Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Hello, everyone, and thank you so much for joining us here at the Citi Investment Research Global Technology Conference. My name is Jim Suva. I'm the IT hardware and supply chain analyst here. I want to let you know a few housekeeping items. First, Western Digital will be making forward-looking statements, and we ask that you refer to the SEC filings for the risks associated with these statements. Western Digital will also be making references to non-GAAP financials and reconciliations of their non-GAAP and GAAP results can be found on their website. We also want to note also that Citigroup Investment Research has disclosures. And if you're a MiFID II subject investor, make sure you have those agreements in place. If you're the media or press, you're expected to disconnect. Media and press are not allowed on this call, and we will disconnect you if you do appear as media or press. This is held for Citigroup institutional investors and not for the media or press. We're very pleased to welcome Western Digital, stock ticker WDC. We have the CEO, David on the line, as well as the CFO, Bob, on the line. We're going to talk -- make this quite interactive. But to kick things off, first of all, I want to say, hey, David, this is your first time attending a Citi conference as CEO. Normally, Bob and I are in New York on stage, talking kind of an entire packed room of investors. In this situation, it's all virtual, and I see the list, it's quite large. So maybe, David, if you can take a few minutes, since this is your first time and explain to us kind of what attracted you to Western Digital. And now that it's been your first 6 months that you've been there, kind of how should we think about what you've seen so far?

So first of all, Jim, it's fantastic to be here. Maybe at some point, we'll get back to being on stage, but I think this format, it's amazing how the world has transitioned in the last 6 months. So I'm very happy to be here, and I'm super happy to be at Western Digital. What attracted me to Western Digital in the first place was a lot of what we're seeing in the world over the last 5 or 6 months, not the pandemic side of it, but the way we've all become much, much more dependent on technology. And I had a high degree of conviction. I've been in the technology business for quite some time. I've had roles where I have kind of global scope and can kind of see what's going on. And I have a lot of conviction in the architecture that we're all using more and more every day. I was really in the early innings of driving that architecture across all business, across all of our lives every day. I think the pandemic has shown that, that's accelerated. It's unfortunate it happened because of a pandemic. But I think we're all more dependent on technology every day. We're all finding more use cases for it every day. And I think Western Digital is very, very well positioned as the storage infrastructure for all of the data that's both generated by that technology and is leveraged in that architecture to deliver better experiences for all of us. And we're in it on the cloud side, which is the -- we're kind of the foundation of the storage in the cloud with both our hard drive business and our enterprise -- emerging enterprise SSD business and also on the device side of that and all the devices we use every day, whether they're our phones or tablets or PCs or gaming consoles. And I think Western Digital is very, very well positioned in that world, and I'm excited to be here.

David, what's interesting is your background, if I remember right, is more of an engineering background, if my memory is correct. And maybe I'm wrong on that. So how is that a little bit different than other CEOs? Not necessarily to name them, but what's going to be your area of focus since joining the company?

Yes. I am -- I do have an engineering -- I am an engineer by background, a software developer, came up through the industry doing that. I've spent the last decade plus running all different kinds of technology businesses, whether they're silicon businesses to the most sophisticated SaaS franchises in the world. And so I think when I come into Western Digital, I bring a different lens of kind of understanding the intersection of technology and business model and having really run businesses at scale with -- like I said, all different kinds of technologies, all different kinds of business models. And I think it's been fascinating to learn more about the HDD business and the flash business and all the technology that underlies those. But also have dealt with all customers in almost every segment in the world. And I think that's one of the really fantastic things I've come to appreciate about Western Digital is just the visibility we have of what's happening in the world. I mean we're -- anybody that's storing data is our customer. And so we have a strong position with all of the cloud providers. We clearly have a strong position with all of the OEM enterprise suppliers of devices and storage. We have a significant channel business with tens of thousands of distributors. And we have a multibillion-dollar retail business as well with 350,000 points of presence. So it's a broad business. And it gives us a lot of visibility to what's happening in the world, and it gives us a lot of opportunity.

You're starting a new fiscal year. What type of priorities or marching orders are you giving to the Western Digital team?

Yes. I think over the last 6 months, we've really been digging into the business. We're getting the whole company aligned. There's some very key product transitions we have to drive this year. We're driving our 18-terabyte hard drive, which is really important. It's going well for us to get fully qualified and ramped up. The production of that device, we think that's going to be the emerging sweet spot in the market. Our enterprise SSD portfolio, our NVMe product, we're getting good feedback on that. We've had some good results with it, but continue to drive that product into the market is super important for us this year. And then I've got the whole organization focused on some key principles as we think about our business and where we're focused. And the first one of those is get everybody focused on gross margin improvement. I think it's a big lever for us. Bob and I have talked about in past sessions like this that the 2 main things we're looking at are gross margin and cash generation by the business. By getting the whole company focused on gross margin, I think whatever part of the business you're in, you can drive gross margin improvement, get the company focused on profitable market share gains. Wherever -- whatever markets we choose to play in, we need to make sure we're driving profitable market share gains. And then capital efficiency. We've talked a lot about our capital plans, but we've got a lot of opportunity. I think one of the -- again, one of the things I really like about the markets we're in is there's lots of demand for what we build. I mean we're obviously in a global pandemic right now. We're also in a recession. So there's clearly some near-term things to work through. But when we talk to our customers, the demand for our products are significant. Looking years out, that takes capital investment. We need to do that the most efficient way possible. So -- and also keep an eye on expenses, be disciplined about OpEx expenses as well. But it starts with the technology, drive the technology, drive the road map, deliver the best value proposition for our customers. And then do it in a way that drives value for us as well.

And switching over to the operations of your joint venture. Whether you or Bob want to answer that, it's fine. Can you kind of give us an overview of it and how it works and the kind of financials and the flows of that agreement and that partnership?

Yes. Let me just say a few words, and then I'll turn it over to Bob. I mean, again, coming into the company 6 months ago and really digging in, it's been really, really good to understand the joint venture, the detailed working level of how it works on a day-to-day basis. I think it's a tremendous strength of the company for both of us that are involved. It's been around for 20 years, very, very successful. I think it's talked about most in kind of the scale around manufacturing in the fab, which is certainly very, very, very important. And something we both continue is very important to both of our businesses. But also, we collaborate on R&D as well. And so the nodal transitions in flash are extremely important for us to continue to drive that forward. It's how we get the cost improvements in the portfolio, which are extremely important. And the fact that we have scale and R&D scale on that through our partnership with Kioxia is extremely important. And finally, before I turn it over to Bob, I'll just -- I want to publicly congratulate our partners on their pending IPO. We're -- it's fantastic. We're super happy for them. And they've been a great partner, and we look forward to a very, very continued, long and productive collaboration with Kioxia.

Yes. I think that was a good overview. I mean it's obviously been a very successful JV, and we make a tremendous number of very important joint decisions every day and -- in terms of our R&D road map and in terms of capital deployment. I think what you're asking about, Jim, is kind of how the financial flows work with the joint venture. And we both make investments in R&D, and then we both make investments in CapEx that flow into the JV. And then we both take wafers out of the JV at cost plus a small margin. In terms of CapEx, we fund it really 2 -- I guess, really 3 different ways. One is some of the capital that's deployed, we both guarantee leases on behalf of the JV. The second thing that happens is when we buy wafers from the JV, there's a depreciation charge embedded in there. So the JV actually generates cash based on the depreciation and that cash is then used to invest in capital. And then finally, to the extent there's a difference, we'll invest more. We'll load in the JV more money or as was the case last year, the JV will actually return cash to us. They'll pay back some of the loans that we've made. So it's -- I think it's a really efficient joint venture. I think it's tremendously valuable to both partners.

And Bob, the contributions there, are they equal or are there something different about the CapEx or the R&D or the contributions in or the risk or the loans coming out? How should we think about that?

No, it's very comparable. It's basically a 50-50 arrangement in the JV. I think we might have 49.9%. They run the day-to-day operations, Kioxia does. They run the operations for the joint venture. But in terms of the financial relationship, we both take wafers back out at cost plus a small margin, like I said.

Got you. Shifting over to also the business trends. Given the breadth that you both mentioned about the breadth of your business, can you talk about the demand trends in the near term, say, 6 to 12 months? And how have these changed versus when we entered 2020? The pandemic has spread globally. But now many of your plants are open back up and you're in business and things like that. How should we think about demand trends?

Yes. I mean it's certainly been an unusual time that we're all working through. I mean I think it's -- I think your starting point is a good one at the beginning of the year. I mean when we saw -- I mean I came into the company on March 9, and I think the WHO declared the pandemic 2 days later. So it's been something that's been top of mind. At that time, we had kind of a demand-side shock and a supply-side shock at the same time. So we had customers take retail out of it for a minute. We'll come back and talk about that. But we had customers have an increase in demand right at the time where there was questions about the supply chain. So I think that led to a lot of consumption. I think as the supply chain has normalized and things have gotten back to predictable performance, now we have customers working through all of the things that they had accumulated. And I think that we're driving through that. I mean, when is it -- how long is that going to last? I mean I don't know, a couple of quarters, 1 or 2 quarters maybe. But it depends on different parts of the market. We can go through all of them, where -- we talked about it on our call in the cloud. We're seeing some digestion in the cloud. Clearly, when you start talking about 6 to 12 months out, I mean we see -- we're all -- it's where I started. We're all more dependent on this technology every day. So the underlying demand trends have not changed. And so we see the cloud continuing to win and demand coming back there. Even in spite of COVID and the recession, we're going to see that come back when we get through kind of the disruption that we saw in the first half of the year. We talked about on our call last time, the channel business, which is kind of maybe more through thousands of distributors more into midsized businesses. That's been pretty consistent. It's been -- it was a bit of a slog last quarter, but it's playing out as we thought when we went into this quarter. On the consumer side, we talked about it on our call, we saw retail have some momentum in June in the last month of our last quarter. And it certainly seems like the retailers have dialed it in around either pick up at the curve or shifting to online buying. So that's continued to show some strength. I don't know, Bob, do you want to add anything to that?

No, I think that's a good summary.

Okay.

Gentlemen, a question I had is a lot of industry forecasts are pointing to annual data growth ballpark around 30% per year. Are you seeing that? Is that in your type of a forecast or a down shift given the pandemic? And is there going to be enough supply to meet this demand? Or are we going to face some component shortages?

Yes. I think we -- I mean if you look at both sides of our business, I mean if you look at the flash side of the business, I think people are -- the industry, and we agree, is centered on 30% year-over-year. On the demand side, we see investment in the industry, and we're there, 25% to 30% supply. So keeping those in line is very, very important and something I think the industry has been pretty rational about and we have as well. On the drive side of the business, we've seen about 35% CAGR exabyte growth in that business. We're coming off of a year of 60% exabyte growth. So that's why you're seeing this -- sometimes you're above the trend line, sometimes you're below it. But we don't see -- we see that trend being pretty solid for quite some time. Certainly, we talk to our customers in the drive business, and they are the -- the cloud is continuing to expand, and we expect continued growth there. In fact, when we talk about investing in the business on our capital allocation strategy, that's what we're talking about. We see long-term growth there that we need to invest into build the capacity so that we can continue to fuel the growth of where our customers want to go.

Let me dive a little bit deeper. Let's talk maybe about the HDD part of your business first. You talked about the 18-terabyte ramp. Can you update us on where we are in that ramp? And why being first to 18 is so important for Western Digital?

Yes. I think in any technology business, kind of leading from a technology point of view, I mean technology businesses are rewarded on innovation. I think innovation is the hallmark of the businesses. And so the 18-terabyte drive allows us to give our customers a better TCO proposition. There's a lot of power and space and everything required to fuel growth in the cloud. And if we can give them a denser solution that allows them to get better top -- total cost of ownership of their infrastructure, that's somewhere they want to go. So it's very -- this is an important transition for us because we are leading the 18-terabyte transition. We feel very good about the product. We are going through the ramp this quarter as we've talked about. And we're in qualification with a very, very large customer, and that's something we've got to drive through over the next several months. But we feel -- it's on plan, and we feel good about where we're at.

And then still on HDD, energy assistance, whether it be MAMR or HAMR, can you talk about customer preferences? Do they really want this the qualification process? How should we think about energy assistance?

I think you should think of energy assist as a tool in a toolbox to build a better product. So -- and you want to use those tools in your toolbox when you need them. And so we're introducing energy assist in our 18-terabyte drive. It's around on the head. It allows us to get some advantages. And we thought it was the right time to introduce the technology to drive it forward. We have clear line of sight on our portfolio for many, many generations to come. Specifically on HAMR and MAMR, we're working on both of those technologies. We learn from them and we incorporate the technology at the appropriate time into the road map. And we want to be very disciplined about how we do that so that we can get predictability of product delivery and we can control the costs. You don't want to put too much cost in the product until you have to have it. So we feel really good about the line of sight we have on our road map. We feel very good about our R&D on all of the technology it's going to take to drive that road map. It's not just those technologies. There's actuator technology. There's firmware. There's a number of different levers we have to drive density. Now why is it important to our customers because it changes the total cost of ownership equation. You can deliver more in the same space, and that allows them to continue to fuel their growth without having to invest more. So storage -- this gets back to your first question, why did I come to WD. I mean, storage is the fundamental underpinnings of the digital economy we live in and continuing to drive the road map of hard drives is extremely important because it is the storage of the public cloud, and it's going to be for a long time to come. There's very good underpinnings technologically and economically on why that's going to continue, and it's important for us to drive the road map forward.

So we spoke about hard drives. Why don't we shift over now to flash or NAND? How should we think about your position there and your views of maintaining share outperformance relative to peers? Or where are you at in your cycle for flash?

Well, there's a whole bunch of levers in flash. So we'll kind of walk through some of them and where we are. But it starts with the fundamental technology where I talked about before with our JV with Kioxia and making sure that we're driving, if you will, productivity improvements in the development of flash, and that's as we move from BiCS4 to BiCS5, make sure we make the right choices so that we continue to drive the cost down on a predictable -- we're very comfortable with the 15% a year of cost reductions, and we're seeing that in the portfolio. So we've talked about our BiCS5 yields are ahead of plan. We feel very good about the node we chose for the future. We're obviously working on BiCS6, but that's a couple of years out. But for BiCS5 will be the underpinning of the portfolio for a while, take us a while to move the portfolio for that. Where the predominance of bits are on that part of the portfolio is going to be a year from now, maybe. So that's why it's so important to continue to drive that technology forward. Once we have the technology underpinnings in place, then it's what markets we choose to participate in, where we want to put that supply. We feel very good about our position in client SSD. And this is an area where I think Western Digital, as I've come into the company and been focused on, where is the synergy. Where are the synergies to leverage between the drive portfolio and the flash portfolio? Because we believe flash is -- the drive portfolio is super important, a lot of growth in the cloud there. Flash is the biggest opportunity for the company going forward. We've said that. And so -- but there is a synergy in the go-to-market. And I think we've seen that. If you look at our client SSD share at around 25%, the fact that we understand the client very well, have a heritage of providing storage in the client. Now we're providing storage in the client on an SSD and the customer relationships that we have and the depth of our relationship with those customers because we can bring them a larger portfolio and help them manage that transition. We think that same thing will play out in enterprise SSD. And why -- and that's one of the reasons we're so focused on driving that portfolio as well. So Bob, anything to add to that on the flash portfolio?

No. I think that's good. I mean, we're also excited about retail. We're doing really well in most of the markets around the world. We saw strength in June. It continued into July, and we're progressing this quarter well on retail.

Okay. Maybe could you update us a little bit on the production, whether it be in the K1 fab or 64 to 96 layers? How should we think about the price declines in the production?

Yes. So I mean, Dave talked a little bit about BiCS5, which we're very excited about, but that won't be a dominant node for us until the end of next year. Right now, we're producing over 60% of our BiCS on BiCS4, which is our 96-layer product. We've had a number of quarters where we've been able to demonstrate 15% year-over-year cost declines. We think we can do that as we continue to shift to BiCS5 over time. So I think we're in a good place in terms of the cost structure for our products. And it's also -- BiCS5, in particular, is a very capital-efficient node for us. And that's part of why we chose 112 layers versus 128 layers. And we're converting a lot of equipment, and we're able to do that very, very efficiently. So we get good cost benefit and good capital benefit as we move to BiCS5.

Before David joined the company, Bob, you actually suspended your dividend. Can you talk to us a little bit about that around the decisions? And then your outlook, suffice it to say, wasn't overly encouraging. I don't know if they're related to each other or not. And how should we think about the dividend? And what are you looking at to potentially reinstate it? Is it like some ratios of debt-to-EBITDA? Or how should we think about that in the dividend?

Yes. So I'll give you some background on it. It was something that has been discussed quite a while. I think Dave actually came in at the end of those discussions. So it was through the whole trough, it was something that we had talked to the Board about. So it wasn't a hasty decision. Then we got into the pandemic and the Board decided it was the right point in time to reemphasize our desire to delever the company. And so that's why they elected to suspend the dividend. And I think it's going to prove to be a very prudent decision. We're going to really accelerate our ability to delever. We're going to invest in the business first. We've said that all along. And whether it's R&D or whether it's CapEx, so we're going to make sure that we're investing for the long-term health of the business, and we're very excited about the future growth that we have in the markets that we're participating in. So I think in terms of what's our goal, it's really to get down to the point where we have a gross debt of around $6 billion and net debt of $3 billion. And we derive those goals by really looking at our gross leverage through the cycle. So if you go and you look at our peak EBITDA on a trailing 12-month basis, it was about $6.3 billion. And at the peak, we then have our gross leverage a little below $1 billion. And then if you look at our trough EBITDA on a trailing 12-month basis, it was around $1.7 billion. And so if you look at that on a gross leverage basis, it implies about $3.5 billion. So I think we've got the right plan. I don't know how long it will take. I mean it's -- it really depends on how our cash generation goes. We've had some years where we've generated a tremendous amount of cash, and we've had other years that have been more lean, but we're very committed to delevering.