are a part of that about getting more predictability, but the fact that we can continue to drive down the cost of storage continue to drive a better TCR with every generation of product to do that through innovation.

It gives us opportunity.

To create margin and create value.

Thank you. Our next question will come from Nam Kim with Arete Research. Please go ahead.

Thank you for taking my question.

How should we think about some of your hyper scaler moving into their own enterprise SSD.

Do you expect such DIY, and I'll, probably to SSD to impact your business negatively or just to have a limited impact any color would be great. Thank you.

Various.

Various of our of our customers have DIY projects I think that's fine they still.

First of all I don't know if anybody does a 100% that because everybody wants diversity in their supply chain.

But even DIY it provides us opportunity to provide raw NAND. So not just the full enterprise SSD.

But like I said, even anybody that's doing DIY is also going to be buying enterprise ssds as well for part of their.

Their footprint in the numbers here are getting so large that whichever way you play or both that gives us the opportunity to play in both of those franchises quite frankly, with our big customers, providing enterprise ssds and in providing land into their projects. So.

I think it's I think it's a reflection of how important enterprise ssds are to the future of a very modern cloud datacenter, it's extraordinarily important technology and we're very happy to be.

Involved with the biggest customers and qualified at the biggest customers with our technology.

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

Thank you and I look forward to seeing you all next month, but before that it's great to see the contamination issue.

Behind Us of course, we're working through that.

With that being said.

The costs of all that is that solely borne by western digital or does your supplier kind of redo Marie to for that ore makeup, Florida and future pricing or some type of insurance and most critically what are you doing have you put in something to make sure.

Thing doesn't happen again.

Yes.

<unk>.

Get some input when we sum can maybe provide more details if you have them but.

Look we the issue is fully behind US the team has done.

Fantastic job of route, causing it down to the very very bones of what the issues are and then putting in place obviously, putting in place screens and other things to make sure. It doesn't happen again or if it does happen again too.

Make sure we catch it.

Actively.

As far as the.

Costs are split by us at our JV partner and as far as the ability to recoup any of those I mean, I think we will look at that once we get fully passed everything will look and see if there is any anything that will happen there.

Anything to add to that we saw.

I think.

No David I think you've covered it well.

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

Hi, Good afternoon. Thanks for taking my question I was wondering if you could just talk a little bit more about the hard disk drive pricing. So as you mentioned your asps were up 4% in the quarter.

But can you talk a little bit about the like for like pricing currently and for the rest of the year, how youre approaching it maybe differently by different segments.

And whether it's being impacted by the sort of extended lead times.

You talked about in terms of where you are maybe putting more bits than maybe you were a year ago. Thank you.

I think like I said, we're working on.

I want to repeat the same thing again pricing starts with value we have to deliver value and we are constantly innovating to deliver more value.

But we're clearly working on pricing to see to defray some of the input costs and all the logistics cost Covid has impacted so that's going on across the portfolio.

And then we're having conversations with our customers about the value we're providing with these next generation drives about what what that value is and how do we how do we move to a value based risk based pricing model I don't know if theres a whole lot more to say about them we.

Some anything from your perspective.

No.

Yeah.

Not on this.

Not on this David Thank you.

Thank you. Our next question will come from Christian Schwab with Craig Hallum. Please go ahead.

Great I just have a quick question.

Just drive gross margins given the positive impacts of mix and.

Decrease input costs.

Okay.

<unk> value pricing.

If we have a.

China Covid shutdown and.

Is there any reason why the disk drive business can't be operating it.

<unk> plus growth.

Exiting calendar year.

I'm sorry.

You broke up when you set the number.

Is there any reason that you.

You could you would be exiting the calendar year.

With gross margins at 30% plus again.

So I think we broke those numbers out although with some I think he's got the details you had it in his remarks, but I mean, if you just took all the COVID-19 costs off the business right now I think we'd be about 30 right.

Yes, so that's a true David.

We did have in the quarter down 240 basis points.

Related to the Covid costs.

We've talked about we've been slightly impacted of course by Covid Lockdowns.

We continue to see some inflationary cost pressures short term with the supply chain disruptions.

I mean to your question.

Wouldn't necessarily you want to.

Talking about where the margins are going to be in Q4, but we did say that we do expect the margins.

<unk> margins to be better from here in the second half of the calendar year 'twenty two.

Yes, it was.

We're not going to commit to your number but just as a general point I mean.

There's just been a lot of.

A lot of additional costs on the business, we've talked about for many quarters now logistics costs.

And now increased input costs that hit us this past quarter.

And you would think as the world comes out of the pandemic I think which is the major <unk> to your point as this starts to unwind in logistics gets back to two.

On a steady state.

And some of the input costs get more.

More reasonable.

We stopped paying expedite fees for certain components and things like that because it was just a more smooth flowing supplier ecosystem.

It will it will unburden a lot of costs on the business and again I think this is masking somewhat.

That completely a major fundamental structural change that's going on in the business, which I've talked about a lot which is.

The HDD market is a growth market and it's a growth market, where we're going to need to invest capital to build additional heads and media capacity.

And when that happens I think the economic equation changes and we get the key thing in that kind of world is can you still innovate and can you still bring new things to the to the product that makes them more valuable to your customer.

I think that is what we've really been focused on from <unk> to opt in NAND to SME.

We're just really focused on innovation and bring a better value propositions that will that will be able to build a better product for our customers, who will get into that value based pricing things. So if we get both of those going and.

And we can get the cost out because of the pandemic I think we will we feel very good about the business.

Thank you. Our next question will come from Mark Miller with Benchmark Company. Please go ahead.

Thank you for the question I'm, just wondering in terms of mix and mix how is that progressing in terms of mobile versus the other segments you ship into or are you seeing increasingly more shipments in the mobile and where do you expect that is growing.

Yes.

There's a couple of dynamics to this I think over the looking at the past couple of quarters, we've had a higher shift higher mix towards mobile as we were ramping fixed five.

We talked about it in the.

And in the prepared remarks, we've got.

In the past our qualifications of <unk> five in the consumer market.

And our client SSD market, so we see an acceleration of.

Mix into those on <unk> five.

And then there is a lot of hard work going on to qualify our enterprise Ssds on <unk> five and as that happens throughout this year and then youll see an acceleration of that market as well into fixed five. The reality is is we have we have demand on enterprise SSD we.

We can't meet because its on <unk> four right now so as we get that into fixed five youll see the mix change and Youll see the.

Enterprise SSD.

Mix accelerate through the second half of the year, which will provide us with those long. This we'll talk about this a little bit more at Investor day, as well to put one more one more plug in to see all of you on the 10th.

Yes.

Thank you. Our next question will come from Kevin Cassidy with Rosenblatt Securities. Please go ahead.

Yes, Thanks for taking my question, yes, looking forward to.

May 10th.

May 9th Stuart.

Absolutely.

Yes, I was just wondering if you could give us a little more details on the fab seven ramp.

You've mentioned brownfield production, then can I, just understand a little better what that means.

You started off with like 20000 wafers a month there.

I mean any numbers like that you can give us.

So first of all let me clarify that Brown field I think the point. We saw was making there was that case to expenses will not be at the level of K. One because Q1 was a greenfield in Q2 as a brownfield so.

The same situation with <unk>, seven which switch.

Ramping.

And Youll Keiichi, obviously, obviously, a brownfield launch there as well.

Although some may have some some information about how the expenses rollout as far as how the wafer scale look we'll start ramping that I think all of our newer nodes, but.

And we will have more to say about that when we start getting tools in there and all of that.

But we saw anything to add.

Yes.

Just maybe to clarify that thanks, David to clarify the my comment on brownfield versus Greenfield was exactly.

Just to really highlight that the costs aren't as high as we've seen NK one.

We werent really theyre, not very significant but of course, it's a bit of a headwind to the gross margin.

Yes.

Thank you speakers I'm showing no further questions in the queue. At this time I would now like to turn the call back over to Mr. Kessler for any closing remarks.

Alright. Thanks, everyone. We appreciate you joining us as we've said a couple of times, we look forward to seeing hopefully we'll see you on may 9th as was pointed out for some new product launches will have some exciting new technology coming out then and then on the 10th of May 10.

May 9th intense on the 10th we will be have our investor day, which we've been looking forward to for quite some time. So we will see there thanks everyone.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.

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Good afternoon, and thank you for standing by welcome to Western Digital's fiscal third 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 as a reminder, this call is being recorded now I will turn the call over to Mr. Peter Andrew Vice President financial planning and analysis and Investor Relations you may begin.

Statements, including product portfolio expectations business plans and performance demand and market trends and financial outlook based on management's current assumptions and expectations.

And as such does include risks and uncertainties.

We will also make references to non-GAAP financial measures today.

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 fiscal 2022 third quarter results.

Additionally, we reported non-GAAP earnings per share of $1, 65, which exceeded our revised guidance.

Overall, the western digital team did an amazing job of meeting our customers' growing and evolving storage needs.

Looking ahead, we are optimistic about the business outlook for calendar year 2022.

We believe the secular demand for storage and our new product ramps in HDD and flash combined with the seasonally stronger second half of the calendar year will drive growth across our end markets.

With 40% of the world's data stored on western digital products, our innovation powers, the global technology ecosystem from consumer devices to the edge to the heart of the cloud.

Our vision is to create breakthrough innovation inspired by the convergence of human potential and digital transformation that enables the world to actualize its aspirations.

Of us.

I'll now turn to an update on our HDD and flash businesses.

Our HDD revenue was as forecast and in line with typical March quarter seasonality led by growth in capacity enterprise drives.

Robust demand in the cloud and market for 18, and 20 terabyte drives generated a nearly 40% increase in near line revenue from the same period last year.

No our 20 terabyte drive exabyte shipments approached high single digit percentage of total capacity enterprise shipments.

During the quarter qualification of <unk> NAND based hard drives progressed as planned across multiple cloud and OEM customers combining.

Combining opdivo and <unk> with our <unk> leadership uniquely positions western digital in the marketplace.

Putting it all together, we have positioned our innovations in <unk>, NAND and <unk> to drive business results and our capacity enterprise business for the rest of this calendar year and into the future.

We will provide more details around these exciting innovations at our Investor day on May 10.

Turning to flash or overall business was impacted by our ability to ship products due to the fab excursion.

From a product perspective client SSD demand improved in the quarter as our PC OEM customers successfully worked through their own supply chain issues.

Gaming is another growth market for us, where we continue to have success with exabyte shipment nearly doubling year over year.

We have a leading position in the marketplace with our brands, including WD Black Sandisk and Sandoz professional recognized globally for cutting edge innovation performance and quality.

Qualifications are fixed five based products for clients and consumer end markets were largely completed.

And we are making great progress in qualifying qualifying our next generation <unk> five enterprise SSD products. We expect these products to drive revenue growth and mix improvements into the future.

Lastly, fixed five represented nearly half of the flash revenue up from 41% in the previous quarter.

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

In cloud, we see continued strength in calendar year 2022 the.

The increase in cloud capital investment for datacenter build outs is expected to propel growth for our HDD and flash products in this growing end market in.

And client PC end demand growth has been solid for the last two years and we are starting to see some normalization in the PC market. We expect PC unit demand remained significantly above pre pandemic levels with the return to site trend driving a mix shift towards commercial and enterprise Pcs.

With Richard client SSD content versus consumer oriented Pcs.

In mobile we have a strong position of <unk> phones, and we see demand for the latest five flagship phones remaining solid.

With NAND content doubling from prior generation smartphones.

In other emerging applications demand from gaming and VR AR devices remains robust industry analysts expect VR headset sales to grow at a 47% CAGR over the next couple of years.

<unk>.

We feel good about the overall demand in calendar year 2022, we are continuing to navigate the macroeconomic and geopolitical factors I mentioned earlier.

While these transitory issues are affecting both revenue and gross margin in the near term, we expect them to subside over time.

Confident that the growth our growth and profit profitability opportunities in front of us have not changed.

Before turning the call over to Rick I wanted to make a quick announcement that western digital in the IRS have reached a tentative agreement to resolve our long running tax matter covering the fiscal years 2008 through 2015.

With offsetting tax benefits, we expect the ultimate net amount will be in the range of $500 million to $600 million.

While this settlement will result in a previously and forecasted cash payment in fiscal year 2023.

Let me now turn the call over to <unk>, who will.

Our fiscal third quarter results and provide a more detailed outlook for the fiscal fourth quarter, we saw.

Thanks, David and good afternoon, everyone.

As David mentioned.

Overall results for the fiscal third quarter were better than our revised expectations.

Despite the incredibly dynamic macro environment and David discussed our results reflected the resilience of our business and our ability to continually deliver solid financial performance.

In addition, we completed the debt restructuring with our lenders in the March quarter, marking continued success in paying down debt and providing increased financial flexibility and stability.

Total revenue for the quarter was $4 4 billion down, 9% sequentially and up 6% year over year.

non-GAAP earnings per share was $1 65.

Above the revised guidance range of $1 30 to $1 60.

We provided in early March.

We are pleased to have delivered such strong results in the face of the challenging environment.

Turning to our end markets.

<unk> represented 40% of total revenue at $1 8 billion down, 8% sequentially and up 25% from a year ago.

Within cloud Western Digital's leadership position at the 18 terabyte capacity point.

And ramp of 20 terabyte drives.

Drove a nearly 40% year over year increase in near line revenue.

This growth was partially offset by lower enterprise SSD and smart video hard drive revenues.

The client end market represented 40% of total revenue at $1 7 billion down, 7% sequentially and 2% year over year.

The sequential decrease was primarily due to typical seasonality in both flash for mobile.

Client hard drives.

On a year over year basis growth in flash was offset by decline in hard drive.

Lastly.

Consumer represented 20% of revenue at zero point, $9 billion down, 17% sequentially and 8% year over year.

On a sequential basis, the decline was primarily due to lower ethane flash shipments.

The year over year decrease was roughly evenly split between hard drives and flash products.

Turning now to revenue by segment.

We reported flash revenue of $2 $2 billion.

14% sequentially.

Up 3% year over year.

On a blended basis flash asps were down 1% sequentially.

On a like for like basis Flash Asps were down 2% sequentially.

Flash bit shipments decreased 14% sequentially and increased 9% year over year.

During the quarter.

We recognize the majority of the bit supply impact caused by the fab contamination.

Hard drive revenue was $2 1 billion down, 3% sequentially and up 9% year over year.

Sequentially total hard drive exabyte shipments increased 1%, while the average price per hard drive increased by 4% to $101.

On a year over year basis.

And hard drive exited by shipments.

And average price per hard drive increased by 20% and 22% respectively.

As we move to costs and expenses my comments will be related to non-GAAP results unless stated otherwise.

In the March quarter, total fab contamination charges of $203 million.

Were excluded from our non-GAAP results.

Margin for the third quarter was 31, 7% down 190 basis points sequentially and up 400 basis points year over year.

Including approximately $59 million in Covid related expenses.

Our flash gross margin was 35, 6% down 50 basis points sequentially and up 560 basis points year over year.

Our hard drive gross margin was 27, 7% down 290 basis points sequentially and up 270 basis points year over year.

Hard drive gross margin included Covid related impact of approximately $51 million or 240 basis points.

Operating expenses of $740 million were below our guidance range as we tightly managed our expenses.

Operating income was $650 million.

Presenting at 26% decrease from the prior quarter and a 58% increase year over year.

Earnings per share was $1 65.

Up from $1 <unk> in the year ago quarter.

Operating cash flow for the third quarter was $398 million.

And free cash flow was $148 million.

We remain disciplined in investing in manufacturing capacity and expect gross capex for the current fiscal year to be around $2 9 billion.

We expect cash capex to be around $1 $3 billion as we actively manage our overall spending.

Yes.

In the fiscal third quarter we.

We made a discretionary debt repayment of $150 million.

Our gross debt outstanding was $7 $25 billion at the end of the fiscal quarter.

We ended the quarter with $2 $51 billion of total cash and cash equivalents.

Our trailing 12 months adjusted EBITDA at the end of the third quarter as defined in our credit agreement.

$5 billion.

Resulting in a gross leverage ratio of one four times.

Compared to two six times a year ago.

As a reminder.

Our credit agreement includes $1 billion in depreciation add back.

So she ended 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.

Before discussing our outlook.

Wanted to provide some more details on the settlement with the IRS that David mentioned.

As previously disclosed in our quarterly SEC filings.

The company has been a significant long run things situation with the IRS.

Taxes owed for fiscal years 2008 through 2015.

As you can see in our GAAP statements, we took a tax charge in the fiscal third quarter, primarily based on our latest assessment of the situation.

In the last few days, we reached a tentative agreement to settle the transfer pricing issues in dispute.

Sometime in the first half of fiscal 2023.

Note that this is the cash out number.

Currently expect that the ultimate net amount will be in the range of $500 million to $600 million.

After accounting for certain offsetting tax benefits expected to be recouped over the next three years.

Finally in the fourth quarter, we will make a GAAP only adjustment to the reserve associated with this settlement.

You will find additional details in our 10-Q, which we plan to file next week.

I will now provide our view of both hard drive and flash businesses for the fiscal fourth quarter.

As we indicated on our last earnings call.

We continue to expect hard drive revenue to increase.

By growth in near line hard drives.

We also expect flash revenues to increase sequentially in the fourth.

Fiscal quarter as our flash supply improves.

For our fiscal fourth quarter, our non-GAAP guidance is as follows.

We expect revenue to be in the range of four five to $4 $7 billion with sequential revenue growth for both hard drive and flash businesses.

We expect gross margin to be between 31% and 33%.

We expect operating expenses to be between 770, <unk> and $790 million.

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

Our tax rate is expected to be approximately 11% in the fourth quarter.

We expect earnings per share to be between $1 60, and $1 90 in the fourth quarter, assuming approximately 317 million fully diluted shares outstanding.

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

Thanks.

Looking ahead, we remain optimistic about our business outlook for the calendar year as customer demand across our end markets continues to be generally strong.

Despite the supply chain challenges and macroeconomic factors. We discussed earlier it is evident that we have the right foundation for long term growth the right technology portfolio in place to meet evolving customer needs and the broad routes to market necessary to scale our business over the last couple of years, we have planned and executed.

Significant changes to improve our focus sharpen execution and set strategic goals to place western digital in a position of greater strength.

We are excited that we are witnessing the positive impacts of those changes.

Before I wrap up I want to remind everyone. We have investor day coming up on May 10th and I look forward to seeing you all there let's start the Q&A.

Thank you as a reminder to ask a question you will need to press star one on your telephone.

I'm restraints, we ask that you. Please limit yourself to one question to withdraw your question. Please press the pound key please.

Please standby, while we compile the Q&A roster. Our first question will come from C. J Muse with Evercore. Please go ahead.

Hey, good afternoon, and thank you for taking the question I guess the question relates to your June quarter outlook.

I would love to hear.

How youre thinking about.

Any kind of ongoing implications both demand contamination issue.

Or kind of impact that might have on your.

Availability.

And then secondly in terms of the China Lockdown.

Impact on your HDD media side, and whether that's pushing out any shipments beyond the June quarter.

Hey, C J thanks for the question.

Yeah on the flash side. So first of all as we said the flash contamination issues behind us in the fab.

We expect bit growth next quarter.

We wont be all the way back, but we'll we expect to accelerate from where we were this quarter.

As far as the situation in Penang in China, We did we did have that facility.

Shut down for a couple of weeks at the end of last quarter, we've mostly recovered that as far as the as being able to meet demand for this quarter I would say that as a general statement.

I think it is very difficult for everybody to meet what true demand is right now in the market. So between component shortages and the situation in China. It makes it makes it really tough, but I think we were able to navigate through the situation quite well quite frankly the team there did a fantastic job.

Recovered there was some.

So the incremental cost as we saw in the HDD margin line that we didn't expect but.

All in all I think.

<unk> navigated through the situation fairly well.

The coming quarter.

<unk>.

We saw them anything to add.

Not much David.

I think you've covered it well.

Thank you guys appreciate it.

Sure.

Thank you. Our next question will come from Aaron Rakers with Wells Fargo. Please go ahead.

I guess with it hard disk drives how much COVID-19 related expenses are you still embedding.

Just any other variables you can help us appreciate on both those two segments.

So it will take us.

I'll start on it and we found can add.

On the drive business last quarter, we talked about.

The two to 300 basis point impact that we're expecting I think we took a little more of that this quarter than we had expected.

Some of that with some cost we didn't expect like I just talked about in <unk>.

Sure.

I think I said, playing earlier, but Shenzhen.

And.

So is that business looking forward I think we see it as pretty much we pretty much hit the bottom basically see it flat.

Going forward in the flash business, we expect expect some acceleration of.

Gross margin given given the.

The supply demand balance situation so.

<unk> anything to add to that yes.

David just maybe to follow on on the comments.

Aaron's question with respect to Covid.

Where we see.

Corporate costs going into next quarter are expected to be a little bit less than what we experienced in the fiscal third quarter.

Thank you.

Thanks Sharon.

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

Great. Thank you.

Just following up on the contamination issue.

Seven exabyte number that you guys talked about still the right kind of number anything like the loss production and how does that split across the March and June quarters.

Hey, Joe.

Yes, that's still the right number I mean, the team will always work in kind of an evolving situation to see what they can do with the material.

We had to take out but.

I don't think it will be super material to the numbers. So 7% is good place to work from.

And we haven't split it up over over the quarters, but.

The majority of it we took in the.

Previous quarter.

Okay and your joint venture partner.

Yes.

But I wont speak for them, but like.

In terms of assessing the industry situation would have lost proportionately the same amount.

Yes, I'm not going to speak for them, but we have we have joint manufacturing.

Facilities for sure.

Great. Thank you.

Thanks, Joe.

Thank you. Our next question will come from Patrick Ho with Stifel. Please go ahead.

Hey, Patrick are you there.

Hey, Sherri why don't we skip over I'm trying to get Patrick backend.

Our next question, we'll go to Tom O'malley with Barclays. Please go ahead.

Good afternoon, guys. Thanks for taking my question Youre seeing really.

I'll put a much larger frame on it.

I think what is happening and we see it show up in a number of ways and there's a lot of COVID-19 implications and cost in it too but.

I think we're just seeing the industry change from <unk>.

The World, where there was always.

Capacity enterprise drives available.

Hard drives for available it was about.

Putting as many as you could in places, where you could fill our factories and get good absorption and not have to pay incremental cost for that.

That's.

Kind of a decline of the client era and the rise of the cloud era, we're pretty much through that we are in the last legs of it and I just think youre seeing a lot of industry dynamics change.

Making investments in this business essentially we don't have a lot of capacity anymore to shift from client to to enterprise and the cloud and we're having to invest in that and thats, causing.

The whole industry to shift the way it thinks about this technology in my point of view I think it starts with we're still driving a strong <unk>.

Model for our customers, that's where it all starts every generation of technology, we're able to bring down the tcl for our customers in the past I think as we did that the reward for the for our side of it was more volume.

Cup that capacity well, that's not the case anymore now we have to invest in new volume. So the industry has to change. So we're bringing a lot of <unk> value and I think youre seeing the industry move to providing more visibility thinking about value based pricing more and how do we how do we.

Move that value equation in a way that we can continue to drive the <unk> down and rights.

Better pricing environment.

That's the Big picture and then of course there is.

A lot of cost in the system right now in inflation of input.

Input costs are going up and we're working through pricing.

We can if we can mitigate parts of that.

Is happening as well.

Helpful. If I could just sneak just another quick one.

On the flash side, obviously, you have a lot of disruptions during the quarter. It looks like the implied cost was relatively flat.

Yes.

Yeah.

Yes.

Go ahead, yes of course, yes, Tom so.

We do it we do expect that.

Our long term to continue to reach our long term.

Cost reduction, which is a 50% year on year.

Yeah.

We did see a bit of headwind in the current quarter, but it is impacted by a few factors.

And that we expect will dissipate in the next.

A couple of quarters. So we saw for instance, we continue to.

Orion power mixed flash technology, and as well as just like everybody we're seeing.

Some inflationary pressure.

As well as the startup of our <unk> fab.

Seven.

We still expect for this.

Fiscal year 'twenty two to be at least 15% year on year in terms of cost reduction and as I start to dwindle.

Do we expect to continue to.

I mean that targets going forward.

Helpful. Thank you.

Thanks, Tom.

Thank you. Our next question, we'll go to Timothy Arcuri with UBS. Please go ahead.

Hi, Thanks, a lot this is Jason on for Pam.

So could you. Please provide any color on the trajectory of your HDD gross margin through the second half of this year.

I'm asking because.

We are expecting some benefit that we'll get for that.

The stronger likely stronger pricing environment second half versus first half. Thank you.

Sure.

Yes, we do expect.

As we talked about last quarter, we're pretty much in the same place, which is we expected the decline we saw this quarter.

We actually expected gross margins to be a little lower next quarter now we think that will be flat and then we expect that to improve in the second half for a number of reasons mix input costs that are changing a bit.

And also some pricing benefit so yes, we expect.

We expect next quarter to be the low and then we expect to improve from there.

Thank you.

Thank you. Our next question will come from Patrick Ho with Stifel. Please go ahead.

Thank you very much I apologize before.

Dave maybe you could give a little bit of color you gave some very encouraging commentary regarding the data center and cloud spending.

Into the second half of the year what are these because of the long term agreements.

Signing with customers and maybe secondly, along with that question.

How do you see the customer base in terms of the transition from <unk> to 'twenty is it a new set of customers or are your customers quickly transitioning over 20 terabytes.

Yes, So let me unpack that a little bit again, thanks Patrick.

So.

Sure.

The.

It's largely the same customers that we will move from <unk> to 'twenty I mean, I think as I said earlier, the Tcl equation improves as you go as you keep driving forward. So.

It's a very important part of what we do I mean, this is I talked about innovation a lot around here and the innovation, we've driven around the <unk> and now opt in NAND in SME.

Those are all things that we layer into our products and allow our customers every time they move a generation forward they get better Tcl equation. So there's reasons to keep moving forward. So that's kind of the way.

That's kind of a way that works a little bit by the way, we'll come back and talk about SMA are a little bit more we're continuing to see more momentum towards SMB that is the future of the cloud HDD business as SLR all the big players are now moving down that path, which is in technology, we've been investing in for quite some time.

On your other question on look for LTA don't drive the spending of the LTA helps smooth out the spending I think the whole idea with the LTA has to give.

Drive investments in heads and media to fund to fuel the exabyte growth.

We're going to need more visibility than that and so.

Lta's have been adopted.

And we strike those with our big customers on multi quarter Timeframes and then we stick to them and that's been very good as far as smoothing out any ups and downs and builds on their side.

And so.

Yes.

As far as the second half environment.

Our big cloud customers continue to tell us and signal a strong demand environment in the second half of the year. So.

We will be excited about driving to that with starting with 2018, and then transitioning to <unk> as we move through the year.

Thank you.

Thank you. Our next question will come from Chris <unk> with Cowen. Please go ahead.

Hey, Hello, guys, Hi, Chris Thanks for taking my question core HDD when do you expect the crossover between 2018.

It's all about.

Can you.

Please tell us if you did see a slowdown in that.

Market for HIV over the quarter. Thank you.

Yes.

I would imagine the 'twenty crossover will be in the second half of the year I mean, we're deep into the <unk>.

Now I mean, 18 is probably 80% of the portfolio, but shipping so it's the sweet spot of the market as we move through the year, we will start to ramp.

We will start to ramp 20, so towards the end of the year early next year, we can circle back on a specific date, but that's the way we're thinking about it.

The surveillance market smart video market.

Thats been us Ben been soft all year so.

We continue to see that with the Lockdowns in China.

We expect that once that ends there'll be some some snapback in some recovery of pushed out demand there, but right now given the COVID-19 situation.

I think that that market is not going to change until the COVID-19 situation changes.

And if I can squeeze one and they are available and margin accretive.

Is it margin I don't think we breakout at that level of lateral we suddenly have to comment on that or Peter.

Yeah actually David we don't break out down to that level.

10.

Alright, great. Thank you.

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

Thanks for taking my questions a couple of short ones.

How.

Or are you thinking about your full year bit shipment growth for calendar 'twenty. Two I know you don't want a quarter by quarter, but for the full year and then as a follow up question is gross margin for flashing and just talk about maybe up a little bit for next quarter.

Are you actually expecting much price increase.

How much is mix a factor and maybe talk about.

Can you talk about the <unk> startup costs can you kind of quantify what that number is.

Alright.

Our strategy has been very consistent for a long time, we invest to maintain share.

And you see us doing that.

And including recent fab announcements with with coach.

We saw them you want to talk about gross margin a little bit in.

In flash.

Sure Stephen So Sidney Thanks for the question.

When we think of the.

Flash business I think to address maybe the.

The part of the question.

In the UK.

Startup cost then theyre not.

Very significant and actually much lower than the.

Yes.

K one fab.

Startup and we're talking about really a brownfield expansion here versus a greenfield expansion.

And do the part of your question with respect to.

Flash.

Gross margin, that's sort of embedded in the guidance.

Of course mix always plays a part in any gross margin.

Yes.

So whether it's an actual or projected so but as I said earlier.

We're still expecting too.

And to meet that 10%, 15% plus.

Year on year cost reduction for flash in the fiscal year 2022, I hope this helps.

Thank you.

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

Yes, Thanks for taking my question and just as a follow up to the previous question, how should I think about the impact of.

FX exchange rate on our flash gross margin.

So maybe.

<unk> for the question and then maybe I'll just talk.

Talk about the FX in general so our approach as we do we use.

Layered hedging.

Approach, which means.

It's.

There is so much more coverage in hedge in the on the shorter term versus the longer term.

So that smooths out the impact of FX over time.

And the way also to think of it as.

Any incurred cost within the quarter.

Typically we will not try to impact the P&L.

Approximately 90 to 120 days later, given the manufacturing cycle times and lead time for delivery product and so.

Whenever we see.

At least in the past short term in terms of currency fluctuations will not be there.

That impactful to the numbers.

What we saw.

What were sort of expecting.

Actually what we saw in this quarter and what we're anticipating for.

In the fiscal.

Fourth quarter is.

Less than 1% impact on all of our cost of goods sold.

Let me ask you can you talk about all of the cost of goods sold mainly not only the flash.

Okay.

Can I ask a question.

FX was more clarification.

Okay.

This movement.

And back to David.

Given your LTA then you sound.

Confident that the cloud.

A man who is going to sustain into the second half how should we think about near line exabyte growth prospect in calendar year 'twenty two versus 21.

Okay.

Supply growth in 'twenty two versus 20.

I can get you.

<unk>.

Look this up real quick.

Yes.

If I have a look.

Look I mean, if I look at it over looking at over <unk>.

Keep coming back to 35% growth in the.

Yes.

In exabyte in the cloud.

<unk> been a pretty consistent number I'd have to go back and put it in.

Tend to look at it more in fiscal years in calendar years, but I can follow up with you on a calendar year number.

Okay. Thank you and I look forward to meeting you at the analyst day.

I look forward to a refund.

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

Yes, thanks for the question and good afternoon.

David you talked about <unk> quite a bit on this call maybe can you impact how should we think about the impact on <unk> on mix pricing and margins in HDD and maybe can you touch on what kind of workloads are the cloud guys looking to deploy a similar initially.

I'll defer the workloads one.

Our Investor Day, we'll go into a little more detail there, but look I think big picture, we see this last quarter I think.

So we had two big cloud Titans that we're working on SLR and we expected significant shipments towards the end of the year within the quarter. We had another one and another one come to us about adopting SLR. So.

I think that.

It's very it's very clear to me that that the.

<unk> gains that can be achieved with essent Mark I know you've been investing in this technology for a long time and this idea that you can get an extra 10.

As a percent or more and again, we'll talk about that next week or in a couple of weeks as well as very attractive, especially given the size of the of the drive style and how big they are you're talking big numbers multiple terabytes that are being added through changes now.

And the thing that gives me a lot of conviction on this is because it requires the on the host side you have to do some software work and nobody wants to do software work if they if they can avoid it.

Or if the return is not good enough and the fact that the big players are coming in they're saying look we're going to invest in this and we're going to we're going to pull <unk> into our data centers.

Tells me that this is the next leg of growth in this industry. So yes.

Again.

We will get to our Investor day to talk about what it means on the portfolio, but I get back to just another way that allows us using innovation to drive a better <unk> equation for our customers and where we can drive better <unk> and then we can leverage that into a conversation about value based pricing.

And that's exactly what we're doing and that's.

Lastly, where the industry is going I like I said Lta's are a part of that about getting more predictability, but the fact that we can continue to drive down the cost of storage continue to drive a better TCR with every generation of product to do that through innovation.

That gives us opportunity.

Two to create margin and create value.

Thank you. Our next question will come from Nam Kim with Arete Research. Please go ahead.

Thank you for taking my question.

Harsh how should we think about some of your hyper scaler moving into their own enterprise SSD of yield do you expect such DIY enterprise SSD to impact your business negatively or just have a limited impact any color would be great. Thank you.

Various.

Various of our of our customers have DIY projects I think that's fine they still.

Yes.

First of all I don't know if anybody does a 100% that because everybody wants diversity in there and their supply chain.

Even DIY provides us opportunity to provide raw NAND, so not just the full enterprise SSD.

But like I said, even anybody thats doing DIY is also going to be buying enterprise ssds as well for part of their.

Our footprint in the numbers here are getting so large that whichever way you play or both so it gives us the opportunity to play in both of those franchises quite frankly, with our big customers, providing enterprise Ssds, and then providing NAND into their projects. So.

I think it's I think it's a reflection of how important enterprise ssds are to the future of a very modern cloud datacenter, it's extraordinarily important technology and we're very happy to be.

Involved with the biggest customers and qualified at the biggest customers with our technology.

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

Yes.

Thank you and I look forward to seeing you all next month, but before that it's great to see the contamination issue is.

Behind Us of course, we're working through that.

With that being said the costs of all of that is that solely borne by western digital or does your supplier kind of redo Marie to for that ore makeup, Florida and future pricing or some type of insurance, but most critically what are you doing are you put in something to make sure.

Thing doesn't happen again.

Yes.

Give some input when we sum can maybe provide more details that we have them but.

Look we the issue is fully behind US the team has done that.

Make sure we catch it.

Proactively.

As far as the <unk>.

Anything to add to that.

I think.

No David I think you've covered it well.

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

Hi, Good afternoon. Thanks for taking my question I was wondering if you could just talk a little bit more about the hard disk drive pricing. So as you mentioned your asps were up 4% in the quarter.

But can you talk a little bit about the like for like pricing currently and for the rest of the year, how youre approaching it maybe differently by different segments.

And whether it's being impacted by the sort of extended lead times you you've talked about in terms of where you are maybe putting more bits than maybe you were a year ago. Thank you.

I think like I said, we're working on.

I will repeat the same thing again pricing starts with value we have to deliver value and we are constantly innovating to deliver more value.

But we're clearly working on pricing to see to defray some of the input costs and all the logistics cost Covid has impacted so that's going on across the portfolio.

And then we are having conversations with our customers about the value we're providing with these next generation drives about what what that value is and how do we how do we move to a value based risk based pricing model I don't know if theres a whole lot more to say about it.

With some anything from your perspective.

No not.

No not on this.

Not on this David Thank you.

Thank you. Our next question will come from Christian Schwab with Craig Hallum. Please go ahead.

Great I just have a quick question.

Disk drive gross margins, given the positive impacts of mix and decreased input costs.

Okay.

<unk> value pricing.

If we have.

China Covid shutdown and.

Is there any reason why the disk drive business can't be operating it.

<unk> plus growth.

Exiting calendar year.

I'm sorry.

You broke up when you set the number.

Is there any reason that you.

<unk> could you will be exiting the calendar year.

With gross margins at 30% plus again.

Yes, I mean, so I think we broke those numbers out although with some I think he's got the details you had it in his remarks, but I mean, if you just took all the COVID-19 costs off the business right now I think we'd be about 30% rate we saw.

Yes, so that's a true David.

We didn't have in the quarter at around 240 basis points.

Related to the Covid costs.

We've talked about.

Slightly impacted of course by Covid Lockdowns.

We continue to see some inflationary cost pressures short term with the supply chain disruptions.

I mean to your question.

I wouldn't necessarily want to.

Talking about where the margins are going to be in Q4, but we did say that we do expect the <unk>.

Margins to be better from here in the second half of the calendar year 'twenty two.

Yes.

We're not going to commit to your number but just as a general point I mean.

Look there has just been a lot of.

A lot of additional costs out of the business, we've talked about for many quarters now logistics costs.

And now increased input costs that really hit us this past quarter.

And you would think as the world comes out of the pandemic I think which is the major <unk> to your point as this starts to unwind in logistics gets back to two.

On a steady state.

And some of the input costs get more.

Reasonable we stopped paying expedite fees for certain components and things like that because it was just a more smooth flowing supplier ecosystem.

It will it will unburden, a lot of costs out of the business and again I.

Think this is masking somewhat although not completely a major fundamental structural change that's going on in the business, which I've talked about a lot which is.

The HDD market is a growth market and it's a <unk>.

Gross market, where we're going to need to invest capital to build additional heads and media capacity.

Think that is what we've really been focused on from <unk> to opt in and to <unk>. We're just really focused on innovation and bring a better value propositions that will that will be able to build a better product for our customers look at instead value based pricing things. So if we get both of those going.

And we can get the cost out because of the pandemic I think we will we feel very good about the business.

Thank you. Our next question will come from Mark Miller with Benchmark Company. Please go ahead.

Thank you for the question I'm, just wondering in terms of mix and mix how is that progressing in terms of mobile versus the other.

Segments, you ship into are you seeing increasingly more shipments in the mobile and where do you expect that is growing.

Okay.

There's a couple of dynamics to this I think over the looking the past couple of quarters with a higher shift higher mix towards mobile as we were ramping fixed five.

We talked about it in the.

In the prepared remarks, we've got in the past our qualifications of fixed five in the consumer market and in our client SSD market. So we see an acceleration of mix into those on <unk> five.

And then there's a lot of hard work going on to qualify our enterprise Ssds on <unk> five and as that happens throughout this year. Then you will see an acceleration of that market as well into fixed five. The reality is is we have we have demand on enterprise SSD we.

We can't meet because it's on VIX floor right now so as we get that into fixed five youll see the mix change and you'll see the.

Enterprise SSD.

Mix accelerate through the second half of the year, which will provide a disposable.

We'll talk about this a little bit more at Investor day, as well to put one more one more plug in to see all of you on the 10th.

Yes.

Thank you. Our next question will come from Kevin Cassidy with Rosenblatt Securities. Please go ahead.

Yes, Thanks for taking my question, yes, looking forward to.

May 10th.

And the May 9th two right.

Yes.

Yes, I was just wondering if you could give us a little more details on the fab seven ramp.

You've mentioned brownfield as production then can I, just understand a little better what that means.

You start off with only 20000 wafers a month there.

I mean any numbers like that you can give us.

So first of all let me clarify that Brown field I think the point.

We saw him was making there was that case to expenses will not be at the level of K. One because Q1 was a greenfield in Q2 as a brownfield so.

The same situation with <unk> seven with switch.

Ramping or annual Daiichi, obviously is obviously, a brownfield launch there as well.

Some may have some some information about how the expenses rollout as far as how the wafer scale look we'll start ramping that I think on our newer nodes, but.

And we will have more to say about that when we start getting tools in there and all of that.

Anything to add.

Yes.

Just maybe to clarify that thanks.

Thanks, David to clarify the my comment on brownfield versus Greenfield was exactly.

Just to really highlight that the costs aren't as high as we've seen in K one.

They werent really.

They are not very significant but of course, it's a bit of a headwind to the gross margin.

Yes.

Thank you speakers I'm showing no further questions in the queue. At this time I would now like to turn the call back over to Mr. David Kessler for any closing remarks.

May 9th intense on the 10th we will have our Investor day, which we have been looking forward to for quite some time. So we will see there thanks everyone.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.

Q3 2022 Western Digital Corp Earnings Call

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