Western Digital Corp (WDC) — Q1 2021 Earnings Call Transcript

Thank you, and good afternoon, everyone. Joining me today are David Goeckeler, Chief Executive Officer; and Bob Eulau, Chief Financial Officer. Before we begin, let me remind everyone that today's discussion contains forward-looking statements, including product portfolio expectations, business plans, trends and financial outlook based on management's current assumptions and expectations and, as such, does include risks and uncertainties. We assume no obligation to update these statements. Please refer to our most recent financial report on Form 10-Q filed with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially. We will also make references to non-GAAP financial measures today. Reconciliations between the non-GAAP and comparable GAAP financial measures are included in the press release and other materials that are being posted in the Investor Relations section of our website. With that, I will now turn the call over to David.

Thanks, Peter. And thanks, everyone, for joining us this afternoon to discuss our fourth quarter and fiscal year 2020 results. I hope that you and your families are staying healthy and safe. As I reflect on my first full quarter as CEO of Western Digital, I am extremely proud of the way our team has navigated the complexities of uncertainties inherent in this unprecedented environment. As a company, we continue to adapt to provide continuity and high-quality products for our customers, deliver value to our shareholders and, importantly, prioritize the health and safety of our employees. We have a unique view into many drivers and trends that play both domestically and internationally due to the breadth of our portfolio of innovative flash and hard drive solutions going into cloud, OEM channel and retail end markets. We look at our business holistically, but it is especially important now to understand the nuances, challenges and opportunities in each market we serve. So before we dig into the results for the quarter and full year, I want to talk about how the COVID-19 pandemic and other macro trends are impacting the business. I'll then update you on how we are thinking about our strategic priorities for the fiscal year 2021, before turning it over to Bob for a financial update, which will be followed by Q&A. Western Digital has successfully managed through this unpredictable time with limited business impact from the pandemic. We made important investments and changes to minimize manufacturing and logistical challenges that were primarily impacting our hard drive business. Bob will discuss the financial impact of these later in the call. And we have maintained our focus on delivering for customers throughout. From an end market standpoint, demand was mixed in the quarter. And if there's a common theme among our end markets, it's uncertainty. In the second half of fiscal 2020, customers were focused on ensuring they had enough supply to meet heightened demand. As expected, demand in our cloud business was strong, due to the work-from-home trend. At the same time, healthy demand for our flash-based notebook solutions drove record revenue in our OEM end market. Finally, in retail, while we have a robust distribution channel with over 350,000 points of purchase around the world in well-established brands, we were impacted by COVID-related lockdowns at many of our brick-and-mortar customers. We did see the business recover as the quarter progressed due to easing of lockdowns and the transition to online buying with curbside pickup. As we look to the first half of fiscal 2020, uncertainty remains. We remain vigilant given the resurgence of the virus and its potential to disrupt our supply chain, including our ability to keep full teams working in our manufacturing facilities. Apart from COVID-19, we're managing through other macro trends. The global economic contraction is generating an uncertain demand environment, and we are closely monitoring trade-related geopolitical developments, which are pertinent to a global business like ours. These near-term headwinds will eventually subside, and we are confident that the strength of our portfolio and strong customer relationships are well-aligned to where the growth is, in the cloud and on the edge. We've continued to make strategic technology and product investments in both flash and hard drives to drive long-term revenue growth and gross margin expansion. Now turning to our financial results. In the fourth quarter, results were generally in line with our guidance. We achieved this while partially offsetting higher than anticipated COVID-19 related costs, which Bob will discuss in more detail. We reported revenue of $4.3 billion and non-GAAP earnings per share of $1.23, mainly driven by growth in the cloud and record results for our client SSD portfolio for notebooks. Looking back at the full fiscal year 2020, I am pleased with our performance. Our end market diversity and breadth, broad customer base, channel reach and innovative leadership all position Western Digital to benefit from the multi-year growth in data creation and storage. For fiscal 2020, revenue totaled $16.7 billion and we reported non-GAAP earnings per share of $3.04. We continue to align our portfolio with a sharp focus on growth and margin improvement. Importantly, over the last year, we brought to market several exciting new innovations across both flash and hard drives that I'd like to touch upon. Starting with flash, as you know, we believe flash is the greatest long-term growth opportunity for Western Digital and is an area where we've already had a tremendous foundation with consumer cards, USB drives and client and enterprise SSDs. As I mentioned on the Q3 call, the migration to flash within game consoles is yet another example of flash penetrating deeper into the edge and endpoint. The adoption of 5G and the build-out of the edge to support new generation of real-time services is another exciting development. We see an expanding total addressable market for flash that underpins a multi-year growth opportunity. To capitalize on this opportunity, we launched BiCS5, our 112-layer flash product in retail last quarter, which delivers exceptional capacity, performance and reliability, all at an attractive cost. The ramp has gone very well with impressive yields, and we are just at the beginning stages of this product ramp. While we focus on ramping BiCS5, BiCS4 has continued to provide the right balance of performance and cost reduction. BiCS4 represented over 60% of bits shipped in the quarter. Earlier this year, we celebrated the first production wafer shipment from our K1 fab, our new manufacturing facility for 3D BiCS flash memory. This is another important milestone reflecting the successful 20-year partnership we've had with Kioxia. Another major highlight has been the ramp of our Enterprise SSD product line. Enterprise SSD revenue in the quarter grew nearly 70% sequentially, and our revenue share increased to the low double digits. This will remain an important area of focus within our flash portfolio. Now turning to hard drives, we continue to lead the industry in aerial density using innovations across the entire drive, algorithms, firmware, mechanical, heads and media. We were the first in the industry to ship energy-assisted drives for mass production and expect a strong ramp into the fiscal second quarter and beyond. In short, we are going through important product transitions in both our flash and HDD businesses that we think set up Western Digital well for the future. Recognizing that these are uncertain times, we believe that the most important thing we can do is keep our foot on the proverbial innovation pedal and execute on the roadmap across the business. We have an extremely talented team working on new products that will continue to drive leadership in flash and hard drives. Looking ahead, our strategic priorities are centered around driving innovation for customers and value for shareholders. First and foremost, we will focus on driving long-term shareholder value as we bolster our flash and HDD portfolios, including ramping two important product lines to high volume, our SSD products and our energy-assisted capacity enterprise drives. Secondly, we will accelerate our transition to BiCS5 delivering additional performance for our customers and notable cost advantages for Western Digital. Third, we will continue to sharpen our execution from a product roadmap and strategic business objectives. And finally, we are evolving our portfolio to drive growth, margin improvement and cash generation, while also paying down debt and investing in the future. In the near term, we expect to remain challenged by the pandemic and the global economic contraction. Internally, we're also navigating multiple substantial product transitions, which will require sharp execution focus, but we are very confident they will set us up well for the long term. With that, I'll turn the call over to Bob to share our financial highlights and outlook.

Thanks, Dave, and good afternoon, everyone. As Dave mentioned, the COVID-19 pandemic has created a challenging global economy that has continued to impact Western Digital's performance, in large part due to the high level of uncertainty that both we and our customers are facing. While this uncertainty isn't going away in the near term, we'll continue to adapt, and we believe Western Digital is well positioned for the future. With that, I'll walk you through our fourth quarter and fiscal year 2020 results. For the fourth quarter, revenue was $4.3 billion, up 3% sequentially and up 18% from a year ago. Non-GAAP earnings per share was $1.23. For the full fiscal year, revenue was $16.7 billion, up 1% from fiscal 2019 and non-GAAP EPS was $3.04. Looking at end market, Client Devices revenue was $1.9 billion, up 5% on a sequential basis and up 19% year-over-year. Within this end market, our robust family of client SSDs, which are ideally suited for remote learning and work from home applications, achieved another record quarter of revenue. Notebook and desktop related hard drive revenue declined slightly sequentially as the market continued to transition to SSD-based products. Smart video was weaker than our expectations due to continued headwinds associated with the pandemic. In Gaming, we began shipping our flash solutions for the upcoming new game console launches. Finally, mobile flash revenue was down sequentially, but up year-over-year, off a low base. Moving on to Data Center Devices and Solutions. Fourth quarter revenue was a record $1.7 billion, up 11% sequentially and up 32% year-over-year. For the full fiscal year, revenue of $6.2 billion was up 24% from fiscal year 2019. Capacity enterprise hard drive revenue was down slightly on a sequential basis, while enterprise SSD revenue grew nearly 70% sequentially and more than doubled from a year ago. Next, Client Solutions revenue was $687 million, down 16% sequentially and down 9% year-over-year due to COVID-19 related lockdowns. Despite this, we were encouraged to see demand pick up in June, as countries began to ease lockdown restrictions and as brick-and-mortar locations shifted more of their operations online. This strength continued into July. Given the unprecedented circumstances, we executed very well in this business in a difficult environment. With over 350,000 points of purchase around the world, we continue to have incredibly strong distribution breadth and brand recognition. Turning to revenue by product category. Flash revenue was $2.2 billion, up 9% sequentially and up 49% year-over-year. Flash ASPs were up 1% sequentially on a blended basis and up 3% on a like-for-like basis. Bit shipments were up 8% sequentially. Hard drive revenue was $2.1 billion, down 3% sequentially and down 4% year-over-year. Total exabyte shipments were down 2%. On a sequential basis, the average price per hard drive increased 2% to $87 as mix continued to shift to the cloud. As we move on to cost and expenses, please note all of my comments will be related to non-GAAP results, unless stated otherwise. Gross margin for the fourth quarter was up 1 percentage point sequentially to 28.9%, slightly below our guidance range. The major item that impacted our gross margin was COVID-19 related costs of $96 million. This almost exclusively impacted the hard drive business and was primarily related to reduced factory utilization and higher logistics costs. For clarity, this item was included in our non-GAAP gross margin. Our Flash gross margin was 30.5%, up 4 percentage points from last quarter due to cost reductions and slightly favorable pricing. Our hard drive gross margin was 27.2%, down 2.1 percentage points from the prior quarter. The biggest driver of the lower gross margin was the $96 million in COVID-19 related costs, representing a 4.7 percentage point impact on our hard drive gross margin. Operating expenses were $713 million, well below our guidance range, primarily due to our decision to cap variable compensation expense given the current economic environment. Non-GAAP earnings per share was $1.23. Operating cash flow for the fourth quarter was $172 million and free cash flow was $261 million. In fiscal 2020, we generated $1.1 billion in free cash flow. Capital expenditures, which include the purchase of property, plant and equipment and activity-related to flash ventures on our cash flow statement, were an inflow of $89 million due to the timing of funds flowing to and from the joint ventures. In the fourth quarter, we distributed $150 million in dividends to our shareholders, which was our final distribution prior to suspending the dividend. We also made a standard $63 million debt repayment in the fourth quarter. I would note that we have already made an optional debt repayment of $150 million in July. Our liquidity position continues to be strong. At the end of the quarter, we had $3 billion in cash and cash equivalents, and our gross debt outstanding was $9.7 billion. Our debt to EBITDA ratio was 4.2 times in the fourth quarter, and our adjusted EBITDA leverage ratio, as defined in our credit agreement, was 2.8 times. As a reminder, our credit agreement includes an approximate $1 billion in depreciation add-back associated with the joint ventures, which is not reflected in our cash flow statement. Please refer to our earnings presentation on the Investor Relations website for further details. Moving on to guidance for the fiscal first quarter. We are somewhat challenged in the near term as a result of the uncertainty of the pandemic and being in the midst of a global economic contraction. Despite this uncertainty, we continue to execute and focus on our great products, deep customer relationships, and large and growing markets. We are working on a number of substantial product transitions that will set us up well for the long-term. We expect revenue in the first fiscal quarter to be in the range of $3.70 billion to $3.9 billion. Growth in Client Solutions is expected to be more than offset by a decline in both Data Center Devices and Solutions and Client Devices. We expect non-GAAP gross margin to be between 25% and 27%. This range includes approximately $80 million in costs associated with the K1 fab. This should be the peak quarter in fiscal 2021 for K1 period expenses. We expect operating expenses to be between $700 million and $720 million. Interest and other expenses is expected to be between $70 million and $80 million. The tax rate is expected to be between 22% and 26% in Q1 and for the full fiscal year 2021. We expect non-GAAP earnings per share to be between $0.45 and $0.65 in Q1, assuming approximately 304 million fully diluted shares. Gross capital expenditures, which include our joint venture, leasing and self-operating funding, is expected to be approximately $3.1 billion in fiscal year 2021. This includes approximately $1.3 billion in cash capital expenditures. We will continue to monitor capital expenditures very closely given the current business environment. In summary, we are executing well in a challenging environment and results are generally in line with expectations. We are taking decisive steps to successfully navigate through the current macroeconomic environment while ensuring we focus our resources to address the significant long-term growth opportunities that are ahead. I'll now turn it back over to Dave.

Thanks, Bob. While we continue to navigate through a complex and dynamic environment, I'm confident that Western Digital can lead the market for years to come. As I've said, I came here because I have a very strong conviction that Western Digital can play an increasingly vital role in the digital transformation, and that conviction has only strengthened in the past five months. We have a deep flash and HDD product portfolio, operational scale and great customer relationships, combined with the ever-growing demand for data creation and storage. All in all, it's a great place to be, and I'm extremely thankful for the hard work that our talented global team puts in on a day-in and day-out basis. We're operating in uncertain times, but Western Digital's strong consistent performance reflects our ability to maintain our market leadership by delivering technological innovation with the quality, performance, and cost-effectiveness that our customers rely upon. With that, I'll turn the call over to the operator to begin our Q&A.

Yes. Thank you. I was hoping you could give us some sense on your 18-terabyte ramp. It appeared that you were expecting that ramp before in the September quarter. It looks like it might have been pushed out further. Can you talk about what's going on there? And I have a follow-up.

Yes. No, it hasn't pushed out. The ramp is on plan, as we've talked about. We plan on producing in excess of 1 million units this quarter. It's a very important quarter for us on that ramp, Wamsi, because it's the quarter where we get the yields up, which gets us the margin profile we need to go into the second quarter of the fiscal year at full production capacity. So it's on track, where we want it to be. We feel good about it. And this is going to be an important quarter for us, but it's something we know how to do in ramping a drive platform.

Thank you for that. I would like to understand the gross margin outlook for this quarter compared to the previous one, specifically the key factors influencing it. How much do you expect the HDD segment to contribute, considering some recent weakness in enterprise capacity was not anticipated?

Yes. I'll make a few comments before handing it over to Bob. Looking at gross margin going forward, we face several challenges. While we anticipate that COVID-related costs will decrease next quarter compared to this quarter, they are still present. Additionally, the logistics costs are quite variable, changing week by week. We're also in the early stages of ramping up the 18-terabyte drive, which is a headwind for gross margin during this phase. That's why this quarter is crucial for us as we navigate through these issues, and we are on track with that. Regarding flash, the pricing environment is easing, which will also affect gross margin. Bob, did I leave anything out?

No, I think those are the keys. I mean on the hard drives, obviously, volumes are a little lower, so we'll be amortizing our fixed costs over a smaller volume as we go up the yield ramp on the 18-terabyte drives. Now on the flash side, as Dave said, I mean, we've got some price and mix headwind. And we also, as I mentioned in my comments, we have costs up a bit on K1, which amounts to about one percentage point on the flash side. So it's just we have multiple challenges this quarter. But I think long-term, we're going to be really well-positioned once we get up these product ramps.

Okay. Thank you.

Yes. Thanks. Just kind of building off that last question a little bit. I mean, when you look at the hard disk drive gross margin at 27.2% and you adjust, it looks like adjusted ex-COVID, looks like it's close to about $32 million. I think it would be helpful just to kind of frame what the expectation is for COVID impact in this quarter? Is it probably not as high, but are we still carrying three percentage points plus of kind of headwind on gross margin? Just kind of any framework there. And on top of that, what are you seeing in pricing dynamics in nearline right now in the market?

I will address the second question. Bob can provide more insight into the first. The market is currently very competitive for all businesses transacting at AT&T. We are nearing the end of one phase and transitioning to the next, which makes it crucial for us to ramp up the AT&T 18 and 16 initiatives. This will help position us effectively and create accretive margins for our portfolio. We anticipate that as we engage customers with 18, it will present a different total cost of ownership proposition for them, adding more value for both parties. Overall, we are moving toward a better situation. Bob, would you like to discuss the impact of COVID for this quarter? It’s a bit challenging to assess since it remains quite dynamic.

Yes. Yes. It's not going to be as significant as last quarter. And last quarter, we did offset the COVID cost a bit by pricing, but obviously did not fully offset it. That's a big number. As we look at Q1, we don't think we're going to have the kind of absorption variances that we had last quarter. You may recall in the earnings call in April, I said that we had some challenges on volumes in April. So we already knew we had that headwind last quarter. We don't have that issue this quarter. So I would say the costs will be down, but I don't want to be too specific. We think we've got it covered in the guidance range that we articulated.

Okay. And then as a follow-up, I know there's a lot of discussion around cloud digestion, kind of mixed data points out there. Relative to the 30% implied nearline capacity ship growth this last quarter, what is your current assessment of the demand from a capacity ship standpoint nearline through the back half of this calendar year, any kind of views on that front?

Yes, we believe we are entering a digestion phase. After experiencing three strong quarters of exabyte shipments, the demand signals we're receiving indicate a slight decline for the next quarter or two. Long-term trends remain positive as cloud usage continues to increase. However, a significant amount of product has been shipped over the past few quarters, and the customers show varied demand patterns. Overall, we see a negative bias in demand for the next quarter based on recent trends.

So down sequential? Sorry.

Yes.

Thank you.

Thank you. I wanted to follow up on Aaron's last question regarding exabyte growth. You had a strong quarter for exabyte growth in the data center, but it seems the outlook is expected to decline sequentially as you mentioned. Could you compare what you're observing in on-premises and private cloud environments versus the public cloud, in relation to both your hard drive and enterprise SSD portfolios? That's my first question. For my follow-up, you've been a relatively smaller player in the Enterprise SSD market recently, which has contributed to significant share gains. You've made substantial improvements in your technology portfolio within that market. Do you expect to outperform end market demand in September, given the share gains you've achieved lately? Thank you.

We have made significant progress in launching a new product in the Enterprise SSD sector. We've introduced a couple of new products, with the first one already available and aimed at cloud providers, while the product intended for OEMs is still in the pipeline and expected to be released in the next few quarters. We're currently undergoing a major transition with our products, making it difficult to provide a clear answer regarding on-prem versus cloud trends in the Enterprise SSD market, as our focus is primarily on the cloud side at the moment. As this new product undergoes various qualifications over several quarters, I anticipate we will see improvements, although the progress may be uneven. Looking at the organizational activity, we are experiencing double the number of calls compared to a year ago, indicating that our portfolio is evolving, and we are pushing it into the market. Regarding hard drives, I can mention the OEMs in private data centers as part of a broader market discussion, but I believe it would be better to address that separately since it is more relevant to PCs. Bob, do you have any insights to offer on the hard drive market in relation to on-prem versus cloud?

No, I think we're seeing softness in both areas as we move forward into Q1.

Thank you, gentlemen.

Thank you for taking my question. Regarding the hard disk drive, one of your competitors mentioned weaker demand trends, particularly for client non-compute from China. If this is affecting your client non-compute, it appears that shipments for that specific segment may have declined by over 20% quarter-over-quarter. Could you provide some clarification on this? I also have a follow-up.

Yes. I'll provide some insights into the general market. I'm not sure I can quickly calculate the figures you mentioned. However, the channel, particularly in smart video, faced significant challenges this past quarter. The team put in a lot of effort, but we noticed a contraction in the total addressable market of about $100 million over the quarter. This suggests an overall decline in demand, which has created a negative outlook for the market moving forward. Bob, do you have any additional thoughts on smart video specifically?

No, I agree in the short term. If we look over the longer time horizon, that is going to be another area of growth in the hard drive business. We really see the capacity in Enterprise business and the Smart Video business growing as we look over multiple years.

Yes, I think the overall theme you’re hearing from us is that as we look forward to the next quarter, we anticipate some challenges due to COVID, the state of the economy, and the inventory adjustments happening. However, in all of those markets, we observe strong long-term trends. The key question is how quickly things will bounce back. The pandemic has highlighted our reliance on technology, and I believe our portfolio is well positioned for this environment as it hasn't been in quite some time.

Great. Thanks for the detailed color. And just my follow-up question has to do with the Flash. You highlighted the fact that your revenues were up 70% or so. But I heard that commentary suggests there is an unfavorable mix shift into the September quarter. Perhaps you could help us better understand dynamic, if you were to elaborate on the mix of your NAND, how SSD and smartphone application are trending? And it seems to me that maybe the game console is happening later in the year? And if you could elaborate on it, it would be great.

Yes. So I think there are a bunch of pieces in there, Mehdi. So game console is definitely a growth area, and we're very fortunate to be participating in that. And as you know, we haven't been in the hard drive side of that business for quite a while. So it's all upside from our perspective. And then I would say, overall, there may be slight mix changes as we go quarter-to-quarter. We are seeing some pressure in terms of price, and that's factored into our guidance as well.

Yes, Mehdi. This is Peter. Also don't forget, we do have a little bit of a step-up in the K1 cost, but as you go Q-to-Q, that will be another pressure on the flash gross margins.

Okay. But in terms of the end market mix as it relates to Flash, you shouldn't assume a significant change.

I think the biggest change is the one I mentioned on game consoles becoming more significant. But otherwise, it will be up and down here and there, but I don't think it will be that material.

Got it. Thank you.

Yes, good afternoon. Thank you for taking my question. I guess first question, as it relates to your overall revenue guide for September, down 11% sequentially, should we be thinking that each business is down similar to that rate? Is one doing better than the other? Could you shed a little light on that, please?

Sure. In the last quarter, we faced challenges in the retail segment, which represents about 20% of our business. However, conditions improved as the quarter progressed, with June showing positive signs. While it wasn’t fully back to normal, it remained strong, and we've seen that trend continue into July. We anticipate this business will show positive growth in the upcoming quarter. Regarding our other segments, particularly the cloud, we are observing a digestion phase. OEMs are being cautious and closely managing their inventories. For the channel, we remain optimistic about long-term prospects for our portfolio. However, in the short term, this is how we view the performance across our four major business areas.

And so if I just read between the lines, given the commentary on retail that would suggest NAND might be a little bit better than HDD?

I wouldn't provide specific details.

I don't know if I'd go into that level of detail.

I have a question regarding the Flash segment, following up on Mehdi's inquiry. For the June quarter, I was somewhat surprised by the lower ASP uplift despite higher bit growth. Can you explain what contributed to that? Additionally, should we expect a similar mix as in the June quarter, along with an increase in gaming, as we refine our ASP assumptions?

Yes. So I'll make a few comments. I'm sure Bob will make a few comments. I mean, part of the ASP, looking back, was retail where ASPs were more challenged. So, that's a big piece of that number. I think going forward, you shouldn't expect a tremendously different mix minus what you said gaming, it was good to see gaming start to ramp up. We expect that to continue to ramp through the second half of the year and take a low double-digit percent of our supply. So, that's a good story.

Yes, I don't have a lot to add. I mean I think in the transactional businesses, we've definitely seen more pricing pressure than we've seen from the OEMs, although overall, we think prices will be down this quarter.

Thank you.

Thank you. Could you discuss your current comfort level in the NAND business? Last year, when demand weakened, you implemented underutilization actions to reduce inventory, but you’re not doing that now. Does this indicate an improvement in supply and demand? Additionally, could you provide insights on the status of your inventory and customer inventory, as well as your plans moving forward?

I will share a few thoughts, and then Bob can add his input. We feel positive about the balance between supply and demand in the industry. Of course, during a recession, we experience a decrease in demand, leading to some pricing effects. However, we believe the supply and demand situation is fairly balanced moving forward. We are being very diligent with our capital expenditures and managing them closely with our partner. Bob, do you want to discuss inventory?

Yes. I mean, I joined the company right in the middle of the last trough. And I can tell you, the supply and demand imbalance is nothing like it was then today. So I think everybody is behaving pretty rationally. We still see the industry growing bits and then bits both supply and demand in the neighborhood of 25% to 30%, and that's our intention as well.

Okay. For my follow-up, it seems you feel confident about the adjusted EBITDA covenant calculations for September. However, memory can be uncertain beyond that. Can you share your overall comfort level regarding the covenants? Additionally, are there any actions you could take if the situation worsens to ensure you won't encounter any issues?

So I'm very comfortable. In fact, if you go back to the trough, I was just talking about; we never really got that close to breaching the covenant on the adjusted basis. So I really don't think there's much of a risk there.

Hey, Joe, also just to put a little bit more transparency into the credit agreement metrics. Please make sure you take a look at the slide deck that's on our website. We've got a lot more detail on that metric in there.

Yes. Got it. Okay. Thank you very much.

Yes.

Thank you.

Hi. Good afternoon. I appreciate you guys taking the questions. I guess the first one for me is with regards to the gross margin guidance, could you give us a sense of which part of the business you expect to contract more of the hard drives versus flash? It sounds like on flash there's slight mix. And on retail, Bob as per your remarks, slight pricing pressure. They're not from OEM contract yet. And then, it sounds like on the hard drive business, it's probably more mix related. Is there anything in addition to that? And then could you just give us a sense of magnitude for each of these businesses? And then I have a quick follow-up. Thanks.

Yes. I mean, I'll touch on it again. I don't want to get into too many specifics. As you know, we only guide gross margin for the company overall. But we're definitely seeing pressures on both sides, both on the hard drive and on the flash. Like we said before, we've got significant product transition going on, on the hard drive side. We've got a yield curve that we're working our way up. And we've got the COVID-19 pressures that they won't be as bad this coming quarter, the quarter we're in now, as they were last quarter. But we definitely have pressures on the hard drive side. And I would say, on the flash side, we're seeing pressures, primarily on price and a little bit of mix. And then the K1 cost that we talked about as well.

The K1 costs are a factor. You mentioned experiencing a period of adjustment in the cloud, which aligns with comments from your main competitors and the hyperscalers. Can you provide some insight into whether you believe this indicates the end of the cycle or if this adjustment period simply suggests that we may see a return to some level of growth in the near future?

Yes, it's a long-term growth market with a projected 35% CAGR exabyte growth for years to come. We have recently experienced a couple of quarters of growth that exceeded that rate, so it's not unexpected for us to go through a phase where we deploy all that capacity. However, looking at our surroundings, we are using the cloud more each day. The past five months have significantly sped up the transformation towards cloud technology that was already on the horizon. While I'm not entirely sure how we would define a cycle, I see a very positive long-term trend and believe we are well positioned. That's why it's crucial for us to ramp up the 1816 platform, produce 1 million units, and ship them to ensure we are in a good position for sustained growth.

And just the one thing I would add. I just think there's been a lot of supply chain disruption this year, both in terms of our own production, our customers trying to make sure they get supply. Now our customers working off inventory levels. So I just think between the pandemic and the recession and concerns on supply, it's been a very challenging year.

Hey, thanks for taking my question. I just wanted to follow up a bit on the gross margin side. So when you talk about COVID-19 issue, kind of being a little bit better than you guys saw or better than last quarter. How do we think about the bigger drivers for your gross margins going back to 30%? Is there really going to be NAND improvement on pricing? Or is it going to be a lot of supply chain issues? Trying to get an understanding of what's really moving the margins so dramatically on a quarterly basis?

Yes. I'll provide an overview, and Bob will go into more detail. Firstly, it's important to highlight our progress in flash technology, particularly with BiCS5. BiCS4 has significantly contributed to our cost reductions and performance. The team's decisions on transitioning to BiCS5 have proven effective, and we are ahead of our internal plans regarding yields for that node. Continuing to advance this technology is essential for maintaining our cost advantages. Additionally, we are optimizing our portfolio to enhance gross margins, especially by shifting more towards enterprise SSDs, which we believe will yield higher margins. Pricing remains a market concern as well. Regarding hard drives, innovation is key to driving gross margins. The ramp-up of our 18-16 terabyte platform offers a better total cost of ownership for customers and a stronger value proposition, leading to higher gross margins for us. This focus on production ramp-up for that platform is why we're optimistic about it. Those are the primary drivers from my viewpoint. Bob?

Yes. I don't think I have much to add. I mean think it's clear, we've got room to improve in both the hard drive area and in the flash area and we've got the products to make it happen.

Got it. And then just one other small one just on the smartphone cycle, I mean, it's been very clear that some of the bigger products got pushed out right to the time that they're going to ramp up more in Q4 into the Q3. Can you maybe give us an understanding of how that impacts you? And how you guys think about the push out and relates to the flash business?

Hey if I can start?

I miss the question.

I will start. So as you know, we've been underweight mobile for quite a while. We continue to be underweight in terms of mobile. Now if that business is lower than was anticipated, our competitors need to find homes for those bits. So, we're not completely insulated from the challenges on the mobile side because they do need to move into other markets in order to move the bits. But I think in terms of our strategy of focusing on the other areas, I think it's worked out pretty well.

Okay. Well, thank you everybody for taking the time to listen to Western Digital today. We look forward to talking to you throughout the quarter. Good day.

Yes. Thanks, everyone.

Thanks, folks.