Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Good morning. Good afternoon. This is C.J. Muse, semiconductor and semiconductor equipment analyst with Evercore ISI. Welcome to day 3 of our inaugural TMT conference. Very pleased to have Western Digital with us. We have Dave Goeckeler, CEO; and Bob Eulau, CFO. I'm going to turn it over to Bob to read the safe harbor statement, and then we're going to move to Q&A.

All right. Thanks, C.J., and we really appreciate the opportunity to be here with you and everyone. We will be making some forward-looking statements, and I ask you to 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. So with that, I'll turn it back over to you.

Excellent. Thanks, Bob. Well, welcome, gentlemen. I guess, Dave, you've been in the seat now for 15 months. Curious what the greatest surprises have been since your arrival. And based on your prior experience, most recently at Cisco, what are your biggest takeaways as for strengths and what have you done to improve Western Digital?

So C.J., first of all, thanks for having us. It's great to be here. Good to see you again. So yes, it's been an exciting 15 months for me. I'm really happy to be here. I think if I think about the last 15 months and when I come into the company and look at the strengths of the company and where we can make some differences, I start with, we're in great markets. I think that the drive market is a market that is in transition, going from client to capacity enterprise and the foundation of the cloud. So that's returning to growth. Obviously, the NAND market is a growth market. And so I'm really, really happy with our ability to provide a diversified storage portfolio to our customers. I think we calculate roughly 40% of the world's information is stored on a Western Digital device. And I think in the world we live in today, that's a great place to be. So I think it starts with the markets we're in. I think from there, it's a cost and technology leadership we have in both of those markets. I mean, in the flash market, we have a JV with Kioxia that has been a joy to become a part of and work with my colleagues in Japan. Together, we're the largest provider in the industry. We collaborate not only on fabs and production, but also in R&D in all of our memory road map, nodal transition. So together, we're the largest provider in the market. That means we invest an enormous amount in this, and it gives us cost and technology leadership, which is, of course, a huge foundational element in that market. And then on the drive side, I think Western Digital has a long history of aerial density leadership and leading at capacity points. We didn't do that at 16, and now we're getting back on our front foot on 18 and so feel really good about where that business is. But I think when I look at the underlying technology, our introduction of energy-assist and the first in the industry to do that, again, just underlies the fact that we've got tremendous technology and cost leadership in markets where it's very, very important. And then I think what's been a really, really pleasant part of being in this business is just the visibility we have what's happening in the world and our routes to market, very, very impressive. The fact that we have a multibillion-dollar retail business. We have points of presence in every country in the world. Obviously, on every e-commerce platform, we have a very at-scale channel business. And then, of course, we sell to all the PC and mobile OEMs. And then the big thing is that also the cloud, you can't build the cloud without our technology. So every single hyperscaler and anybody that's building a cloud in the world, they're a customer of ours. So literally, we just have tremendous visibility of what's happening in the world and the ability to sell all the way from -- to an individual consumer anywhere in the world to the largest technology buyers in the world and everything in between. And so I think that's been -- that visibility is tremendous. And I come from a place where that's noted for the visibility we have into the technology world. And I can tell you, for being here, I feel like I have more. Now what could we do better and what we've changed over the last year? I think when I came in, I think one of the things I noticed right away is we could do portfolio management better, like how do we decide what projects we're going to invest in, how do we think about the portfolio, how do we invest in it, how do we make sure we're putting our OpEx in the right places, that wasn't world-class. And I think that's one of the first things we've changed. I think more agility in the business and be able to respond more. I think the way we were organized. We had a lot of people thinking about both hard drives and flash where that wasn't necessary. So what we did is we focused on -- the first move was to implement business units and bring in 2 very sophisticated leaders that could -- and then organize the technology around those so we could get better on portfolio management, how we engage with our customers, how we drive the road map on our technology, make good decisions, really drive the P&L on each business separately and put more agility in the system to match the go-to-market strength that we have. And I've been really happy with the way that's proceeded. I think we've brought in 2 very sophisticated leaders that, quite frankly, have each run technology portfolios as large as our company. And so they bring scale and understanding of how to work at this level really, really plug-and-play from that perspective. And I think that agility that -- and that better decision-making is showing up in the business now. Last quarter was a good quarter for us. And we feel good about the guide we had and feel good about the changes we made in the business and how that's evolving.

Excellent. Great overview. I guess, would like to dive into your HDD business. And it's hard not to start with the positive pre-announcement from Seagate we saw yesterday. And I think the most interesting takeaway was, obviously, Chia is helping gross margins a bit on the margin. But something that they talked about was that the uplift they anticipate into the second half of the calendar year was going to happen with or without the benefit from additional demand from Chia. And so I think very interestingly, it certainly seems as though there are structural changes afoot in the oligopical market of HDD. And so I guess do you agree with that view? And with new leadership of Ashley Gorakhpurwalla, what are you guys doing to kind of drive perhaps more kind of mature behavior in this market where I think gross margins should continue to move considerably higher over time?

Yes. I think you outlined it there. I mean there's like multiple tiers of time horizon to think about the hard drive business. And one of the reasons I wanted to bring in a new leader to the hard drive business because I think it's a market in significant transformation. I mean, it's going from a business that was predominantly dominated by client to a business that's dominated by the large capacity enterprise drives, which is the foundation of the cloud. That transition has been going on for a long time. I think we're nearing the end of it. That means the market is returning to growth. I think hard drives are the foundation of the cloud, and they will be for a very long time. We can talk about that if we'd like about the technology underpinnings of that. I think they're very strong. And I think we needed a leader that was going to drive us through that transition and how to think about our portfolio investments, how to think about the business model, how to think about our engagement with our customers as this market returns to grow. So that's the big picture what's going on in hard drives. That's playing out over years, but I think we're in the middle of it, and I think we're seeing signs of what that new world looks like on the other side. Going down a level, we walked into this year knowing it was going to be a strong year in drives. We were coming out of cloud digestion into cloud ingestion. We're coming out of a pandemic. We expected enterprise demand return, and we're seeing that. We're continuing to still see strong retail demand, quite frankly, in hard drives. So we walked into the year believing it was going to be a strong year. And then for us, in particular, we're returning to leadership with our 18-terabyte energy-assisted platform, which we feel very, very good about. So we felt good about the year all along. And then Chia kind of showed up early this quarter, like really, really strong additional demand driver. As I talked about earlier, I think one of the things, I think, is a real strength for the company is our visibility into what's happening in the world in the technology space, and we saw this right away. And first in the channel. And then in the retail business, and there's no doubt it's a tailwind for the business.

Excellent. I guess, just to stay on that topic for one more question. I guess, where are you in terms of channel inventory? Has that kind of just evaporated because of Chia demand? And what is your visibility like in terms of the demand picture there looking ahead?

Demand in the channel continues to be very strong. I mean there's unmatched demand in the channel. We've had that for a couple of months now. And so we're working very hard to fill that every way we can. And we're adjusting pricing appropriately for that. So -- I mean, the team is on top of this. My leader that runs the channel business has been in this business for 33 years, and he told me like I've never seen anything like this. So it was really, really, really strong demand almost immediately. And again, I think we have a lot of real-time visibility into the market, and that really helped. And we've been kind of really surrounding the Chia situation and learning as much as we can from developing relationships directly with the miners, talking to the company itself, really understanding what's going on throughout the market. And it still is driving very, very strong channel performance. And we'll see how long it lasts. I think that's going to be related to how the coin does, but it's definitely what was a strong business to start with and where we expect it to be in the year and especially going into the second half of the year with our 18-terabyte drive in the cloud. It's been another tailwind on the business.

Excellent. And so I guess, what effect, if any, has the tightness there or increased demand there played a role with your large cloud customers, particularly around long-term agreements?

Yes. So I think you walk into a quarter with a big customer knowing what the demand is going to be and a commitment just to fill that demand. And so it's a little bit like we've been talking about the NAND market over the last couple of quarters. Is like we'll see how this translates from the more transactional markets into the more negotiated markets and how big of a tailwind and how sustainable is the tailwind this is. But there's no doubt if somebody shows up right now for upsides, for example, on what their forecast was that it's going to be -- there's just -- there's a very, very strong demand for drives in the world right now. So we're dealing with that across. We have commitments to customers that we made. And we -- of course, we hold to those commitments. And as we start to negotiate new ones, then we'll see where the environment is and what impact that has on our ability to supply in the competitive environment.

Excellent. I guess, can you give us an update on how you're seeing 18-terabyte ramp? You clearly started to see strong growth in the March quarter. And so just curious your thoughts into the second half of '21 and beyond?

Yes, we feel very good about where it is. I mean, I think let's talk about the technology first. I think what we've been -- and we've been very transparent on quals and how they've been going and some are ahead of what we thought they would be. And some, quite frankly, take a little longer than we thought, but we're past that phase in the technology now. And really what we've all been watching is the introduction of a new technology and productizing it. I mean, there's a big difference between a technology and a product. I mean, a product is something that another customer is going to bet their business on. A technology is something that has promised to make better products. So we've been watching this last phase of a decade longer more process of energy-assist making its way from a technology into the 18 -- or 16, 18 platform that we have. And we feel very good about where that is. I mean, clearly, we were not in the lead on 16. We feel like we're in the lead on 18. And not only we're happy with where the drive is at, but we've introduced a major new technology in energy-assist that continues to help us drive aerial density, which is the name of the game in the drive business. So we feel very good about where it's at. We talked about it in the quarter. Last quarter, we saw a pretty balanced shipment of 14, 16, 18, and we expect that to pivot to 18 in the current quarter.

And I guess thinking a bit longer term, how has your confidence in energy-assist technology to drive aerial density improve over the last few months? And does this necessarily mean that you should be able to scale through the 20-terabyte plus range without adding additional disks?

Yes. So we feel -- I mean, we wouldn't have brought it to market in the product if we didn't feel good about it. So we feel very good about it. And now we productize it, which is no small feat. And so feel good about where we are. It's going to underpin the technology for many generations into the future until we eventually get to HAMR as the next inflection in the road map. But feel good about where it's at. It drives the aerial density improvements we need. That will carry over into the next several generations of our drives and allow us to continue to drive aerial density while controlling the BOM cost as much as we can. So that's -- again, it's -- this goes back to the first point I made about cost and technology leadership. That's the underpinnings of the portfolio, and we feel like we're in a very good spot in our drive portfolio.

Got you. Got a question from the audience on the HDD side. It appears that as you're in execution on the HDD side is improving, it comes at a time when your largest competitor has had a structural change in thinking moving to a focus on optimizing gross margins and return on investment. Have you seen that? And how do you think about how the industry may or may not be evolving in that type of thinking?

I think this goes back to the first comment or maybe the second comment we talked about the HDD business is like this is a business in transition. And when I came into Western Digital, I thought this coming in. And as I got into the business, I see it even more. It's a business that's coming from where -- it was a client business. It was dominated by client. There was a lot of infrastructure built in the world to build hard drives and a lot of fixed costs that was in. We all have -- we have facilities all over the world. That -- those have been transitioning over the last decade to basically build the cloud. It's just as simple as that. 90% of the storage in the cloud is on hard drives, and we expect that to be the case for the next decade at least. And so that transition has been going on for a very, very long time, but we're near the end of it. It's hard to say exactly when it's over, but I think a couple of years from now, we'll look back and we'll say, wow, I mean, we completely transitioned this business. And I think that's showing up in all kinds of ways. You don't -- absorption costs in the fixed business -- fixed cost business are very, very important. So we just need to -- you need to make sure you keep everything full. It's not -- it's a fine way to run a business on return on invested capital. However, when you now have to start building new factories and start building new capability and you now have to start building new buildings to do testing on bigger drives, then you have to make different decisions, like how you invest that capital, you got to make sure you're going to get a return on it. And so I think we're seeing the industry. I think there's several elements of your starting to see the industry change and think about the business model differently. This was -- when I came in, this was a business that was transacted every quarter. I mean, every quarter, we would have a conversation with our biggest customers about drive, volumes and pricing. I mean, it just struck me as like a highly transactional business on something that's supporting the growth of the cloud. I think people know the cloud investments they're going to make more than a quarter in advance. So now we're starting to see more long-term conversations, but I should say, longer term. I mean, it's not like we're talking years. We're talking -- like instead of talking about 1 quarter, let's talk about 2 or 3. And I think that will continue to evolve because it has to because we have to make very long-term decisions on capital investment. I think you're seeing it on everybody thinking about profitability differently. So -- and these are the base reasons why I thought develop -- putting a HDD business unit in place and bringing a very sophisticated technology leader to lead that business was very, very important and somebody that has managed different kinds of businesses than just a hard drive business because now this is a very, very important technology franchise to the world. Again, we all use the cloud every single day. All of us on this call are leveraging the cloud in very significant ways. That infrastructure requires hard drives for a very, very long time and how we provide those as an industry is changing. And I think that, that changes the economics of it. But we got to do that in partnership with our customers, right? We're going to go down that journey together. It's all about us continuing to deliver a valuable product to our customers. And we stay focused on that. And then we think about the business model to get it right. But these changes don't surprise me at all. I think it's just a question of if, not when.

Yes. Makes sense. I guess just around that thinking...

I think the backwards when, not if.

Just to round up the discussion on the drive side, you previously outlined a 30-plus percent gross margin target. I guess, can you kind of walk through some of the drivers that you anticipate getting there? And then thereafter, what should we be thinking about?

Yes. So first, I would stress, and the way I think about it is driving a better value proposition for our customers. So if you continue to drive the technology in the right place and you're in a good market, where you're providing something valuable to your customer, you'll continue to drive profitability. And that's what we're focused on. And again, how to think about that whole equation given the market that we're in versus the market that we came from, very different things. So -- but yes, we're going to continue to drive -- I mean, there's -- I mean, it's the highest level, there's 2 main levers, like what's driving costs down and storage, you want to continue to drive the cost down. So all the levers to do that to continue to drive aerial density higher, introducing energy-assist, getting yields up, scale, all those kinds of things help. And then on the pricing side, making sure that we're delivering a valuable value proposition to our customers. We're continually increasing their total cost of ownership equation, and we do that through driving more density. It's not -- it's not as if we're worried about, is there enough data to store. There's like almost -- there's like an endless supply of data to store. The question is, is it economical to store it or not? And so as long as we continue to deliver a very strong value proposition, and I think we have a long road map to do that. I think we have energy-assist. I think HAMR comes after that. It's a very important technology. And as I said, as we look at it, we see a very, very, very long road map for hard drives being the foundation of anywhere you need mass storage because we see a long road map that we continue to be able to drive the TCO equation in the right direction.

Excellent. I guess moving to the flash business, we'd love to focus here kind of on the supply-demand dynamics. I think interestingly, as you think through calendar '21 demand, the largest NAND consumer in the world is moving to 2 of their models to 1 terabyte in the second half of the year. And on the data center side, CapEx demand is clearly accelerating in the back half of this year. So does it seem like supply demand and pricing trends should improve further into the second half of the year?

I mean this is another one, I think, we're -- again, our visibility into the market, I think, is a big advantage for us. And I think I started talking in September or October that in the retail markets, we stopped chasing pricing in flash, and we saw some stabilizing. We saw that translate into the channel. And then we saw that translate into negotiated markets, and we continue to see a good demand environment for flash in the second half. I mean, we have our customers talking to us all the time about second half demand in -- across the board, quite frankly. So we continue -- we saw this all along. We're coming out of a pandemic. I think all of us are more. I think we entered the pandemic more technology enabled than ever. And I think we've exited -- or we are exiting the pandemic lease here in the U.S. By the way, the pandemic is still -- we feel a lot for countries around the world where it's a very, very big issue. But we're all much more technology dependent now than ever, not just technology enabled. And so what that means to long-term demand, I think we're all still figuring out. But for the visibility we have into the second half of the year, we continue to see strong demand.

And where are we today in terms of inventory? Is -- I guess that's the question. And I guess as part of that, how are you thinking about the supply side?

So I'm also going to give Bob a chance to answer your question here at some point. I don't want to take all the airtime. But I mean, I think inventory has been pretty balanced. I mean, on the hard drive side, inventory is very lean in the channel. And on the flash side, I think that a lot of people are -- have been maybe a little surprised to the pricing environment has been stronger sooner. So it's hard to believe anybody built a lot of inventory in that kind of environment. So we don't see anything in the inventory environment that particularly bothers us. I don't know, Bob, anything to add to that one?

No, I think that's right. And in terms of our own inventory, we think we're pretty lean on flash, and we expect our turns to get better on the hard drive side. And I agree with Dave. I think it's pretty lean in the channel and with our customers.

Excellent. I guess moving to margins, you guys have really been doing a great job in terms of cost downs, what well above your kind of 15% year-on-year target. Can you kind of walk through what's driving that outperformance? And how we should think about cost downs looking out further?

What's driving it is great technology. And what I said earlier about the JV with Kioxia and the fact that we have a big investment in the foundation of our business, which is BiCS4, BiCS5, BiCS6 transition. So we invest more than anybody else. Again, we're the largest supplier between the 2 of us in the world, and you would expect us to have a great technology position. We're still comfortable with 15% long term. There's -- you're always going to go up and down a little bit. We've had a couple of really good quarters. BiCS4 is a great node. It's a mature node. We're -- very, very high yields, and that's been performing very, very well for us. And we've got the whole BiCS5 transition in front of us. And we -- last quarter, we just started talking about BiCS6 yielding. So we feel very good about the underlying road map. We're not going to get to performance. We've got the last couple of quarters every quarter. So there's some variability in it, but we're very comfortable with the 15% long term.

Excellent. I guess from an overall operating model perspective, as the world opens up from COVID, how should we think about normalized OpEx and tax rate?

I'll let Bob...

Yes. I can start on that one. So from an OpEx standpoint, I mean, this quarter, we guided I think a range of $760 million to $790 million. A lot of that is driven by the profitability we're expecting in the business and the fact that our variable compensation will be higher. As we move into next year, obviously, business is starting to get more active. We're having more employees in the building. We're having more meetings with customers. We're expecting to have more meetings with customers, with supply chain partners. Hopefully, meetings like this will have in person. So I think the business just kind of comes back to life. And we expect that spending will be up next year. It's -- we're going to make some very specific investments in the technology area, but I still think it will be very well controlled and probably roughly the kind of level you're seeing this quarter.

Yes. I'll just build on the last point Bob made. Last year, I entered the business, right, as we were going into a new fiscal year. Now this year, I was who he's here for the whole year and was deeply involved in the planning and not just me, but we had 2 new business units. We had 2 new general managers that were getting their arms around their portfolio. And I can tell you the visibility we have into we make portfolio investments and the confidence in the projects that we're going to invest in are going to get the right return. And then on the execution side of it as well. I mean, I think that's one of the things we didn't quite cover in the beginning, but we needed to up our execution game, and that's happening as well. And so the business unit structure will bring a lot more focus on that. And I think our ability to make portfolio decisions and of the OpEx we do invest to make sure we're getting the best return for it, I feel like we're in a significantly better position than I was last year when we [indiscernible]. That's continue to improve, given the structure of the company and the focus we have.

Excellent. So you stated that the desire is to get to net debt of $3 billion, gross debt $6 billion. And so just curious, given improved visibility, positive trends across 2 large businesses, is there a time frame in your heads that where you think you can achieve that goal?

Well, we're not really ready to put a time frame on it, but I agree with you. We're optimistic that we'll be able to generate good free cash flow over the next few quarters. And obviously, the first thing we're always going to do is reinvest in the business. We spent in the neighborhood of $3 billion in CapEx this year, probably spend something in the ZIP code next year, spending $2 billion in R&D. So we need to reinvest in the business. And once we do that, I mean, to the extent that we have excess cash, the #1 priority is going to be to delever the company.

Excellent. I guess, we've got 4 more minutes. So I'll ask kind of the investor focus question, which is that if I look at Seagate's enterprise value in the rumor Kioxia IPO valuations that's roughly an 80% premium to Western Digital's enterprise value. So curious, do you and the Board of Directors spend any type of thinking about this? And are there realistic ways to unlock that value?

Yes. Of course, we think about it. I mean our job is for shareholder return. We're very focused on that. So creating value. I think as we continue to execute on the model we put in place, you're going to see that gap close. I think it started to show up last quarter. I think we have very good bookends on the business. We've got good technology leadership, very good structural cost leadership given NAND, I've talked about the JV and HDD, we have aerial density leadership and continue to invest heavily in that. On the other side of the business, we've got great routes to market. Very well developed at scale, retail business, channel business, every OEM out there. And then every cloud provider in the world is our customer. So in between those 2, we got to put the right operational model and the right focus. And we -- I started to make the moves to put that in place. I think it's showing up in the business. So I think there were some questions when I did it, how long is it going to take to show up, is it going to take a whole product cycle? No. I mean, we've got 2 much more sophisticated business leaders with their finger on the pulse of the business every single day, making better decisions, talking to customers, driving execution of products thinking about pricing, thinking about the value proposition to our customers, thinking about how do we invest in the right projects to get the best return for the things we do execute in. And then when we make the when we make the investments, make sure we execute and deliver the product to market when we said we would. And I think that is showing up in the business. I think it started showing up last quarter. And I think as we continue to operate under this model and continue to make those improvements, we'll see that gap close.

We've got one more minute left. I'll try to -- to you, Dave, is there anything that we missed or anything about Western Digital and your thinking around strategy that we should -- we or investors should be thinking about?

I think we covered it here. I mean, I think that, one, we're very focused on the storage needs of our customers, right? And we have a diversified portfolio to do that. We have tremendous routes to market that give us visibility into the most important technology franchises in the world and how to deliver a very strong value proposition to them. And I think we have cost and technology leadership in both of our franchises. And both of those franchises are critical to the digital economy that we live in and is being accelerated. I think it's up to us to execute on that. And I think that we're making significant progress on that of organizing ourselves, bringing in the talent to augment this considerable talent that was here to drive that -- to drive the results. So I feel very good about where we are. I feel great about the markets we're in. I feel great about the technology leadership we have, the go to market. And we're getting the products portfolio where we needed to be to run a very balanced strategy across flash. We have multiple end markets where we play in. Client SSD is a big anchor part of the portfolio. Obviously, a retail business that is significant mobile business. We're under-indexed to the market as a whole, but we say qualified at the biggest, most important customer so we can play in that market. And now we've added the enterprise SSD leg to that stool, and that's a big one. I mean, that is -- the product is qualified at one of the top players, and we expect those qualifications to continue at the other one. So I think our ability to run a very balanced strategy in flash across multiple different end markets and then the synergies we have in that go-to-market with the hard drive business and reasserting ourselves on technology leadership in that market in what is the fundamental storage mechanism for the cloud and will be for a very, very long time. So I think we're in a great place. It's up to us to go execute it and deliver the results.

Excellent. Well, we've run out of time. But David, Bob, really appreciate you spending time with us today. And hopefully, next time, we can do this in person.

I look forward to that. Thank you, C.J. And thanks, everybody, for tuning in. We appreciate it. It's always fun to talk about business.

Yes. Thanks, everyone. We'll see you.

Thank you.