Good afternoon and thank you for standing by. Welcome to Western Digital’s Fiscal Second Quarter 2022 Conference Call. As a reminder, this call is being recorded. Now, we will turn the call over to Mr. Peter Andrew. You may begin..

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 and performance, 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..

cloud, client and consumer. Our customers remain optimistic about demand trends in calendar 2022, driven by capital investment for the cloud build-out, continued recovery in enterprise spending, growth in smart video applications, increased adoption in 5G phones, consumer gaming and emerging trends such as VR/AR devices.

In cloud, our customers have announced a 36% year-over-year increase in capital investment for the cloud build-out. This coupled with an increase in enterprise spending and continued growth in smart video applications, is expected to drive growth for our flash and HDD products into this growing end market. In client, PC end demand has remained strong.

Our customers are driving more consistent demand than the past several quarters and we see continued stabilization in 2022. PC unit shipment forecasts continue to be robust and significantly ahead of pre-pandemic levels.

In addition, we anticipate an eventual return to site to drive a mix shift towards commercial PCs, which tend to offer richer client SSD content versus consumer-oriented PCs. In mobile, the latest 5G phones have doubled NAND content from prior generation smartphones.

We expect mobile device content to benefit as ongoing 5G adoption and new 5G-enabled applications are expected to drive the storage demand in both endpoints in the cloud. In consumer, the highlight of this end market is our WD_BLACK SSD line of products optimized for gaming enthusiasts. Revenue more than doubled in calendar year 2021.

The consumer recognition of the strength and value of WD_BLACK, along with the SanDisk and SanDisk Professional brands, drove a 34% year-over-year growth in average capacity per unit in consumer flash. While end customer demand in calendar 2022 looks promising, supply chain challenges are increasing.

This both limits our ability to source components to meet customer demand and increases component costs. These costs are on top of the ongoing elevated logistics and health and safety COVID costs.

While we believe these incremental costs are transitory and will subside as the supply chain conditions normalize, they will impact our results through the first half of this calendar year. Let me now turn the call over to Bob who will discuss our fiscal second quarter results and provide a more detailed outlook for calendar year 2022.

Bob?.

Thanks, Dave and good afternoon everyone. As Dave mentioned, overall results for the fiscal second quarter were better than our expectations, marking the seventh consecutive quarter that we have met or exceeded guidance. Total revenue for the quarter was $4.8 billion, down 4% sequentially and up 23% year-over-year.

Non-GAAP earnings per share, was $2.30, which exceeded the high end of our guidance range. Please note that this figure includes $70 million in total COVID-related costs, which was higher than we anticipated entering the quarter.

I will provide more details on these costs in a minute, but we are pleased to have delivered such strong results in the face of ongoing supply chain issues and COVID-related challenges. In addition to this solid financial performance, we hit a major milestone this quarter in receiving an investment grade corporate rating from Fitch.

This marks the company’s second investment grade corporate rating. We are pleased to see that our work to build a stronger financial foundation is being recognized and is providing us with greater financial flexibility for the future.

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

Turning to our end markets, cloud represented 40% of total revenue at $1.9 billion, down 14% sequentially and up 89% from a year ago. Supply chain disruptions impacted cloud hard drive deployments at certain customers, which led to a sequential decline in exabyte shipments in the fiscal second quarter.

However, healthy overall demand for capacity enterprise drives, along with Western Digital’s leadership position at the 18-terabyte capacity point, drove a greater than 50% year-over-year increase in exabyte shipments. The client end market represented 38% of total revenue at $1.9 billion flat sequentially and down 1% year-over-year.

The continued ramp of 5G phones helped offset decline in both client SSD and client hard drive revenue, enabling total client revenue to stay flat. Client hard drives represent less than 15% of our HDD revenue. Lastly, consumer represented 22% of revenue at $1.1 billion, up 9% sequentially and flat year-over-year.

With a strong holiday season, retail flash led the sequential growth in consumer. On a year-over-year basis, growth in consumer flash was offset by a decline in consumer HDD. Turning now to revenue by segment, we reported flash revenue of $2.6 billion, up 5% sequentially and up 29% year-over-year.

On a blended basis, flash ASPs were down 6% sequentially due to a seasonal increase in shipments to mobile and retail. On a like-for-like basis, flash ASPs were down 3% sequentially. Flash bit shipments increased by 13% sequentially and 37% year-over-year. Hard drive revenue was $2.2 billion, down 14% sequentially and up 16% year-over-year.

On a sequential basis, total hard drive exabyte shipments decreased by 14%, while the average price per hard drive decreased by 5% to $97. On a year-over-year basis, total hard drive exabyte shipments increased by 27%. As we move to costs and expenses, please note that my comments will be related to non-GAAP results unless stated otherwise.

Gross margin for the second quarter was 33.6%, down 0.3 percentage points sequentially. As noted earlier, the COVID-related impact was $10 million higher than we anticipated at $70 million. Our flash gross margin was 36.1%, down 0.9 percentage points sequentially. This included COVID-related impact of $10 million or approximately 0.4 percentage points.

Our hard drive gross margin was 30.6%, down 0.3 percentage points sequentially. This included COVID-related impact of $60 million or approximately 2.7 percentage points. Operating expenses of $741 million were below our guidance range due to prudent cost control and lower variable compensation expense.

Operating income was $882 million, representing a 7% decrease from the prior quarter and 157% increase year-over-year, highlighting our ability to drive profitable growth. Earnings per share, was $2.30, which exceeded the high end of our guidance range. Operating cash flow for the second quarter was $666 million, and free cash flow was $407 million.

Despite a slight increase in inventory due to supply chain disruption, we maintained strong cash flow generation in the quarter. Capital expenditures, which include the purchase of property, plant and equipment and activity related to our flash joint ventures on our cash flow statement, with a cash outflow of $259 million.

We remain prudent in investing in manufacturing capacity and continue to expect gross CapEx for the current fiscal year to be around $3 billion. We now expect cash CapEx to be around $1.5 billion as we actively manage our overall spending.

As we mentioned on our last earnings call, we fully repaid our Term Loan B in the amount of $943 million last October. In addition, last December, we closed a public offering of $1 billion in senior unsecured notes and repaid $1.3 billion on our Term Loan A, bringing our gross debt outstanding to $7.4 billion at the end of the fiscal second quarter.

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

Our trailing 12-month adjusted EBITDA at the end of the second quarter as defined in our credit agreement was $4.8 billion, resulting in a gross leverage ratio of 1.5x. This compares to 3.0x in the third fiscal quarter of 2020, when we announced the plan to focus on debt repayment to achieve greater financial flexibility.

As a reminder, our credit agreement includes $1 billion in depreciation add-back associated with the flash ventures. This is not reflected in our cash flow statement. Please refer to our earnings presentation on the Investor Relations website for further details.

Considering the transitory supply chain challenges we discussed earlier, I would like to provide a bit more color on our view of both hard drive and Flash businesses in calendar 2022. Within our hard drive segment, we expect hard drive revenue to decrease on a sequential basis in the third fiscal quarter.

While the supply chain disruptions at some of our customers are expected to remain, the larger issue of late has been our ability to source components to meet customer demand. We expect revenue to return to sequential growth in the fiscal fourth quarter.

While overall hard drive pricing is expected to remain relatively stable, we expect gross margins to decline 2 to 3 percentage points from the fiscal second quarter through the fiscal fourth quarter due primarily to component cost inflation.

Within our Flash segment, we expect Flash revenue to decrease on a sequential basis in the fiscal third quarter driven by ASP. We expect Flash revenue to return to growth in the second half of calendar year 2022.

Furthermore, we anticipate downward pressure on gross margins for the first half of this calendar year as cost reductions revert towards our long-term target of 15%. In regard to our fiscal third quarter, our non-GAAP guidance is as follows.

We expect revenue to be in the range of $4.45 billion to $4.65 billion with a sequential revenue decline for both Flash and hard drive businesses. We expect gross margin to be between 30% and 32%. We expect operating expenses to be between $750 million and $770 million. Interest and other expenses are expected to be approximately $70 million.

Our tax rate is expected to be approximately 11% in the third quarter and for the fiscal year. We expect earnings per share to be between $1.50 and $1.80 in the third quarter, assuming approximately 318 million fully diluted shares outstanding. I’ll now turn the call back over to Dave..

Thanks Bob. Looking ahead, we remain optimistic about our business outlook in calendar year 2022 as our customers continue to indicate strong end demand across cloud, client and consumer end markets.

Despite the transitory issues we discussed earlier, it is clearer than ever that we have the right foundation for long-term growth and the right technology portfolio in place to ensure that we are successful in scaling our business.

Over the last couple of years, we have made significant changes necessary to improve our focus, sharpen execution and set strategic goals to place Western Digital in a position of greater strength. And I’m excited that we are starting to see the fruits of those changes.

Before I finish today, I’d like to take a moment to comment on the CFO transition we announced earlier this afternoon. As you may have seen, we announced that Wissam Jabre will be joining Western Digital as Chief Financial Officer effective the week of February 7. Wissam was most recently Chief Financial Officer at Dialog Semiconductor.

In addition to his deep financial and semiconductor expertise, Wissam also has technical expertise, and importantly, shares Western Digital’s values of collaboration and innovation. You can read more about his background in the press release issued today.

I’d like to extend my sincere thanks on behalf of the entire Board and management team to Bob for his dedication and hard work at the service of Western Digital. During my tenure as CEO, I’ve greatly benefited from his friendship and expertise. He’s been an essential part of our leadership team, guiding key aspects of our strategy.

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

Bob’s insight was also instrumental in helping us navigate COVID uncertainty and execute other strategic changes at the company to position us for growth and value creation. Next quarter, you’ll have an opportunity to hear from Wissam. I know he’s looking forward to it. With that, Peter, let’s begin the Q&A..

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

Yes. Thanks for taking the question. I guess I want to dive into, obviously, the hard disk drive results. I mean, by my math, it looks like your capacity shift in nearline declined by about high teens or even 20% sequential.

Can you help dissect the impact of your larger cloud customers having their own supply constraints relative to the comment of your own component availability? And then on top of that, gross margin in this next quarter, I know you alluded to, but how much COVID costs are you factoring into the gross margin expectation with 2 to 3 percentage points decline? Thank you..

Okay. I’ll take a crack at it. Aaron thanks for the question and thanks for joining us, as always. So I don’t think it was quite down quite as much as you said. I think we’re kind of like mid-teens. A big piece of that is, we talked about it last quarter, we have one very, very large customer that’s going through some challenges of their own.

And now we have issues with our own supply chain. So I would say in the last quarter, it was primarily on the customer side. And as we went through the quarter, it started to creep in on our own components. And as we move into the next quarter, it’s much more of a component issue as the rest of the market normalizes out or the customer normalizes out.

On the COVID costs, you saw they are going up, and I’ll let Bob comment through this in more detail. But the health and safety and logistics costs continue to go up. We’ve seen that over the last couple of quarters, and now we’re seeing component costs that are almost approaching that same level of spend as far as increases.

So I thought I’d give you some idea of sizing it. But Bob, you want to....

Yes. I can add a little more detail. I think that the COVID costs we’ve been reporting, which are the logistics costs and the costs in the factory associated with keeping our employees safe, probably peaked in the second fiscal quarter at the $70 million.

I think it will come down some in the third quarter, and hopefully, continue to come down from there. The logistics costs, as you know, have been elevated for probably at least six quarters now.

The thing that’s different as we look at the next quarter or two are the component costs, and we’re seeing a lot of inflationary pressures on the component costs. We think those are transitory, a lot of expedite fees, a lot of expenses associated with trying to get the parts in so we can get the products built and delivered.

So I think that’s really what’s different as we look forward the next quarter or two..

The other thing, Aaron, I’ll just wrap up by saying, I mean, as we look forward into the next quarter, we’re expecting right about on seasonality for our hard drive business. I would say earlier – midway through last quarter, we were hoping to do better than that because we saw the demand there.

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

Okay, thank you..

Sure, thanks..

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

Yes. Good afternoon. Thanks for taking the question.

I guess to follow-up on Aaron’s question, can you speak to when you expect these constraints to no longer be a headwind? And as part of the higher component costs, is there a point in time where you can – where contracts can be renegotiated and you can increase those higher input costs in terms of your pricing?.

Yes. So there is – first of all, thanks for the question and thanks for joining us again. There is a lot to unpack in that question. Let me take a bit of a crack at it. So the component constraints are not necessarily new. We’ve been dealing with them for a long time.

I think early in the pandemic, we were able to qualify additional component suppliers, diversify. And then as things went on, we would always remix and do what we could to get the most out of the components we could get. It’s just gotten to the point now where it’s getting even more constrained.

And quite frankly, a little bit more surprises that orders that we thought were going to show up get either delayed or canceled. So we continue to work through that. So to your point, there is a number of dynamics about why it gets better. One, we stay very close to our suppliers, and we will obviously work many quarters into the future.

And we can see as we get through the first half of the year, things get better. We also – the technology moves forward. And in some cases, we just move on to different nodes in the semiconductor business that have more availability on them. So we know as the portfolio shifts, things are going to free up.

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

That’s very helpful. And as my follow-up on the NAND side of things, I think you’ve historically talked about the transactional market kind of as a leading indicator.

And so curious, as you look into March, how are you thinking about pricing? And I know you don’t guide pricing, but curious, is there a larger headwind like-for-like or on a blended basis as you sit here today and consider the likely mix?.

I would say pricing is – look, I mean, I said it in the script. Pricing has stabilized in the more transactional markets. I think there was a little bit – I think the narrative in the industry given some of the shutdowns that are going on, would it flow through immediately? We haven’t seen that. But we did see a stabilization.

Also it’s worth noting that majority of the portfolio is priced before we go into the quarter, and that happened before any of the events of the shutdowns in China. So that’s not going to show up for another quarter or two. But I would say we’re seeing more stabilization.

Our view, I think, has been that we will see better pricing in the second half, and that’s pretty much the way it’s playing out. Depending on kind of the impacts of some of the shutdowns, that may move forward a little bit.

But I think mainly the impacts of what we’ve seen – impact on NAND pricing is going to be more second half favorable, including some of the stuff we’re seeing now on even the tool vendors, the component issues hitting them. So we’re watching that very closely. I would say right now, we’ve got a more stable environment over the last 2, 3 weeks..

Thank you..

Yes. Thank you..

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

Great. Thank you. Just following up on the NAND question, you guys have been going through this BiCS5 transition, and I know part of that has sort of – as you’re waiting for controllers and qualifications that you end up in those more transactional markets.

Where are you from a mix standpoint? Is that still a negative impact in the March quarter? And do you see that at some point reversing as you start to get traction in other markets with BiCS5?.

Yes. Joe, thanks for the question. So definitely, as we go through the year, the mix gets better on BiCS5. It starts out in more transactional markets. Consumer, it’s moved into mobile, it’s into gaming. This quarter, we will start to ramp client and then more of that as we go through the year.

And then in the second half of the year, we will ramp BiCS5 into enterprise SSD. And that’s really where the whole enterprise SSD story comes together. We’ve got – this year, we went through all the qualifications. That’s BiCS4 material right now, which is in shorter supply.

And then as we ramp that into BiCS5 throughout the year, the mix gets better as we go throughout the year. So it’s a really important point and one of the reasons why when we talk about the setup for 2022, as we go forward, the portfolio gets stronger..

Great.

And then in NAND, I don’t know if you mentioned because I’ve been on multiple calls, but have you had constraints from SSD controllers as well as HDD and power management, anything else that’s constraining on the NAND side of the business?.

Yes. I would say the NAND – the business we’re leaving on the table in the NAND business is higher than in the drive business. It’s significant in the drive business, in the order of $100 million to $150 million in the third quarter there. But in the Flash business, it’s basically twice that.

So yes, it’s controllers, it’s power ICs, it’s a number of different parts on enterprise SSDs and embedded as well..

Great. Thank you..

Sure. Thanks..

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

Yes. Thank you. Two questions, if I may. It’s great to see crossover of BiCS5 this quarter. But may you discuss the timing of ramping BiCS6? I ask given your plans to reduce cash CapEx and expectations for a moderation in NAND cost declines. And I have a follow-up, please..

So we expect – so first of all, let me talk about how we think about ramping different nodes. I mean the main thing we’re looking at is the cost side of it. So the cost numbers, good again this quarter. We expect that to revert closer to the $15 million that we always talk about modeling. It’s been above it, I think, for nine quarters in a row now.

But still, the nodes are producing, and we’re getting the cost we need as we go forward. We – BiCS4 was a great node for us on yields, record yields. We expect BiCS5 to be – that BiCS5 is the most capital-efficient node the team has ever built. And so at this point, we expect BiCS6 to be in FY ‘23 type of ramp. We’ve got lots of runway on BiCS5..

I appreciate that. For my follow-up, there have been some investor concerns that channel inventory has been increasing for non-enterprise hard drives and retail areas of the NAND market. I’m curious whether that’s the case for you. It doesn’t appear that way given the constraints you are seeing from a component perspective.

But if you could just discuss the level of visibility and the amount of channel inventory you see or the leanness of that, that would be very helpful. Thank you..

Yes. I don’t think it’s anything noteworthy that’s particularly out of the norm across the portfolio. We talked a little bit about some stuff last quarter that’s normalized. So there is really nothing to call out.

I don’t know Bob, is there anything to come to mind from your perspective?.

No. I think we’re within normal ranges in every region..

Thank you..

Thank you, Karl..

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

Yes. Thanks for taking my question. Two follow-ups. I want to go back to the supply chain dynamics for HDD.

And now, that – two follow-ups here, now that you’re actually impacted by component shortages, is that – if you were willing to pay a higher premium, would you actually be able to procure the components you needed? Is that just holding going on in the supply chain or just the parts are not available, no matter how much a premium you’re willing to pay? And I have a follow-up..

Well, I think there is a premium to get them. And so we have good contracts with our suppliers. So – but there are premiums to get the pieces. But like I said, there is just more variability on timing, especially in the fact that orders that have been placed many, many, many quarters in advance, then we get push-outs.

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

Thank you. And a follow-up to that, when I look at your December quarter, you were impacted by one particular customer, and now it’s a supply chain issue.

Does that mean that we should expect a step-function in your HDD shipment, especially into the September quarter, or is the recovery in recouping these loss shipment and revenue is going to be more gradual?.

Yes. Well, look, let’s talk about it. I mean I think we are back on seasonality as we go into Q1. We obviously have a margin impact. We expect the revenue – Q3 to be the bottom on the revenue in that business. I think the margin will probably hit the bottom in the next quarter, but we will see some sequential growth.

What I can say is when we look at calendar Q2, calendar Q3 through the end of the year, the demand signals from our customers are very strong. So, assuming we get the parts and like I said, especially in the drive business, as the portfolio transitions, we move on to different nodes that are freer as far as getting the controllers.

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

Got it. Thank you. And Bob, good – best of luck in your next endeavor..

Alright. Thanks, Mehdi..

Thanks, Mehdi..

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

Good afternoon. Thanks so much for taking the question. I have got two as well. Dave, I guess you have been focused on, I guess shifting your ACD business from a more kind of transactional business to one that’s more perhaps a little bit more strategic and longer term in terms of how you engage with your customers.

Any progress on the LTA front over the past couple of quarters?.

Yes. I think the business is definitely changing. I mean we have talked about this for a couple of years. And let me just frame it up as a kind of where we were when we walked into 2021 and where are we when we walk into 2022. And so as we go into ‘22, we are clearly – we clearly have strong customer demand.

I mean in the first quarter, we have more demand than we can meet. We have customers asking us for upsides. And we get good demand signals as we move through the year. The LTA percentage to your point, are multi-quarter agreements. I am starting to say a little more precise.

On the drive business, when we walked into ‘21, we had – we knew were maybe a low to mid-single percent of our exabytes were going to go through agreements. And as we walk into ‘22, that’s more like a third of the portfolio.

So, you have seen a dramatic – we have seen a dramatic difference in what we understand about how much our customers are going to take, especially the biggest of the big customers, what their demand is going to look like, what are they committing to. That obviously helps us plan, that helps us work on pricing.

So, it’s a very, very different situation. From a portfolio point of view, we walked into calendar year ‘21 when we were talking about commercializing energy-assist. We walk into ‘22 not only having commercialized energy-assist and got the areal density gains from it, we have also launched OptiNAND.

We got back on our front foot with 18 and ramped that. Now we are ramping 20. Something we talked about in the script, which has evolved over the year is we are seeing much more interest now from the big customers in SMR. That’s something we have been investing in for many years. We have always thought it’s been good technology.

OptiNAND helps deliver a better SMR drive and better areal density. And we expect by the end of the year, we are going to have multiple cloud titans deploying SMR at scale. On the flash side of the business, we talked about BiCS5 and kind of where we are there and how that portfolio gets stronger throughout the year.

And then I think as we go through ‘22, we are just in a better financial situation than we were before. To the – and as we talked about on the call, getting back to a shareholder return policy, which we are all very much looking forward to as we move into FY ‘23.

So, maybe a little broader than your question, sorry, but we – LTAs in the drive business have become a meaningful increase in the percent of our exabytes and where they are going to be placed throughout the year..

Got it. That’s super helpful. Thank you. And then as my follow-up, Dave, you mentioned at the very end of your response on the shareholder return aspect of the business, it’s next fiscal year, which is great.

What’s sort of the internal debate when you think about dividend versus share repurchases? And just given the evolving macro backdrop and sort of the rate backdrop, any change in how you think about and how you approach capital allocation at a high level? Thank you..

Yes. I think we will have more to say about that as we get a little bit closer. I mean one of the things we are going to do is talk to our shareholders and get their input on that question, and then we will have more to say about it. So, I don’t know if it’s an internal debate just yet, but we are just really looking forward to getting to that point.

We have spent 18 months now paying down well over $2 billion worth of debt. We have the ability – we have made a lot of changes in our execution in the portfolio to generate more cash, and we are looking forward to returning that to our shareholders..

Thank you..

Thank you..

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

Hi. Thanks a lot. This is Jason Park on for Tim Arcuri. So, just I have one question. My question is on HDD. So, we just wanted to ask how your 20 terabyte is ramping throughout this calendar year. As you guys know, your competitor provided some color on this last night, saying there is 20 terabyte will be one of the fastest ramp ever.

So, if you guys could provide any details on how your 18 terabyte and 20 terabyte ramp is going this year, that would be helpful. Thank you..

Yes. 20 is – I guess what I would say is 20 terabyte is ramping. It’s not going to ramp. It is ramping. I mean if I look at units shipped in the last quarter, we are up to a high-single digit percent already of units that are going out at 20 terabyte. And like I said, we see high interest because we have some very, very large customers going to SMR.

And so you are going to get more bang for your buck there with the gains you get on SMR. And OptiNAND is a technology that makes that even more efficient. So, we feel really good about where 20 terabyte is. We feel good about where the technology is. And we think it’s going to be a very successful ramp. I will just leave it at that..

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

Hi Dave and Bob. Just a question here, on your March quarter flash guide, I think you talked about price might be a little bit – pricing will be a little bit softer. Wondering, mix should be more positive for you guys, right, because mobile probably comes in and you have a better mix of, it might be retail and enterprise, etcetera.

So, I was wondering why margins wouldn’t be more stable in the flash side in the March quarter. And also, I think you mentioned component cost inflation. I was wondering if this is actual component costs or logistics costs, or what exactly the component cost inflation was? Thanks..

So, on the second one, it’s actual component cost. Like what the suppliers mix of cost is a different thing. I mean obviously, wafers are going up. But for us, it’s just the cost of the component itself. On your mix question, yes, mix gets better as we go forward because we go more into BiCS5 and more parts of the portfolio.

I guess what I will say is the component impact on the portfolio – I mean one of the places the component impact on flash is hitting the portfolio is on enterprise HDD, which is….

Enterprise SSD..

Enterprise SSD. Thank you, Peter. Enterprise SSD. So anyway, the component impact on the portfolio is a – component shortage impact on the portfolio is part of the equation there as well..

Got it. Thanks..

Thank you..

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

Hi. Good afternoon guys and thanks for taking my question. I just had two on the HDD business. One, I think, David, you have talked about seasonality or a more seasonal march. You have obviously seen some marches over the past 2 years that I would classify as less seasonal.

Could you remind us what seasonality traditionally looks like in that business? And then the second one is you talked about gross margins over the next two quarters, going down 200 basis points to 300 basis points in the HDD business.

Could you give us any color on the cadence there? Do you see a sharp fall off in March and a flattening in June, or is it a step-function for both quarters? Thank you..

First question….

Was on seasonality..

Right, seasonality, about 4%, right?.

For the company overall, yes, usually down about 4% in the March quarter..

And then, Bob, do you want to comment on gross margin, what it looks like in….

HDD..

In HDD fiscal Q3, fiscal Q4?.

Yes. Well, as I mentioned, we have two big headwinds right now. The one we have had for a while, which are the COVID costs, and we hope they peaked in the December quarter. We think they peaked in the December quarter at about $70 million, and it will come down some from there. The logistics costs have been persistent for quite a while.

So, I think it really comes down to when we see more passenger traffic coming out of Asia, which will be able to get the cargo rates down. So, that’s one headwind we continue to have. And then on the component costs, I mean it’s – we are really expecting those to persist through the fourth quarter.

And we expect them to get better as we go through the year, as Dave mentioned, as some of the controllers get on different nodes and we are able to see more supply available. But I think through the fourth quarter, we will continue to have a challenge..

Thanks for the color..

Sure..

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

Thank you. Probably a question for Bob, but when you talk about those COVID costs kind of peaking, I think you said December quarter peaking.

Can they come off pretty quickly if the COVID pandemic ends up for spring and summer kind of going away and critical mass of people overcome it? Just kind of curious about how quick they can go away, or is that too optimistic to think that they could go away, hopefully as fast as warmer temperatures come around?.

Yes. I mean I think that – as I mentioned, the real driver is there is very little passenger traffic coming out of Asia right now. And so there is a lot of cargo on those flights in normal times. So, obviously, we are seeing good indications. A lot of the countries are starting to open up and say they are going to open up in the spring.

Then you have to see the passenger travel come back and then obviously, you have to negotiate with the carriers and see the rates come down. So, I don’t know it’s going to be super quick, but I think that it will come down over the course of the year..

Great. Thanks so much..

Sure..

Thanks Jim..

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

Hi. Just a basic one from me. I understand how different nodes on the controller side can help, and some things are out of your control in terms of freight costs, as you just mentioned. But I am just struggling to – with the idea that in a couple of quarters, you feel that some of these supply chain issues will be more manageable.

Is there anything else you guys are doing to control your own destiny that makes it sort of a little bit different in terms of your outlook, say, out into September, December? And Bob, congratulations, and I always appreciate working with you. Thanks..

Yes. So, I think we are doing everything we can. I mean we are – I mean we always look to diversify our supply chain, especially in this kind of environment. We are staying very close to our suppliers to understand exactly they understand what we need, and we understand what they can provide. Like I said, there has been more variability in that lately.

We are redoubling our efforts there to get close to it. And I think when we look – we plan many, many quarters in the future. And so when we look at where we are at, if we can get the surprises out of there, which we think will get better as more of the nodes in the fab start to free up, we will be able to be in a better position.

And like I said, there are some big issues. When you roll the portfolio forward, you change the bomb of the product, and that gives you a different set of components that you are using. So, when you look at that planning is what gives us confidence on the second half..

That’s really helpful. Thank you very much..

And thanks, Steve. Appreciate your comments..

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

Hey, good afternoon guys and appreciate you guys taking the question. And Bob, yes, really enjoyed working with you as well..

Thank you..

Yes. I guess my question is sticking with 20 terabytes. Guys, do the component constraints, do those impede the velocity of the ramp through the year? And I believe in the past, you had talked about maybe reaching kind of 20 TB crossover sometime midyear and is that still the case? Thanks a lot..

Yes. The component situation is better on 20, I mean is maybe a better way of saying what I said earlier. But – so I mean, at this point, there is no impeding of that roadmap, right, and that ramp.

Where we are running into problems is controllers on 18s because that’s where 75% to 80% of the portfolio is right now, and that’s the sweet spot of what customers are deploying. So, I think as we move through the year and we move into 20, I mean we will get things to free up.

We will get closer to our suppliers and get more capacity on the current products as well. But as we move forward, we also have some other dynamics that help us..

That’s super helpful. Okay. Great. Thank you..

Thank you. Our next question will come from Srini Pajjuri with SMBC Nikko Securities. Please go ahead..

Thank you. Just a follow-up to one of the previous questions on, I guess the cost side of things. Obviously, some of the costs are transitory when it comes to supply chain. But it’s no secret that the semiconductor pricing, IC pricing, has gone up, perhaps on a permanent basis.

So, I am just curious, Dave, as you kind of talk to your customers, what sort of conversations are you having with your customers? And I am trying to understand your ability to pass through some of these permanent cost increases as we go through the next few quarters..

Yes. So, we work – I mean I think this goes back to the conversation we had earlier on multi-quarter agreements. I mean we have been working with our customers quite a bit on what their future looks like and what they are planning. That gives us more certainty in the process. And quite frankly, that’s helped to stabilize pricing in this environment.

I mean – the first order of business is to be as close to our customers and mitigate these costs through staying aligned with them. If it gets to the point where there is – we think they are going to be long-term, then of course, well, the economics of the industry will have to reset to drive the continued investment to drive the exabyte growth.

So, it’s a little bit of how we are thinking about it right now. It’s – we see them subsiding as the supply chain loosens up and we drive the technology forward. If our calculation is off on that, then we will look at all the other levers we have in the business..

Got it. And Bob, thank you for all your help, and good luck..

Thank you. Appreciate it, Srini..

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

Yes. Thanks for squeezing me and thanks for taking the question. We talked about the LTAs on the HDD side.

I wonder what is the appetite from customers for doing LTAs on the NAND side, particularly on the enterprise SSD business and maybe on the client SSD side, as supply is obviously impacting?.

I would say – I mean, definitely LTAs are the routine way the NAND market works with OEMs and anybody that’s buying on a consistent basis. So, that’s been a part of the market for a long time. I think it’s – we are borrowing some of those ideas and moving over to the drive business.

Again, I talked about earlier why I am more confident in ‘22 as we walk into the year and as we go forward. On the NAND side, the percentage of the portfolio under LTAs has gone up as well. I mean when we walked into last year, it was over – it was already over half of the portfolio. We walk into this year, it’s more like two-thirds.

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

But in the NAND market, it’s just the way business is done is to negotiate share for different products with customers and then of course, on a quarterly basis, negotiate price within that share envelope. And then there is always the opportunity for upsides beyond that share amount.

And we are seeing a fair amount of that right now in the NAND business. There is a lot of customers coming to us PC customers, enterprise SSD customers looking for upside in NAND. So, that – again, that makes us optimistic. When we talk about strong demand signals that’s one of them that gives us confidence in the year.

We will manage through the component issues. And we feel super good about where the roadmap is, where the technology that’s underpinning this is. We feel good about the customer relationships and demand signals. And again, to wrap it all up, we spent 1.5 years getting the company in a much stronger financial position.

And we look forward to getting back to a shareholder return policy. So – but again, to summarize your question, LTAs, much, much more prevalent in the NAND business..

Got it. Thanks..

Thank you. Alright.

Is that it, Peter?.

Yes..

Alright. Thanks. Look, everyone, we really appreciate you joining us today. We will be talking throughout the quarter, and we will look forward to engaging then. Thank you very much..

Thanks, everybody..

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