Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Afternoon, everyone. Before we get started, if you are a member of the press or media, please disconnect at this time. This is a restricted line, any unauthorized party in this meeting or any unauthorized use of the information communicated in this meeting is subject to prosecution to the fullest extent of the law. Any unauthorized person, including the media that is on the line at this time, please disconnect. Please note, today's call is being recorded.

Great. Thank you, everybody, for joining this session with Western Digital. I'm fortunate enough to have David Goeckeler, CEO; as well as Bob Eulau, the CFO. I think what is one of, if not the first kind of conferences you guys have done thus far in the December quarter, and I think you've a busy schedule the next week or so. But again, thanks for joining us. I'll just cut right to the chase. You've got half an hour. I'm going to try and fire through some questions here and let you guys get on with your day.

But let us start on hard disk drives. I think one of the notable questions I've gotten after this last quarter and considering that you've got -- 70% of your hard drive business is nearline driven. Is kind of this disconnect of your guidance, I think I'm modeling down 12% are give or take sequential drives versus that of your closest competitor, which is more flattish or down a little bit. Can we just double click on that a little bit? What are you seeing from a demand perspective? Can you help us maybe appreciate why there is that differential in that drive business?

Aaron, before Dave gives the answer to that...

I'm sorry.

No, no problem. We're excited to be here and appreciate the opportunity. 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'll also be making references to non-GAAP financials and a reconciliation of our GAAP to non-GAAP results can be found on our website. So now I'll Dave jump in further.

All right. Thank you. Aaron, thanks for having us, it's great to be here, and get things kicked off. We're excited about it. Yes, so I think the question about where we're at in the business on hard drives, and it's pretty straightforward situation. We've got -- the customers are really big and they have a big influence on our -- on demand every quarter. Although the -- when you look at the whole industry, things look pretty balanced on a share basis. When you look at customer by customer, there can be quite a bit of variability from one supplier to another significant, significant differences. And we have -- as we talked about on our call, we have one of our biggest customers, if not our biggest customer, is in a situation where they have their own supply chain challenges. They can't get all the pieces they need to build their data center right now. They're working on that. So that pushes demand out for us. It's a pretty big impact. We have these really, really large cloud titans have that kind of situation on your demand. And so we factor it into the guide appropriately. And over the next quarter or 2, we think this will get worked out and things will get rebalanced. So it's just as straightforward as that. We also talked about a couple of other things that are real. We have -- in some of the smart video business in the mid-cap space, we have our own component issues where we can't quite meet all the demand. So there are some issues there. Also, we have a slightly different business than our direct competitors. There are some segments that we don't operate in. So when you add it all up, we think it's -- the issue -- the major issue is with a big customer, and that's a transient issue. We expect it will get worked out over the next couple of quarters. Overall, on demand, we feel really good walking into '22. '21 was a good year for the hard drive business. We thought that coming into '21 that it was going to be a good year. I think if we think back to a year ago now, we are in a very different spot. We were talking about really demand in the second half of '21, that started to materialize earlier. We also delivered a lot of innovation in the portfolio throughout the year. We commercialized ePMR. We led on 18 terabytes. We announced OptiNAND. We now have that in the market. So we feel really good about where the portfolio is and where the demand is as we go into '22.

And just kind of dovetailing on that question here. Maybe remind us again how you think about the capacity growth drivers or growth profile in nearline?

Well, I mean, it's not the growth of the cloud. I mean, our customers -- first of all, post-COVID, especially people using the cloud more and more all the time. As I say all the time, we're more technology-enabled and technology-dependent than ever. The architecture that the rest of the world is building on top of is the cloud powering ever more intelligent devices connected by high-speed networks. We play in 2 very, very important parts of that ecosystem and that platform, that is storage in the cloud and storage on the device. So as the rest of the world innovates and delivers new technology, they're building on top of that platform, and that's driving good demand across the endpoints and across the cloud. In the cloud, we talk to our customers constantly, as you would expect. And there's a -- they want to store a lot more data than they have the ability to right now, just from an economic point of view. So if we continue to drive innovation, and we continue to drive storage innovation and lower the cost of storage per bit, I think that we have a very, very strong demand driver in multiple dimensions, increased use, increased demand and also, there's a big part of the iceberg below the water of data that's not stored that could be stored with a different -- if we can continue to drive the economics in the right direction.

You mentioned it a little bit, Dave, in the prior answer to the question. Supply chain or upstream supply chain dynamics. You've got your customers, maybe it's server availability, maybe some other components of their data center, that's a bit of a challenge. What about your own supply chain? You talked about the intelligent video segment. How are you managing through that? I know that there were some COVID challenges in Southeast Asia. Just any update on what you're seeing from your own supply meeting demand?

Yes. So I think about the supply chain in really 3 major categories. So first of all, we're a manufacturer. We're a vertically integrated company. So we have to keep our own people in Southeast Asia in the factory in manufacturing, and that last quarter was probably the most difficult quarter since the pandemic started, is doing that. The delta variant was very substantial. There were times when we had thousands of our employees in quarantine. We worked through that throughout the quarter, where we saw that increased costs associated with COVID. So we're dealing with that. But as the quarter moved on and where we stand today, that's a much, much better situation than it was, let's say, 3 months ago. The second part of that is our own ability to get components for our products. That's a constant challenge. We have suppliers that are out 50-week lead times. We're constantly working to make sure we can get as much as we can to build our demand. Demand is strong in a lot of segments, and we're constantly reshuffling the portfolio to make sure that we can get the controllers, all the pieces we need to build as much as possible. So that's an ongoing process. And I think obviously not just for us, but for everybody in the industry, and we continue to work that. And then to your point, for our customers, where they are having the same issues with how do I get all the pieces I need to build the full kit or build out my full data center. And in some ways, that's gotten more severe where we're seeing some of the biggest customers now in technology have the same challenges as far as the ability to get everything they need to build what we just talked about. Other parts of the market, quite frankly, we've seen -- like in the PC market, we've seen it get a little bit better in the fact of consistency of demand where if you look back where it was a couple of quarters ago, it was a little more lumpy. Now we're seeing a little more consistency of demand from those customers. So still something we're fighting through. We still see, as we go through '22 -- as we go through '22, it should get better. But as I say, we're still planning 50 weeks out on lead times on many of our components.

Very helpful. One of the things that I've noticed these last couple of quarters or at least I felt like we've seen in the models is a bit more discipline in the hard disk drive market, right, particularly as we've seen nearline drives become the majority of the overall market. You've also seen a market share that's now more or less balanced between you and your closest competitors in that high cap space. How -- what are you seeing from a pricing environment? Are you seeing this -- would you validate that view that we've seen more discipline? And do you think that's sustainable? And that's going to segue into the next question, which is the gross margin profile for disk drives. How do we think about the drivers? And what's previously been thought of as kind of a push towards even that mid-30% range?

I think about that in kind of 2 dimensions. One is our own execution. And I think our own execution has gotten significantly better over the past year. We clearly were late in the transition to 16. We flipped that around and led the transition to 18. We commercialized energy assist, that was a big step. And I remember a year ago, we were sitting in these conversations, getting a lot of questions like, is it going to work? Can you commercialize it? What are the yields? I mean we're way, way past all that now. In fact, we've moved on to the next iteration of the road map in OptiNAND. So I think our execution has got a lot better. And I think that's led to kind of a renormalization of a share position. But I think there's also a very big structural issue that's going on here in the drive business is that as we talked about earlier, the demand drivers are there. That's not -- it's not a demand-side issue. But on the supply side, we're coming off of a very, very long transition of the hard drive business transitioning from client to enterprise. And we're in the final stages of that. And so now instead of thinking about a business around, well, how do I make sure I have absorption for all the fixed costs I have built around the world, we're thinking about, well, how much do I need to invest so I can meet demand 2 or 3 years out. It's a very, very different market structure and very different set of issues that we're having to deal with. And I think when you -- and this is something that's been going on for a decade. So it's a long transition, and you can argue that the rise of the cloud has been on the back of the decline of client. And now we're entering a stage where the cloud is just continuing to grow at a phenomenal pace. We're all using it more and more. You have some of the largest technology companies in the world, continuing to fuel innovation for every business out there about how they use technology. It's an incredible thing, and I don't think we've ever seen before in technology. And so now the industry is thinking about, well, storage in the cloud is very important. The vast majority of that data is stored on hard drives and will be for a very, very, very long time. In fact, if you look at the economics, we don't see crossover for beyond a decade, which is more of a -- beyond the planning horizon of any useful technology business. So now we're thinking about investment and being able to fuel that growth. And I think when you go through that transition, you're going to see the economics of the business change. And I think we are seeing that. I think that's happening before our eyes. It's -- like I said, it's been going on -- the transition has been going on for a very long time. So it's not just one day you wake up and it's totally different. But I think we're in the midst of that transition now, and you're seeing the structural dynamics of the industry change because, quite frankly, it has to. I think Bob and I have been pretty transparent about this. We think that the profitability of the industry has to change to fuel the growth that's going to be required to fund the continued rise of the cloud. So I think that structural issue is playing out right before us, and I think you're seeing it and I don't think that's going to change. I think it's going to continue to move forward.

And Bob, I mean, as the financial analyst that I am, 35% -- 35% is reasonable as kind of a long term or?

Long term, we certainly can be talking about that kind of number. In the short term, we're really pleased with the last couple of quarters about 30%. We think we've got a good chance of being above 30% again this quarter. Now last quarter, we had almost 2 points of headwind on COVID-19 and still delivered just under 31%. We're going to have COVID costs again this quarter, and I think we'll still have very good gross margin performance. But I completely agree with Dave. I mean, I think we're in the midst of a change and to fund the CapEx that's required as we move forward where the industry needs to see gross margins expand.

And I think -- let me just add 1 more thing is because this is a super important topic. The key to this is continued innovation in any kind of technology business. If we continue to innovate and we continue to bring a valuable product to our customers that gives them a strong value proposition, we'll be able to monetize that, right? And so I think the continued focus, and this is some of the change we've made in the last year since I've been here, which is like build a business unit, hire a really, really, really high-caliber general manager that's going to focus on driving that technology road map, driving the P&L, making sure we execute on the innovation, I think that's been the story of the last year. I mean, again, we were sitting here a year ago talking about hard drive gross margins in the mid-20s. And the question was, could you ever get to 30. Not when would you get to 30, it was kind of, could you ever get to 30? And then last quarter, we turned in 30.9 and 2 points of COVID headwind. So things are going in the right direction, and we feel good about the structure of the industry, and we feel really good about the technology road map that we're driving that's going to deliver a very, very strong value proposition to our customers for a long time to come.

Great segue. I'm going to try and make this a brief question because I definitely want to get to the Flash piece of the business. But OptiNAND, energy assist, I mean, Western Digital has been pretty clear. HAMR is not a necessarily -- HAMR for you guys is certainly on the road map, right? It's not a -- that's not a technology path that you go down. But energy assist takes you from 18, 20 terabytes to where and maybe just touch briefly on the OptiNAND importance competitively?

Well, let me first touch on HAMR. I mean HAMR is a very important technology. There's no doubt about that. We're heavily invested in HAMR. I think you know we have over 400 patents in HAMR. Any time you're a supplier of hard drives in an industry this big, you're going to be invested in a number of different technologies that you think is going to fuel your road map. So we're a big believer in HAMR. There's no doubt about it. The issue is we need to get there. And so I think the industry now is coming more around to the realization that the HAMR is going to be real, it's going to be in the future. It's going to be very important. It's going to extend the life of hard drives for a very, very long time that issue I talked about earlier, delivering a very strong value proposition, continuing to lower the cost of storage. That's going to drive the future of hard drives for a very, very long time in a very strong industry, a secular growth story around the cloud. We have to get there. So that's very important. So what we've been -- we're focused on HAMR, but we're also focused on the steps to get there. So energy assist, commercialize it that gets us a big step forward. Right on the heels of that, OptiNAND, very, very important technology, higher reliability, better aerial density. It allows us to -- now on the back of that, we'll be able to deliver several generations of technology. We're able to deliver our 20-terabyte on 9 platters, we can add the 10th, and we get another 2.2 terabytes of storage. So it gives us more steps. And I think there's also a dynamic here as the industry kind of gets realistic about the time frame around HAMR, you're seeing other technologies like SMR have been -- now those have been around a while. And OptiNAND makes SMR -- more gains out of SMR. Now clearly, something like SMR requires changes on the client side. That's not something anybody takes lightly. So while the industry thought HAMR was going to be just next year or just around the corner, they weren't willing to -- nobody is willing to do all that software work. Well, now we're getting realistic that HAMR is extremely important, great technology. It's still several years away before it's commercialized, and you can bet your data center on it. So now we're more focused on the steps to get there. And that's where I think we need to just have a tremendous road map that we're building around energy assist, OptiNAND. I think SMR is going to get more real and customers are getting more real about it, about making those changes. OptiNAND has been easier, more efficient. So we really have that staircase to take you to 30 terabytes and then you get on the hammer curve and you go for quite a bit longer. So I think it's a really good story for -- a really good road map for the hard drive industry.

Very helpful. I want to make sure I get time in for the Flash business. Maybe I'll just ask you to looking for this, how would you characterize the demand environment -- supply-demand environment pricing, as you know, always topic sensing there in Flash? So maybe we'll start there and I'll double-click on 2 of the segments.

Well, we talked about it in our last call. So we've seen a good environment for the last several quarters. It's been a year of quite a bit of growth in NAND demand. I think we started the year talking about low 30s growth. And in the middle of the year, we were talking about mid-30s growth. And by the time we ended the year, we're talking around high 30s to 40% demand growth and the bit supply to meet it. We backed that up with a very good technology road map. We're making the transition to BiCS5, which is increasing our bit growth rate. So we feel good about that. And we also talked about -- in some of the markets, we're starting to see some softness in more of the transaction markets around consumer and some of the channel. But we're continuing to see a strong market in enterprise SSD. I think there's a big dynamic going on there about enterprise SSD design that we maybe can talk about in more detail. But we're just going into the conversations on pricing for next quarter. So we'll see how those turn out. We think that the industry has been disciplined for quite some time now on investment. One thing we do know is the nodal transitions are getting more difficult, more capital intensive. And so when we look at the whole picture, we see an industry that's been pretty balanced over the last year has been certainly ramping up bit growth to meet the demand that's there. But we -- going into '22, we feel like it's been a pretty balanced environment for a while. We're seeing -- as I said, in the transactional markets, we're seeing some softness here and some strength in the data center, and we'll see how that translate as we move into the first quarter pricing discussions.

Right. And I think sometimes the mix dynamics of where you can place bits are a bit more difficult than just the broader pricing discussion. And so you kind of alluded to this, the enterprise SSD segment, I think the last data I saw that you guys have maybe a high single-digit market share in terms of capacity in that market. You've talked in the past couple of quarters of regarding more design wins in enterprise SSDs. How do I think about that market? Or how are you guys thinking about that market as far as maybe inflecting as we move forward given the fact that I think that market -- 70% of the market is still owned by Samsung and Intel?

Yes. So I think just -- again, if I look back to a year ago, this was one of our big goals. And again, a year ago, we were sitting here working on our first qualification of cloud Titan, and we exit the year qualified at 3 of them and 1 of the big OEMs. So we feel good about where the portfolio has gone and what we've evolved. And as I said, the changes over the last year are not just about making things better for 1 year, it's about building structural sustainable change into the organization that leads to a better result. We're seeing that better result in the numbers every quarter, and we expect that to continue. But in enterprise SSD, now this has been -- it's been a goal for ours for a number of years to get back into that market. We've been very transparent about the process we're going through to do that. We're happy with the progress that we see. It is a market that's a little -- your question around what can you expect in share gains, which is, I think, a little bit behind the question. Again, we don't think about it like that as setting a specific goal around share gains, we think about it as creating optionality in the portfolio. How do we have the most diverse portfolio so that we have the most optionality to put the bits in the place where we can get the highest return. And that's very important to us. And enterprise SSD over this last year was building out that pillar. It was a major pillar. And we have a lot of other ones in the portfolio. The client piece is very, very strong. As you know, we have a great retail business, very strong, a lot of brand awareness around SanDisk and WD_BLACK. Those are great -- that's a great market for us. We obviously have a great relationship with every cloud supplier out there. And of course, all the OEMs and the mobile providers, where we stay qualified as the premium OEM. So it was about building out enterprise SSD and then giving ourselves the most optionality to get the highest economic return in the portfolio, and that's what we expect to do going forward.

And one -- go ahead, sorry.

One more thing because you touched on it was the -- where you're at in the nodal transitions makes a big difference now on what markets you're serving because the new nodes tend to go into the mobile providers and the component providers where they can take the products right out of the fab. Enterprise SSD is going to be a very, very large TAM, as you know. That's more of a node N-1 market because you have to build the enterprise SSD. So there are some dynamics there about what that means as far as how the market is going to be served and pricing in that market and things like that. And I think we're seeing that show up right now where it is node N-1 kind of market, and you're seeing pricing in that stay strong because a lot of new bids are coming out on the new nodes and flowing into other parts of the market.

Yes. Appreciate that you don't want to assign a market share goal, which I think at the end of the day, it's all about profitable and diversity in the business model where you put the bids. But 3 Cloud Titans designed in, 1 OEM you mentioned. When I look back at the results in the last quarter or so, how many of those Cloud Titans are actually shipping would you characterize in volume? Are 2 of the 3 that's to kind of show up as far as volume opportunities?

[indiscernible] Yes. I mean I think you can assume that once you get qualified, it takes a couple of quarters before you start shipping in volume, so without going into details on a customer-by-customer basis. I mean, we're -- it's an ascendant part of the portfolio for us, let's put it that way. And so getting over the qualification is the first step, and we feel good about that because it's really a strong validation of your technology. And where we are deploying in scale, we're getting very good feedback on the product and performance of it. So we feel good about where we're at.

That's great. Client SSDs, it sounds like from the earlier comments, just in general, that you're seeing a little bit more stabilization in the PC market. I think that's a big, if not the biggest piece of your Flash business from my estimates. Would you characterize it the same way that you actually see that market stabilized? And I think some of the feedback coming out of 3Q's results has suggested that there's an expectation maybe PCs grow into '22?

I think we have seen -- I think Bob and I were talking about this yesterday, and he can comment as well. But if you look back a couple of quarters, we saw a lot more lumpiness. We would have some suppliers that just couldn't get the pieces they need to build their demand and they would be taking their demand down during the quarter or going into the quarter. We're seeing less of that now going forward. It seems to have kind of gotten a little more stable. I mean, obviously, the supply chain issues are still out there. But that business has been a really good cornerstone of the portfolio.

That's great.

It definitely seems to be stabilizing, and we're seeing that. Like we said our challenge is more on the cloud right now.

Right. That's perfect. And where I want to end the discussion and Bob and David, I want to talk about the balance sheet, I want to talk about capital return, but I want to maybe start with valuation because I get this question a lot, right, that David, you put in place kind of heads of the businesses, and you've kind of talked on the several last of these conference calls about the strategic nature of the importance of drives plus the Flash business. But the one question I get oftentimes is that there seems to be a fairly similar enterprise value between you and Seagate. And I'm trying to -- I guess the question I'm asking is, how are you thinking about the balance sheet capital return in the context of it looks like the stock is just unjustly not valuing the Flash business?

That's a loaded question, but I can start. I mean we...

It's a question I get a lot.

Yes, no.

That's a very good question. And we definitely believe we're undervalued. I think by almost any measure when you look at it, we're undervalued. We generated very good cash the last 2 quarters, as you know, I think, with over $1 billion in free cash flow. We've made outstanding progress in terms of paying down the debt since -- we made the tough decision to suspend our dividend. We've paid down $2.1 billion in debt. So I think we'll exit this quarter probably somewhere in the neighborhood of $7.7 billion in gross debt. So really good progress towards our goal of $6 billion in gross debt. We're continuing to evaluate what we do as we get to that goal. And believe me, we want to return capital to shareholders. I mean we understand that that's an important issue for our shareholders. And I think we'll get there pretty quickly. The key is focusing on what we can control. And so as Dave said, building the right foundation, executing well, expanding margins and generating free cash flow, and that will enable us to get the capital structure we want it, that will enable us to ultimately return capital to shareholders.

Aaron, I guess I would just add, I mean, since I've got here, we've been very focused on making -- not just making any kind of change, but making change that is structural and sustainable and it's going to lead to better results over time. We believe very strongly in the franchises we have. We believe in the synergies. I mean we see them every day. We have a unified go-to-market engine for 2 very large portfolios. We see things like OptiNAND, where we're starting to see portfolios collaborate in ways that brings innovation to the market that gives our customers a better product. Those changes are things that we're starting to see the results of. We're executing better. We're getting a better financial result, more focus on the portfolio. I think our investments in the future of the portfolio are just way, way better than they were a couple of years ago. And then the execution of that is very strong, and we're seeing that show up. We've been focused on the balance sheet. That's a commitment we've made. We paid down over $2 billion worth of debt since we made that commitment. As Bob said, we're very anxious to get to the point where we feel like we have the leverage ratios we need going forward, and then we can turn to a capital return policy for our shareholders, and we're very focused on getting there as quickly as possible.

And Maybe a segue comes off of that answer to the question. When you think about drives, and you mentioned you don't see a crossover for the next decade, right? So do I think about the cost curve for the NAND Flash piece of the business relative to hard disk drives kind of in parallel? Like price per gig per annum declining 10%, 15% range. Is that how you think about how you assemble that view? And again, that importance for the 2 businesses kind of being held together?

Yes. I think you got the right point there, which is they're both declining. I mean, for a while, hard drives were declining even faster as far as cost. That slowed down a little bit. It's still declining. As we talked about earlier in great detail, we still see a long road map of innovation in the drive business to continue to deliver a very, very compelling storage solution. And as I said, our customers think about going deeper into the amount of data that they generate and that they want a store. And as we can continue to drive that road map forward, we think that creates a great opportunity. The crossover is always a marginal discussion. Of course, one eats into the -- Flash at the top eats in deeper into -- from hot to warm data that's naturally going to happen. We're going to continue -- we're very comfortable with our road map and driving 15% cost down there. So that's great. But on the other side, you've got hard drives continuing to go deeper into the well of data that's out there, and we see that -- we see those costs continuing to go down. Like we said, we talked about a road map here that is many, many steps into the future with a major technology transition like HAMR in our future, it's several years out, but it's in our future. And so it provides a lot of runway into that drive value proposition.

Perfect. Well, as I promised, 30 minutes, we'll go by quickly. And so I appreciate you guys taking the time today and came up with all the meetings and the other conferences you guys are going through the next couple of weeks.

All right. Thank you very much. It's always fun to talk about the business. It's always great to see you.

Thanks, guys. Appreciate it. Thanks, everybody.

Yes.