Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Thank you very much. Welcome again, everyone, post lunch. Welcome to the Stifel 2021 Cross Sector Insight Conference. I'm Patrick Ho, semiconductor capital equipment and storage analyst here at Stifel. I'm pleased to introduce next on our agenda of leading storage solutions provider, Western Digital, with a strong presence in both flash memory and disk drives. With us today, we have CFO, Bob Eulau; and Vice President of Investor Relations, Peter Andrew. I'm going to throw it first to Peter for some housekeeping, and then we'll get started with our fire chat -- fireside chat session.

Okay. Thank you very much, Patrick, and thank you, everyone, for joining us today. We will be making forward-looking statements, and I ask that you refer to our SEC filings for the risks associated with these 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. With that, Patrick, let me turn it back to you.

Thank you, Peter. Before we get into some of the market opportunities and what I believe is a transformation of Western Digital, I wanted to talk about one of the near-term market trends that we're seeing today and at least get your thoughts about it. There's been obviously a lot of news recently about the crypto mining opportunity and some of the potential impacts for the disk drive market. On the positive side of things, I'm not going to pretend I understand it. I'm not going to pretend that I can give a lot of details. But at least I wanted to bring that issue upfront to you guys in this forum and have you address the current situation and your thoughts on it.

All right. Well, good afternoon, everyone. And Patrick, thanks again for having us today. We really appreciate it. And you're right, I mean Chia is an interesting new vertical market for us. But to put it in context, I mean this is on top of what we already were expecting to be a pretty strong year. We -- as many know, we went through an ingestion cycle with the cloud, the big cloud service providers at the end of last year, and then we had momentum coming into this year. We think that will continue to be the case. And we also had good market momentum in terms of what's going on in the PC market. And overall, I have expected 2021 to be a good year. The Chia opportunity is on top of that. It's a new vertical market, frankly really started to come to light in a meaningful way about a week before our last earnings call. And now it looks like that market has gone from about an exabyte of installed storage to in the neighborhood of 20 exabytes. So it's a pretty rapid growth in a market that was pretty well balanced prior to that, where supply and demand were matched up reasonably well. So it's clearly an incremental opportunity. We're viewing it as such. We don't really know what the longevity is going to be, whether it's a little bit of a short-term spike or whether it's something we're going to be able to count on for many years to come. But overall, we think the value proposition for Chia is strong. It's a lot less power-intensive than the traditional compute-based cryptocurrency. So the -- we think that there's some potential here that Chia will turn out to be quite a good value proposition. But overall, it's definitely a good market, and we'll see how the Chia situation plays out. Incrementally, it's mostly affected volumes in the channel. And we went to a period where we got pretty lean in terms of channel inventory. We're working to get that situation resolved and basically producing for all of our customers at full capacity right now.

Right. That's helpful that you provided some color there. Before we go into the 2 business segments, I did kind of want to start with the strategic change that's going on at WD. And the first part of it is the separation of your flash and HDD businesses. Dave Goeckeler, who's been CEO for a little over a year, that was one of his first moves. And I believe it's been a positive one and will continue to be a positive from a long-term perspective. Can you just give a little bit of color on that decision process, why it was made and, on a going-forward basis especially operationally, how this separation will benefit the company and shareholders overall?

Yes. So it's a good question, Patrick, and I'm really pleased with what Dave chose to do. I think as he got here, he realized we had too many of our senior leaders really worried every day about flash and hard drives and it was pretty much more beneficial to get focused in the organization. A lot of the complexity has to do with the portfolio planning and with the execution in R&D and making sure that we bring the products to market on a timely basis. So I think this -- organizing the company into business units is really a good idea. And the second thing Dave did is brought in 2 really outstanding leaders to run each of those businesses. Each of them has run businesses as big as our whole company. So I think we're immediately getting a lot more focus in each of those areas. And I think it's helping in terms of our execution almost immediately. So the business unit structure was important. I think what's equally important is making sure we get synergy out of the go-to-market capabilities that we have. And we have very broad ways of reaching customers all the way from the largest cloud companies in the world down to individuals buying through a retail channel. And then, of course, in between, we have the traditional OEM channels like selling to major PC companies as well as commercial distribution, where we're selling into small and medium business and other OEMs around the world. So I think we've got really tremendous distribution capability. Now we're getting more focus in each of the product areas. I think it helped as we were bringing our new product families to market. And we've got product families that are really strong right now with our -- we'll probably talk about it later, with our new 16-, 18- and 20-terabyte hard drives using our energy-assist technology as well as the success we've had with our new enterprise SSD product. So overall, I think it was a good move to get the focus in the organization and get the right leadership in place.

Great. The other big-picture item I kind of wanted to discuss before we go into the business groups itself is both you and Dave have talked about how both your HDD and your flash memory businesses are very complementary and not replacement like we've seen in the PC client marketplace. I do believe in that as well. Customer base, as you mentioned, is evolving to data center cloud and a lot of these bigger players who can use both storage capabilities. Can you give a little -- can you give investors a little more color in how they are complementary, how this kind of fits into now your overall strategic rationale?

Yes. I think there's tremendous benefit to having both flash business unit and hard drive business unit. And as you noted, I mean we saw that initially on the client side. And the -- SanDisk was not particularly strong in terms of client SSDs. Western Digital is very strong in terms of client hard drives. And so what we've seen over time is that business has migrated from hard drives to flash. We're now usually in a #1 or #2 market share position in terms of client SSDs. And I don't think that would have been the case had it not been for the strong market position we already had on the hard drive side. But in that case, it was more of a substitute technology. In the case of the cloud environment, the technologies are much more complementary. And so when there are applications that require very high performance, then the flash products are very, very important in the cloud environment. And then on the other extreme, when there's a lot to be stored and cost is a focus, then it's definitely more economical to use hard drives to store. So I think that those technologies are very complementary in the cloud environments. And you'll continue to see new applications using each of those technologies as we move forward as the services continue to evolve. So we feel really good about the benefits that we get for being in both of those.

Right. Let's move to the flash memory business, and we'll start with the near-term environment and the recovery that I believe we're starting to see in the marketplace. If anything, just doing my own recent channel checks, it seems like that marketplace is recovering faster than we expected. I know you gave an update on the earnings call. You talked about better trends as we progress through 2021. One, can you remind investors of that outlook? And secondly, from a Western Digital-specific perspective, can you give a little bit of color on some of the "near-term" opportunities? Your BiCS5 product is now starting to ramp, things of that nature that, again, will separate you in the near term versus your competitors.

Yes. We've been very excited about the flash market, really dating back to October of last year. And one of the other benefits of the broad distribution that I mentioned is with our retail business, we understand what's going on with those consumers very quickly. And back in October, we had already seen prices start to move up. We also see that in terms of commercial distribution. So we get a sense of what's going on in the market, continue to see that trend through the March quarter. And those are what we oftentimes call our transactional businesses. And now as we saw moving into June, we're seeing the more negotiated markets move up in price. And we think that, that trend will -- is likely to continue this year. So from a flash perspective, it's a very good environment this year. We're really well positioned. Now we have over 10% of our bits going into 4 key market segments. One of them, I mentioned already, which is enterprise SSD with our new products there. We have a really good position. We've been strong in retail, as I mentioned, for many years, typically #1 market share. We're also strong in client SSDs, usually #1 or #2 market share. And then with mobile, we are probably under-indexed in terms of market share, but it's still over 10% of our business. So we now have very important segments in the market where we can place our bits. And we're in an environment where it's -- we have to allocate our bits to the right markets. And so I think we're really well positioned to do that through the rest of the year. In terms of technology, we're -- we've really benefited a lot this year from BiCS4, which is our 96-layer product. It's been the dominant portion of our mix. And we're just, this quarter, starting to ramp with our BiCS5 technology, which is our 112-layer product. And it's -- we're very optimistic we'll hit a very good cost structure in BiCS5 pretty quickly as well. The early yields have been quite good. Our long-term goal, you probably know, is to have our cost declines around 15% year-over-year. And we feel confident we'll be able to sustain that as we move forward for the next year. So I think from a technology standpoint, we're in great shape from a -- on the flash side, and it's just a matter of continuing to manage through a pretty tight environment the rest of the year.

Right. Let's move to the longer-term road map for the flash technology as well as the opportunities going forward. You recently hosted a -- I thought a very informative webinar talking about some of your technology differentiations and just how you look at the flash memory business as a whole. This will be a 2-part question. On the first part, on the technology front, one of the key takeaways I took was the scaling process. You talked about volumetric scaling versus just the traditional layers, scaling that other vendor's approach, NAND flash. One, can you highlight the key differentiators in that aspect and why that's an advantage for WD versus the competition?

Yes. I mean Siva can do a much better job than I can on this. But the way I understand it is, I mean you really can get to the capacity point you want using the X dimension, Y dimension or the Z dimension. And if you're really good, it's shrinking down on the X-Y dimensions, then you don't have to go as high on the Z dimension. In other words, you -- we can get the same capacity and same performance with 112 layers that some of our competitors have to use 128 layers for. So that yields a very nice benefit for us in terms of CapEx because we don't need as many layers. We don't need as many steps in the manufacturing process. We don't need as much equipment. Of course, if you don't have as much CapEx, you don't have as much depreciation, so you tend to have lower costs. And then you also -- because you have fewer steps, you tend to have better yields. So overall, it's a really strong position for us because we're able to take advantage of the X-Y dimension. And then we'll do that again on the next generation. We've already announced our BiCS6 product, which will be 162 layers. And a lot of our competitors are more in the neighborhood of 176 layers. So I think we've got a real competitive advantage there that we'll be able to sustain for a number of years. And it's important to understand because I think initially, some people -- I don't know if it's 112 layers, it's not as good. Well, the reality is it's actually better as you get the same or better performance with less cost.

No. Your webinar was extremely helpful in that. Yes, the first thing to think is, well, how is 112 as good as 128? But if you're getting the same performance and actually the area of bit density from lower layers, yes, you're the ones benefiting from the cost side of things. So that was very helpful, Bob. A second part of that technology or the business outlook for the flash memory, I think Dave and yourself have been very firm in your relationship with Kioxia. It's a joint venture you strongly believe in. At the same time, if you look at the industry as a whole, maybe excluding Samsung, there is potential consolidation that you see in the industry. What, I guess, differentiation does your joint venture with Kioxia provide you that you believe are advantages over other tactics that the industry is undertaking today?

Yes. I mean the JV, as you noted, has been a tremendous benefit to both companies. It's existed for over 20 years. It's led to innovations like being able to use 112 layers instead of 128 layers. And I think a lot of that comes because it's 2 companies working together to find the very best solution they can find. So we get the obvious benefits of economies of scale and production, but we also get economies of scale in terms of R&D. So we -- each of us does not have to spend quite as much as we otherwise would. And then likewise, we get a lot of innovation because we're working so cooperatively together. So we think the JV is probably not as well understood as we wish it was, but it's a tremendous advantage to both companies. And in terms of rumors, I mean I really don't want to comment on rumors. I think obviously, a consolidated industry is probably better than a less consolidated industry. But to get there in this geopolitical environment, I think, is a real challenge for anyone.

Fair enough. Let's go to the disk drive marketplace where, as you noted, you're starting to see a near-term pickup in terms of business trends excluding a lot of the crypto mining stuff. My own checks indicate that the data center spending is picking up momentum, and that's obviously a benefit for you. Maybe specifically from a WD perspective, given some of the issues at 16 terabytes, would you -- I think you even, on the last call, mentioned that you're starting to wind down. You're ramping 18 terabytes. It is coming out at the same time as your competitor's 18-terabyte offering. How do you view that ramp and the opportunity? I hate to use the word share gains or share shifts, but how do you see the opportunity with 18 terabytes with your customer base?

Yes. So there's a few concepts in there. I mean first of all, you're right, as we're transitioning into the June quarter, the 18-terabyte drive will be our highest volume drive from an exabyte standpoint. If you looked at the exabytes in the March quarter, it was roughly even between the 14-, 16- and 18-terabyte drives. So we feel really good about the 18-terabyte product, as I said earlier. And we're first to market. So we're able to have more influence in terms of where the price should be on the 18-terabyte drive. And so we expect the margins to be better with the 18-terabyte drive particularly as we continue to make our way up the yield curve. And the 16-terabyte drive was a tough point for us. I mean we had margin challenges with that product. And so we're able to put that behind us. Our goal is not necessarily to gain market share. Our goal is to improve our profitability and make sure that to the extent we can, we get back to gross margins where we can fund future growth that we think is required. The industry is going through a big change right now. It's gone through many years of decline due to the client side of the business. And we're basically through that now. Client will continue to decline a bit, but it's a much smaller piece of the total. And then you have the capacity enterprise business, which will continue to grow for many years to come. And so hard drives overall will be a growth business, and we're going to have to invest more in CapEx going forward to keep up with the exabyte growth. So we feel really good about where we're at in the hard drive business, and we feel really good about the industry overall.

Great. Speaking of the long-term road map for the disk drive business, one thing I wanted to get more color from you in this forum is on your energy-assisted drives and the road map for those -- for your higher capacity drives in the future. Admittedly, Seagate has provided a very detailed road map over the next several years with its HAMR technology. So I give you this forum of how does your energy-assisted drives provide a similar road map for future capacity drives, particularly, as you said, the market is growing rapidly. And how does this provide you the -- I guess the extended road map over the next several years?

Yes. No. I appreciate the question. And we -- our new family of products is what we call energy-assisted. And it's a result of inventions that we came up with as we were working on what we call MAMR technology. We continue to invest in MAMR and HAMR, and we will bring the right technologies to the market when we think they make commercial sense. And so we've been in a position of areal density leadership for a number of years, and the energy-assist technology allows us to continue that leadership. And so you'll see a few more products from us with enterprise assist before we're going completely to something like HAMR. So I think we're in a good place in terms of the products, and SMR is a good technology for us as well. I mean SMR is basically a software change that allows you to get 10% or more capacity out of a drive. And we're seeing more customers interested in SMR as we move forward. So I think we've got a lot of room left before we're moving completely to HAMR.

Great. Let's go to the operating model. And there's always a debate about the margin profile and where it should be for your different businesses, something I take a lot of questions on in terms of, "Oh, the flash memory should be at X percentage and disk drive should be at Y percentage." Given the separation of the businesses and just some of the potential operational efficiencies, can you first discuss some of the key levers on the gross margin line? And secondly, one area where I think you guys have done a really good job is on the OpEx line. How do you maintain some of that OpEx discipline so as your gross margin profile increases, more will drop to the bottom line?

Yes. So a bunch of questions in there. And let me maybe talk about each of the businesses, and then I'll talk about OpEx. So from a hard drive standpoint, I mean we've clearly been going through a transition. We just introduced a new family of products. We've said that we expect yields to improve. And as we get to the 18-terabyte drive, we'll see better margins as we move forward. And our goal is just to continue to make sequential progress each quarter and get back to the kinds of gross margins we've had in the past, and we believe we can get there. The -- on the flash side, it's a little bit of a different dynamic. But we're in a situation right now where, again, we think there'll be very good bit growth in terms of demand this year, probably in the mid-30s. We think supply will be a little bit less than that. That has a big impact on price. And so to the extent price firms or goes up, that's obviously really beneficial. And at the same time, it goes back to what we're talking about before in terms of our technology. So we believe we'll be able to sustain the 15% year-over-year cost decline. And so the combination of a better pricing environment, continued cost declines should allow us to continue to make sequential progress on the flash side as well. So right now, we have both businesses setting up for margin expansion from a gross margin perspective. And then from an operating expense standpoint, the current quarter is a little different than what we're expecting to see next year. This quarter, we expect OpEx to be up quite a bit, but it's mostly due to the increase in profitability that we've had and the impact that, that has on variable compensation. As we move to next year, we think we're going to see the business just continue to get back to normal. And by that, I mean we'll have employees working in the office. We'll have our sales team out with customers. We'll have our procurement teams out working with suppliers. We'll be able to have meetings like this in person. So we really expect next year to be more normal. And we'll make some targeted incremental investments in R&D., but we'll continue to keep a close eye on OpEx as we get into next year.

Got you. As revenues grow, the expectation, at least from my end, that your cash flow generation will improve and this will help some of the tactics that you have, you've lowered your debt in recent quarters. You've talked about capacity expansion plans. As your cash position begins to grow again, can you just remind investors of, one, where you're going to put that use of cash just both tactically in terms of your business as well as shareholder return strategies?

Yes. No. Happy to do that. And we made a big decision last April to suspend our dividend. And we did that as the pandemic was gaining momentum and we were headed into a recession. And I think in hindsight, it was the right call at that point in time. And we -- also, at that time, we're really clear on our goals to delever the company. So our goal is to get to $6 billion in gross debt and $3 billion in net debt. We haven't put a particular time frame around it, but we'd like to get there, obviously, as quickly as we can. Now as we head down that journey of deleveraging, we need to continue to invest in the business. So the first priority will always be to reinvest in the business. And we're doing that. We spend a couple of billion dollars on R&D every year. Gross CapEx is in the neighborhood of $3 billion. So those are significant investments that we'll continue to make. And then to the extent that we have cash in addition to that, the first priority will be to delever the company. And then over time, once we get down to those target debt levels, we'll look at how do we return capital to shareholders. And everything will be on the table at that point, whether it's reinstating the dividend or starting to do share repurchases, et cetera.

Maybe as just a quick follow-up in terms of capacity expansion -- and it's probably more. I'm actually thinking on the HDD side because I've covered semis and semi cap for a long time. So I understand the kind of intermittent needs to add capacity on the flash memory side. But HDD, as the mass capacity storage demand grows and as you move to these types of new technologies, how much of an incremental increase do you believe the HDD business needs to, I guess, add in terms of capacity?

Well, I don't know if I can be that specific, but I can tell you we're going to be very cautious in terms of adding capacity on the hard drive side. We really think the margins in that business need to improve before we make incremental investments. And so we'll make some, but we're going to be pretty cautious there.

Got you. Okay. I guess final question for you, Bob. Bob, before we let you go, what do you think are the 1 or 2 things that investors may have underappreciated about the Western Digital story that you'd like to get out there right now?

Yes. I mean I think the -- and I'm not sure what's underappreciated. We're in 2 really great markets with the flash and the hard drive businesses. The partnership that we talked about with Kioxia is a tremendous advantage, gives us economies of scale both in terms of production and in R&D. On the hard drive side, I mean we're back -- we have great new family of products. We're in a leadership position there. And so we feel very confident in terms of how we'll do the remainder of this year. And then I think the other thing that sometimes people take for granted is the broad distribution that we have, as I mentioned before, all the way from retail up to selling to the largest cloud service providers in the world, including -- in between commercial distribution and other significant OEMs. So I think at times, people lose sight of that fact. But we're really excited about how things are going, and we're focused on one quarter at a time and continuing to make improvements.

Great. Bob, Peter, this has been very, very informative and helpful. I appreciate the time and continued success going forward.

Okay. Thanks a lot, Patrick. We really appreciate the opportunity.

Thank you.

Thank you.