Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you for joining our virtual tech conference this year. Normally, we'd all be sitting in a cozy room at the Ritz in San Francisco, but those are not the times. I'm Wamsi Mohan, IT Hardware and Supply Chain analyst at BofA. We're delighted to have the Western Digital management team with us today. We have CEO, David Goeckeler; and EVP and CFO, Bob Eulau. Thank you both for taking the time to participate in our conference and spend some time with us today.

Absolutely. Thanks for the opportunity. We look forward to the conversation.

Yes. Thanks for having us today, Wamsi.

Yes. No. Absolutely, it's a pleasure to have you both. So let's dive right in. I think what's on a lot of people's minds is really how the demand environment is progressing. Have you seen sort of any green shoots? And the market is clearly worried about fairly significant demand disruption. So any thoughts around color on demand and visibility on the trajectory here would be fantastic.

Sure. Before I jump into that, let me let Bob get the safe harbor statement out of the way.

Yes. So as you know, we will be making some forward-looking statements, and I'd ask you to refer to our SEC filings for the risks associated with those statements. We will also be making references to non-GAAP financials and a reconciliation of our GAAP and non-GAAP results can be found on our website. So with that I'll let Dave get started.

All right. Demand. So yes, it's been a -- obviously an interesting demand environment. Things have been playing out as I think we expected, I mean, cloud demand has remained quite strong. I think that, as you know, this pandemic has kind of reinforced the long-term demand drivers as we think about them. Unfortunately, it's a pandemic, but the idea of the world being powered by the public cloud and highly intelligent endpoints pulled together by high-speed networks as the whole world and all of us are now more dependent on that world than we were in the past. And so we see very good long-term demand for that. Clearly, we're likely in a recession or facing one, but on the cloud side, the demand has remained strong. The PC market, as we talked about, has been healthy, the work-from-home demand, higher client SSD penetration, mobile has been a bit weaker, but we've been strategically under-indexed to that. I think the team has done a good job over the last several quarters of moving more of our resources to the enterprise SSD market. Retail, we talked about retail. Obviously, there's a lot going on in the retail segment of our business between store closings and then transition to pick up at the curb and now some reopening. I think in some countries, we've been seeing the reopening start to pick up. But it's still very, very mixed across the globe. And then we see some opportunities coming around gaming and even VR, a little bit starting to show up. So I would say the long-term demand drivers are there. The near term, we're still seeing the drive to the cloud, the PC market but we're -- we've got a very -- a finger on the pulse. So we're staying very close to our customers to kind of understand what the second half is going to look like. We'll obviously talk about that a little bit more as we go into next quarter. But the demand environment has been playing out as we would expect.

No. Thank you for that, David. It's sort of the same themes that seem to echo. We just came off a call at our conference with Michael Bell and same things around cloud and PC and work from home, that seem to be resonating across the board. There's been a lot of questions around China trade issues, risk to semi-cap equipment to China. Can you maybe play this out for us on how this changes the memory market?

Yes, I can talk about how it affects us. So obviously, we stay very close to it, very important topic to us. We're very much on top of all the different rulings, I think. And we're close to our customers in China. Right now, we don't see any material impact on our business from the current set of trade regulations that are out there. We're staying pretty close to it. Obviously, we're going to stay pretty -- very close to it. But at this point, the way our portfolio is constructed and what we're providing, we don't see a material impact. I mean we're excited about the opportunities we see in the market. But something to stay close to. But we're -- right now, it's -- there's no material impact to the business.

So let's talk a little bit about the product road map. You have a number of new products ramping on both the HDD side and on the flash side, can you give us a quick update on how that's progressing?

Yes. I can -- very excited about the road map. Like I said, I think the team has just done a fantastic job of getting the portfolio aligned to where the growth and margin are, and we're seeing really good innovation across the portfolio. I think it's the strongest product portfolio we've had in quite some time. I know I haven't been here a long time, but people that have been here a very long time and my own look back at the company's portfolio, we're very well positioned to capitalize on the environment we talked about at the start, more specifically, on the flash side of the business, the BiCS5 transition continues to go well. We talked about that last quarter. We've started early revenue shipments. I think the yields are ahead of plan for where we expected at this point in the ramp. I think the team made a really good decision on the node we picked of the 112 layer architecture. I know there's a lot of conversations about the number of layers in the architecture, but remember, it's a 4 dimensional equation as far as the density. So the fact that we can get the cost to decline and the productivity and the increased bits we need with 112 layer architecture that's more capital efficient, I think, is a really good place to be. More on the product side of it, we're ramping our enterprise SSDs. That's a big focus for us, and we expect to continue to do well there. On the drive side of the business, again, 14 is the sweet spot right now. That continues to go well. Of course, we're bringing our 18 terabyte energy-assisted drives to market. That's a very exciting ramp for us. It's as we talked about several weeks ago, we took revenue on the first 18 terabyte drives in our Q3. We're continuing to see the ramp of that, both engagement with customers and building our own capacity to ramp it. We are targeting to ship over 1 million units in our calendar Q3. So things are on track for what we expected. We're excited about that ramp as well. We expect that 18 terabyte to be a sweet spot of the industry going forward. After we get the ramp done, we expect that to be the next sweet spot in the industry.

Okay. Great. Can you update us on your thoughts on industry NAND supply growth versus demand growth in calendar '20? And how do you see NAND prices evolving over the next 6 months to a year?

I mean definitely, again, long-term demand is strong what we talked about. I mean, obviously, we're staying very close to it on a quarter-by-quarter basis. We saw flash pricing increase in calendar Q1. We anticipate pricing increases in calendar Q2. We're currently kind of in negotiations for calendar Q3. We'll have more to say about that at the end of the quarter. We're -- there's a lot of long-term growth opportunities out there. I think the industry forecasting 30% bit growth for the next 4, 5 years is on target. And obviously, as we talked about the conversation, we're going to stay close to our customers and understand demand in the midterm to make sure we make the appropriate investments in capital and get supply/demand in balance. We think the industry has done a good job of staying on top of that. We don't expect it to change. As we talked about visibility, in the current environment, visibility is maybe more challenging than it has been, but we're going to stay very close to our customers and invest appropriately to make sure we got the right supply/demand balance. But over the long term, we see very good growth and continued efficiency in delivering the products.

Okay. How much of your shipments would you say now are BiCS5? And how do you see the product road map in NAND over the next few years? Can you share your thoughts around that?

Yes. The BiCS5 shipments today are pretty small into -- primarily into retail channels as we start to ramp the product. We'll see more meaningful volume later in the year, but the significant mix change in volumes are really a calendar year '21 event. BiCS4 was 50% in Q3 and probably 2/3 going into Q4. So you're going to see a multi-quarter transition. And we're still seeing the expected annual cost declines in the 15% range. We'll see that through BiCS5. And of course, from a road map -- as you asked about road map earlier, from a road map perspective, of course, we're working on BiCS6 and even starting to think about BiCS7. So the beat goes on to continue to drive the road map.

Okay. Great. You mentioned enterprise SSD earlier. You guys were under-indexed to that business historically and have been trying to grow that business quite significantly. Where are you in that growth ramp? And how do you see market share-wise, where would you see yourself sort of 6, 12 months out?

Well, I think we've said we're driving for 20% share. I think that's a good goal. We expect to see continued growth this quarter. It's a big focus for us. The product is -- we talked about, completed [ 20 ] qualifications, an additional 100 qualifications in progress with multiple cloud and OEM customers, some -- ramping well, had a couple of those in the channel today. So we feel good about where the product is, the feedback we're getting from customers throughout the process of qualification engagement has been very strong. We think it's a good market, and we're going to stay focused, and we expect to continue to see share gains there.

On the HDD side, clearly, there is this push towards improving areal density, any updated thoughts on HAMR versus MAMR? And when do you expect a full MAMR-based HDD to hit the market?

Yes. I mean I do have some thoughts on that. So first of all, I think I would think about it a little bit differently. It's not -- we've led in areal density for a while, and we plan to continue to lead in areal density and continue to drive innovation in the hard drive market, whether it's helium drives many years ago, or now with the 18 terabyte, the first energy-assisted drive. And I think that's the way to think about it, at least the way I think about it is we are investing in a wide range of technology for the future of that product -- in the future of that product family. And we're not investing in just HAMR or MAMR, we're investing in both. I think in HAMR, we have several hundred patents. So given our market position and our share, you would expect us to be -- have a healthy investment in the road map of that product, and we plan to continue to invest so we could lead in areal density. As that technology becomes ready to be commercialized, we will build it into existing products. That's why we tend to have a focus on talking about products that are actually coming to market or in the market as opposed to too much speculation about what's maybe years out because lots of stuff changes, and we're going to continue to invest in a lot of technologies. And we're going to learn from that. And when we believe we can commercialize it, we deliver it at scale. We can deliver it across the reliability that's needed that our customers expect, then we'll fold it into the product. And I would expect we're going to learn from our research on HAMR. We're going to learn from our research on MAMR, and we're going to incorporate those into our products on an ongoing basis. I wouldn't think about it as like there's some big transition where all of a sudden you have a drive that's completely this or that or some other technology. It's always a blend of a lot of technologies that you're using at the right time when they're ready to be commercialized to build the best product possible and give the best value proposition to our customers. And that's what we're going to continue to do across a wide range of innovation.

Yes. That's helpful, David. Can you maybe comment a little bit about market share in capacity enterprise HDDs and surveillance? You had noted earlier that 14 TB was the sweet spot. I'm curious how you're thinking about market share evolution here. Your primary competitor obviously posted very strong exabyte growth, curious how you're viewing the market here.

So we -- I mean we're in -- there's like a whole bunch of things happening at once, I guess, is maybe a bit of an understatement. But especially when you look at the last quarter, you obviously had a big demand side [ chop ] where all of a sudden, everybody went home and the use of the cloud exploded, you had supply side issues. We're an essential business, but you've got to get people into work and keep everything functioning, which the team has done a fantastic job of doing. And then in the midst of all that, you have a product transition when you're going from 14 to 18. So I think in the midst of all that, you saw some share shifts. And there was also a lot of stuff on the cost side as costs were going up because of the pandemic situation, especially the logistics costs and absorption costs as well. But -- so we saw some share shifts. I think over the next several quarters as we ramp our 18-terabyte product, you're going to see that share more normalize over the next 3 or 4 quarters. So I feel good about where we're at from a product perspective. I think when you bring innovation to the market, that's what drives profitable growth, and that's what drives market share gains. And that's one of the biggest measures I look at on any product portfolio is are you driving market share gains and profitable market share gains. So I think we're very well positioned there. Like I said, I think we'll ship in calendar Q3. The ramp is going well. We expect to ship 1 million or more of our energy-assisted drives in that quarter. So I think that's -- I think we're well positioned there. In the smart video market, I think it's a good position. We have a good long-term opportunity there. I think we believe we have 35% to 40% market share. I mean, clearly, in the period right now with COVID, that has been a business that had some headwinds, and it's hard to get a lot of installers out to places to put in smart video given the shelter in place around the world. But we expect that as the world emerges from that, we expect that business to reemerge, and we feel good about our position there.

Switching a bit to the financial side. Bob, can you talk about your view on debt position, liquidity and covenants? I mean, clearly, some of the market is concerned about the trajectory here of what might happen with the fundamentals, if we go into a much deeper downturn. So can you share your latest thoughts around this?

Yes. We're very comfortable with where we're at in terms of debt, liquidity and the covenants. We're going to continue to stay focused on generating cash. We've done a really good job this year in terms of generating cash. I think it's around $900 million year-to-date. So -- and we understand that throughout the company, we talked a lot about cash generation. Our liquidity is really strong. It's about $5.2 billion at the end of last quarter. That includes the $2.25 billion credit facility that we have not drawn on. So we're -- and then, of course, $3 billion in cash. So we're really in a very good liquidity position. And then from a covenant standpoint, as you know, we amended the facility back in April of 2019 to give us a lot of flexibility with the adjusted leverage ratio. And our leverage ratios are continuing to improve. You probably saw the non-GAAP ratio that we reported went from 5.7 to 5.0 last quarter. So leverage is coming down with a combination of the debt coming down as well as EBITDA coming up. So I think we have a lot of flexibility, and we definitely have liquidity we need, and we're very focused on delevering the company, which is part of why we made the decision to delever or to spend the dividend to delever. But I think overall, we feel very good about where we're at.

Okay. And can you talk a little bit about the normal level of CapEx for Western Digital all in, including the investments that go towards the JV with Kioxia?

Yes. Happy to do that. There's always a little bit of complexity in terms of the flows to and from the JV. And I would say a normal range of gross CapEx, and that's the CapEx in the JV as well as the CapEx in our company that we report on our financial statements, is usually in the range of $2.5 billion to $3 billion. What was unusual was really FY '20, where our growth CapEx has come in quite low. And I think I said on last call, we're expecting around $1.7 billion this quarter. So I think FY '21 will be much more of a normal year, and we'd see it in that kind of range. With the COVID-19 situation, I think there's a little bit of a negative bias in terms of CapEx. We're evaluating multiple scenarios. I believe a lot of our competitors are evaluating scenarios as well. So we'll stay pretty cautious in terms of what we do on CapEx and definitely have more to say on that at the next earnings announcement. But I think you should assume that the CapEx will be higher in FY '21 than it was in FY '20. And I guess just in terms -- go ahead, Wamsi.

Sorry, Bob, finish it up.

Well, I was just going to say, in terms of what we put out there in terms of guidelines as CapEx for hard drives, we see it in the 4% to 6% range. And on the flash side, we see it in the 8% to 10% range as a percent of revenue.

Okay, great. How should we think about margin progression? I mean there are a lot of moving pieces over here, both with an aggregate mix as well as what's happening from a pricing and cost down perspective. What's your -- how should we think about the next few quarters in terms of just margin progression?

Well, I think, first of all, we're going to focus on one quarter at a time. We're, in my opinion, clearly in a recession, and we need to make sure we execute well, each and every quarter. We do expect that in the fourth quarter, the one we're in now, that we'll see gross margins increase sequentially, mostly driven by flash. And we expect pricing to do better on the flash side and that will be the major driver. For the rest of the year, I think it's just a matter of how things play out in the market. We think that inventory situation is in a reasonable equilibrium right now. We'll see how supply and demand go as we look to the second half of the year. But so far, it's looking fine, maybe a little different than we anticipated a few months ago, but it looks fine.

Okay. What would it take for the margins from a gross margin perspective to get back into sort of the 35% to 40% range? Is it mostly like-for-like price increases? Or do you think that it could be driven by some better mix of enterprise SSDs or more tight NAND supply that helps with pricing? What do you think the key drivers would be to get to that sort of gross margin profile?

Well, all of those are important drivers. Like-for-like pricing is probably the single biggest factor, and that's obviously driven by what's going on in terms of demand and supply. I also think we've done a good job of targeting market segments where we think the profitability can be better. And we think those segments tend to be less volatile as well. So you've heard us talk a lot, I think we already talked about enterprise SSDs, and that's an area that we'll continue to focus on in terms of gaining share. We're going to have gaming come into play in the second half of the year. That will be helpful in terms of more demand and then we just -- like Dave was saying, we just have to keep executing on our road map on the hard drive side, and I think we'll be in very good shape there.

Yes. Wamsi, just a few things to that. I mean a couple of -- one is just portfolio management, active portfolio management all the time to make sure that we got our resources aligned to where the most margin is. And I think like we talked about, I think the team has done a good job of getting the portfolio well positioned. And then innovation. I mean, when you drive innovation, that's where you get rewarded in a technology business. And I think when you're -- for example, us bringing the first energy-assisted drive to the market at the 18 terabyte density point, that gives us a good opportunity on the way we price that and the value, it brings a lot of value to our customers and the ability to drive margin with that transition is there. Anytime you're first in something, it's always good. I think on the flash side, just as much, the fact that the team is driving a very capital-efficient node in getting in the BiCS5 nodes that we've chosen. The fact that we're getting what we need out of 112 layers, we're using other things, whether it's some of the other dimensions of scaling to get the density or the productivity increases that we need. Again, that's another example where just pure innovation and great work by the team is going to allow us to be more capital-efficient to deliver a lower cost product, which allows us to drive margin expansion in the markets we're in. So it's a combination of all those and making sure we stay on top of all of them, and it's a big multivariable equation and make sure we get it set to the best position possible to optimize the return for the investments we're making in the market.

David, just a follow-up on that. I mean it feels as though the industry structure should support sort of better margin profile cycle to cycle. I mean we've seen the last couple of decades, like tremendous amount of consolidation in the space. And so what is it that you think is the gating factor that, cycle to cycle, I mean, on the HDD side, And NAND is obviously super cyclical, and it's got its own cycle. But when you look on the HDD side, given how much larger capacity enterprises become a piece of the mix of revenues, why is it that cycle to cycle we aren't really seeing that margin improvement across the industry, especially given how consolidated it's become when you look at the last couple of decades?

I mean when I look at it, the shift from client to capacity enterprise is now reaching a point where the client business, the margins have been declining but that's becoming a smaller and smaller part of the business. And more and more of the portfolio is on the capacity side of the business where it -- you can in some sense, outrun that volume margin. And so that's why I'm excited about the 18 transition and then the transitions beyond that because I do think more and more of the portfolio is behind that capacity enterprise. Again, in many ways, we're kind of proxy to public cloud growth now on -- not completely, but we're correlated to -- positively correlated to public cloud growth in that portfolio. I think that's a good place to be with any technology portfolio, no matter where you are in the stack. And I think we're going to see the benefit of that as we transition to 18 and beyond with the portfolio returning to growth and margin expansion.

Okay. Switching gears a little bit. Can you tell us how much clean room space remains in the Yokkaichi manufacturing complex? So how much incremental wafer or bit capacity will the new K1 fab add?

Yes. So I mean we announced the K1 fab a few years ago as we were anticipating the need for more clean room space. And as you know, we've finished that shell, and we've been talking about the headwind it creates in terms of our cost structure. But it gives us plenty of room to expand as we move forward. But -- and it's not a matter of adding wafer capacity, it's really being able to handle the higher layer accounts because that takes more equipment and therefore, takes more space. So we've got room to expand in both Yokkaichi and Kitakami as we move forward, and we'll continue to work with our partner in terms of determining what the best plan is.

Okay. Bob, just looking at sort of the cost structure at the OpEx level, what is a sustainable OpEx level for Western Digital? Clearly, these are some unprecedented times and lots of companies are taking cost actions, you heard one from your closest competitor today. How are you thinking about the cost structure, what the sustainable OpEx level is? And any thoughts on any incremental actions that are needed?

Yes. So I mean, obviously, we're in a recession, and we're always looking to become more efficient. I think the best way to think about our OpEx going forward is probably the range we gave last quarter. I would expect our OpEx for the next few quarters to be somewhere in that $740 million to $760 million range. And we'll continue to evaluate. I think we're pretty efficient today, and we took a lot of cost actions over the last couple of years, but we'll continue to scrutinize over.

Going back to the China question for a second. Can you share your thoughts on the pace of entry of the Chinese into the NAND market? And going back to the earlier question on sort of this new licensing requirements that are being put in place. Do you think that materially slows down any true threat from China from a memory -- from a NAND market standpoint?

As far as what we see today, we don't see any impact in the market. I mean we'll continue to monitor it, but there's a lot to do from technology, just getting the technology working to all the controllers and firmware and performance requirements. So there's a big yield decline. We're going to monitor it, but we don't see it as an issue at this point. As far as what is the impact on emerging regulation on that ramp, I think that's a little bit TBD. I think we'll wait and see how that shapes out to have a more firm opinion there.

One question around COVID. Do you think that COVID's changing the penetration level of SSD in notebooks and desktops? Is that accelerating the shift to SSDs? Or are you just seeing the longer-term shift away from, I mean, shift towards SSDs, but no tangible change in pace?

I think it's probably changing, but it may be a little different when you think about it is, clearly, the attach rate of SSDs in notebooks is going up, and we think maybe 10% year-over-year to approaching 90%. The penetration in desktop remains relatively low. But I think we see the COVID pandemic, I think you see more of a shift to notebooks over desktop systems in general. So from that regard, kind of the whole market, you probably do see a shift to more notebooks, so a shift to more SSDs.

Okay. Got it. We're almost out of time here. So I would like to thank you both for taking the time. But to wrap up, maybe either of you or both of you, could you just address what do you think investors are missing about the Western Digital story? Or what do you think is most misunderstood? I mean if you look at evaluation of the drive business, the HDD business, compared to peers, you have this huge optionality on the NAND side. So what do you think investors are missing about the story here?

Look, I mean, what I'll say is, I think we're very well positioned for the technology architecture that's driving the world. I think we've all seen that. With the pandemic, again, unfortunately, it took a pandemic to accelerate it. But we are well positioned in a technology platform that consists of the public cloud, driving an enormous amount of innovation to every company the most sophisticated softwares available to everybody now, a world where increasingly capable endpoints or see that from tablets, smartphones, gaming consoles, VR headsets, and that's just going to continue more and more, all tied together by very high-speed networks. So each part of that is evolving on its own. The networks are getting faster as we go to 5G, which enables more use cases on the edge. That is essentially a platform for innovation for the rest of the world and we are an essential element that's positioned from the edge to the core of that architecture. So I think it allows us to really benefit and set up for a multiyear growth opportunity for Western Digital. I think the product portfolio is the strongest in the history, done a good job both on the flash and the drive side of getting our resources aligned to where there's the most growth at margin. And I think that's showing up in an improving business outlook with growth in revenue, gross margin and cash flow. So I feel very good about how the company is positioned going forward.

Fantastic. Well, thank you so much, again, David, Bob, for taking the time. We really appreciate it. We look forward to seeing you hopefully in person next year as opposed to this virtual format, but we really appreciate you taking the time. And thank you and stay safe.

Thanks a lot, Wamsi.

Thank you very much. We appreciate the opportunity.

Thank you.