Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Got it. Got it. I'll move on to the next question, which is kind of COVID-related impacts on the supply chain. So as it relates to COVID, it appears that the supply chain issues has improved. Can you talk a little bit about the state of your supply chain? And are there any bottleneck within your supply chain or your customer supply chain that you would highlight as maybe a concern in the near future?

Yes. So I mean it's been a very disruptive year, as I mentioned before, from a supply chain perspective, and we're really pleased with how our team has worked through the challenges. The health and safety of our employees was the #1 priority, and I think that's gone really well. We put a lot of additional procedures in place in terms of cleaning and disinfecting all of our sites, making sure it's a safe environment. We do a lot more screening as employees enter the sites. And then we do physical distancing, face coverings, all those kinds of things. So we put a lot of extra measures in terms of protecting our people and our supply chain. We will continue to be vigilant in terms of making sure as much as we can. We have second sources for parts and that we rebuild our supply chain, get our inventory buffers back to where we want them to be. But at this point in time, I think we're essentially back to normal. It's just in this sort of pandemic environment, you never know where you might get surprised by the virus.

Great. And then one more on COVID. You talk about maybe high operating costs. I think other companies have talked about higher logistics costs. Can you remind us what the impact that you are expecting for the September quarter and maybe you can talk about December quarter, if you can. And how do you think -- how quickly do you think those costs will come down? I'll stop there.

Yes. So in the June quarter, I mean, we announced -- we had $96 million in COVID-19 related costs, and almost all of that was attributable to the hard drive side of the business. And part of that was related to the month of April, where we had one of our factories that we were not able to fully utilize. So from the June quarter, we think things are going to get better. And you're right, on the logistics side, we think there's going to be ongoing headwind. The reality is that there are far fewer commercial flights coming out of Asia. So there's less cargo capacity from an air standpoint. And so we've seen air freight rates go up quite a bit. At the same time, given that we were trying to get our supply chain back in order, we've seen more airfreight than we typically would use. So we got hit a couple of different ways there. So I think the logistics costs will be elevated at least for a couple more quarters. And then the other costs that, of course, are incremental are all the safety and disinfection and equipment costs we have associated with keeping our people safe. That will continue for -- until it's not necessary, but for the foreseeable future. So, yes, I think things will get better from a cost standpoint, but it's not going to go back to 0 anytime soon.

Okay. There are 2 questions coming in, so I just want to read them out. The first one is while it seems like you need a license to ship NAND to customers in China. Is this the same with hard drive? Or is there a way to ship without a license? I think you kind of answered it before, but just want to clarify that.

Yes. So on the hard drive side, we're still going through the analysis. We have paused shipping to Huawei. So we're currently not shipping to Huawei for hard drives, and we're going through the analysis to make sure that we can -- if we restart shipping that we're fully compliant with the law. And then simultaneously, like I mentioned before, we've applied for a license for both the flash and the hard drive product families.

Great. And the second question is, if you are not allowed to sell to Huawei, will that prolong the inventory correction that we've been seeing for recently, assuming all else being equal?

Yes. So I don't know that it will have a direct impact in terms of the inventory situation. I mean the reality is there will be other vendors trying to pick up the business that Huawei used to have, and so they'll be ordering inventory. And it's -- I don't know that we can point to Huawei as extending out the current normalization process.

Okay. Maybe moving on to Kioxia. Now that Kioxia's IPO is scheduled for next month, we have been getting interest from investors how Western Digital could be different than Kioxia since the 2 companies are manufacturing partners as far as I -- as far back as I can remember. Maybe, Bob, can you please give us an overview of the joint venture? And why it has worked for Western Digital and Kioxia for so long?

Yes. I think it's been a fantastic success and maybe the longest JV in the industry. I don't know if that's true for sure, but we've been working together for over 20 years, and our teams work very closely together at all levels. There are big benefits to both Kioxia and us from the partnership. One of them, of course, is the economies of scale we get out of manufacturing, but we also get significant economies of scale on R&D. And it may be something Siva can comment on in a couple of minutes. And then there's a lot of value in the partnership in terms of driving technology forward. So we really -- we think we're able to get better products together by making sure that we challenge each other, and we make sure we make the right technical decisions. Overall, we're very optimistic about Kioxia becoming public. We think it's a great company. They have great assets, great scale. And I think it will help people understand our company better and understand how strong that relationship is.

Great. One question that comes up a lot is when Kioxia goes public, is there any kind of impact on the operations of the joint venture?

I don't think there's going to be any impact on operations. As I said, I mean we've been working together for 20-plus years. We're really happy for Kioxia that they're going to be going public. This has been their goal, and we want them to achieve their goal. And we think we'll continue to work very effectively with them going forward.

Great. Maybe last question on Kioxia. At a very, very high level, shouldn't we view Kioxia's flash business as a comparable business for Western Digital's flash business. I don't know -- and a lot of people ask about the difference between the 2 -- basically 2 businesses.

Yes. I think from a flash technology standpoint, we both contribute to the R&D, we both provide capital for the manufacturing, and we both take the raw wafers out of the fab. From a go-to-market standpoint, I think our mix of business is very different. Our productization is very different in terms of which products we take. From our standpoint, we have a really strong retail brand. And we're going to continue to take advantage of that. We've been very successful in terms of the client SSD market. As I mentioned, we had #1 market share there last quarter. And we're really making good progress in terms of enterprise SSD with our new NVMe products. So we're not as big in the mobile market, and that's by choice. We've chosen to under-index there. And so I think there are a lot of benefits to both Kioxia and us from working together, and then we go-to-market the way we think makes the most sense for each of our companies.

Okay. Maybe I'll switch over to some technology questions for you, Siva. I saved these questions for you. So I understand the joint Western Digital and Kioxia's road map is slightly different in the upcoming node. BiCS5 is like 112 layers when everyone else is doing 128. Does it imply any advantage or disadvantage for you guys versus others?

Interesting question. Both Kioxia and us very, very actively closely evaluate. Just like Bob was saying, we both look at the market together so that we can make technology decisions that meet our customer needs. The number of layers is often misquoted. We consistently say -- when we say 112 layers, we say 112 active layers. Other people add their dummy layers, below and above the layers to add to the overall layers. That's number one. But the number of layers has always been slightly different for different manufacturers. When we were doing 64 layers, somebody else was doing 72 layers. When we do 96 layers, somebody else was doing 92 layers. Having said all that, what really matters is how much cost reduction you can get out from node to node? How much bit growth you can get from node to node? And how you can accomplish both of this with the least amount of capital investment? And this equation is fairly specific to each of us. For us, the 112-layer is the most capital-efficient way of achieving our long-term cost reduction goals. We think the way we have implemented it, we've been able to now start ramping in production. The yields are coming out very well. So this is going to be a big competitive advantage to the Kioxia-WDC combination with the 112-layer technology, BiCS5 that we are now ramping.

That's great. Maybe further out beyond BiCS5, you look at the NAND technology road map, how far can we scale this NAND technology? And what are the levers you can pull to scale the 3D NAND?

It's -- those of us who have been watching this, we have ourselves been amazed at how fast this has moved. In the beginning of the decade, we always thought that NAND could not scale anymore in 2D NAND. And that 15-nanometer, we actually hit a wall on how to scale. But in the time period since we have done 48 layers, 64 layers, 96 layers, now we have 112 layers. And we don't see a limit to the number of layers that we are going to see for the next 5 years or so. That's more visibility than we have ever seen in any of our semiconductor technologies. But even more important than the number of layers is the overall bit growth and cost reduction that you achieved, the scaling you achieved. And you do that by the X scaling, Y scaling, meaning on the lateral dimensions, and multiply by the number of layers. And then, of course, the logical scaling of 3 and 4 bits per cell, et cetera. The combination of this is what is consistently giving Western Digital it's scaling path for the next 5, 6, 7 years. We see a good, consistent cost reduction scaling path.

Great. Siva, I know you're from your prior position in Sandisk, but you are now also responsible for hard drive development. Do you see any synergies having both hard drives and flash from a technology perspective? And what gets you most excited about the opportunities in the hard drive business?

I'm glad that you asked me that question, Sidney. Clearly, when we came from Sandisk, we were all solid-state oriented, and we wanted to make sure we had the best solid-state technology only. Now when we come into the combined Western Digital with both hard drive and flash, there are some very, very key synergies that are obvious. For example, Bob talked about our #1 market position with client SSD. In Sandisk, we were struggling at the 6%, 7%, 8%, 10% market share. The reason we could get so rapidly to the #1 market share position is because of the customer qualification synergy. How do we meet the customer needs? Hard drives have been qualified in PCs and client devices for decades now. To be able to leverage on that to go do solid-state drives, we are very quickly able to qualify with our OEM partners. That's on the customer side. Similarly, on the enterprise SSD, between our cloud customers and OEM customers on the qualification methodology, the qual needs, the product needs, they are very, very analogous. But the most interesting one that we see is our ability to have flash technology inside the HDD. So the next-generation of our energy-assisted HDD drives will actually have a significant amount of flash built in, not as a hybrid drive, but actually to control some of the HDD functions that you improved aerial density by putting flash to handle all the meta data and meta information to the inside. These kinds of synergies, for example, in error checking and correction, in fault tolerance, in terms of qualification needs, in algorithms for recording, in terms of operating system synergies, there is a lot that the 2 sites of the company are learning from each other. There is substantive technology synergy between both hard drive and flash.

Excellent. Excellent. For the remaining few minutes, maybe I'll switch it back to the financial side for Bob. On the gross margin side, you have guided your gross margin down for your fiscal first quarter, September quarter, in the 25% to 27% range. What are the puts and takes you're seeing here on the flash and hard drive side? Where are you seeing the most uncertainty? And past the short-term headwinds, how are you thinking about gross margin longer term?

Yes. So we -- you're right, Sidney. We did guide our margins down for the coming quarter. And we do have headwind on both the flash side and the hard drive side of the business. On the flash side, I would say most of it is attributable to pricing, and we've seen a lot of pricing pressure this quarter. I don't know again how long that's going to last. We're encouraged by what we're seeing on retail. But that's really the main driver in terms of flash gross margins. The second driver is one, I think you already asked about, which is our cost on K1 and that's our new facility, and we're in the process of ramping our production there. But we have the building and all the equipment in place, but we're not up to normal production levels. And so we've got some period expense to the tune of about $80 million that we're going to experience this quarter. We think this will probably be the peak, and then we'll start to see it come down fairly quickly over the next couple of quarters. So that's the headwind we're primarily seeing on the flash side. On the hard drive side, it's a combination of factors. I think we've touched on those as well, where we're really seeing customers, both OEMs and the Cloud Service providers, normalizing their inventory levels. And simultaneously, we're in the process of ramping our new 16- and 18-terabyte products. And as a result of that, we're in the early stages of getting up the learning curve and getting up the yield curves on the hard drives. At the same time, we're not shipping as many products. And we're not able to leverage our volumes over our fixed costs as much as we would like to be able to. So it's -- that's one of the key headwinds. And then the other thing we touched on is the COVID-19 costs are not going away. They'll be better this quarter and primarily be logistics and then basic operational costs. But we're still going to have some pressure there. So in the short term, we're definitely seeing some margin pressure as we come through this. As I mentioned before, we're pretty excited because we think we'll have industry-leading products on both sides of the business. And we should -- as we work our way up the yield curve on the hard drive side, we should see some good improvement in terms of gross margins.

Great. Maybe 1 last question. You suspended your dividend in April to focus on paying down debt. And you paid down actually an additional $150 million in July. Remind us what are the target levels you want to get to and how quickly you expect to pay down debt before you look at dividends again? And I know earlier in the year, a lot of investors asked about debt covenant. I don't know if that is one of the reasons why you decided not to pay the dividend.

Yes. So I'll start there. I mean the debt covenants were never a concern and a driver for suspending the dividend. It was really about prioritizing the way we use our capital. And the first priority, when we have the dividend and after we suspended it, has always been to reinvest in the business. So we want to invest the R&D, and we want to invest the CapEx to make sure that we can grow our product lines to stay very competitive in the marketplace. That will always be the first priority. And then our second priority now is clearly to delever the company. And we have a goal of getting to $6 billion in gross debt and $3 billion in net debt. And we derived those because we looked at gross leverage through the cycle. And if you looked at our peak EBITDA in FY '18 on a trailing 12-month basis, it was about $6.3 billion. And if you look at the worst trailing 12-month EBITDA in the last couple of years, it's been about $1.7 billion. And so if you back into the gross leverage, it means you have gross leverage anywhere from a little bit less than 1, up to 3.5. And we think that, that's the right kind of capital structure to have in place for the cyclical business that we have. So that's how we derive the goals. How quickly we get to the $6 billion in gross debt, it's not clear, but we're definitely committed to making progress as quickly as we can.

Great. I think we're out of time. Thank you for your time, Bob and Siva, and enjoy rest of the day.

All right. Thanks a lot.

Thank you, Sidney.

Take care. Bye-Bye.