Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Great. Well, I saved the best for last.

Thank you.

[ Last question ] of the conference. It's been really good to see everybody. It's been good to be back live in front of humans again for the first time in a couple of years. So I'm Joe Moore. We're going to -- very happy to have with us today CEO and CFO of Western Digital, Dave Goeckeler and Wissam Jabre. I think Wissam is going to read a safe harbor agreement, and then we'll go and take Q&A, or maybe not.

Well, I -- I'm supposed to read the safe harbor agreement -- the statement. So let me just ask [ Ross ] to hand me the...

Actually, I have.

Sorry.

That's okay.

Thank you.

I need that back.

Of course. Thanks, Joe. Sorry about that. So we will be making 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 our non-GAAP financials, and a reconciliation to our GAAP and non-GAAP results can be found on our website.

Great. Thank you.

All right.

Okay. So maybe we could just start out with general questions. We've looked at this as a situation where the sum of the parts is, kind of, inexpensive, and I'm not asking to comment on that. But how do you guys think about it, the combination of the NAND and the Drive business? You've obviously recognized the, sort of, difference in the supply chains and separated the operational infrastructure. But can you talk to the value of having these two businesses united under one roof?

Yes. So first of all, Joe, thanks for having us. It's great to be here. It's great to be here with Wissam. I've spent the last 2 years, kind of, rebuilding Western Digital, the executive team, the way the company is structured, all kinds of things. And it's great to have Wissam on board as part of that team, going forward.

Thank you, David. I'm very excited to be here. It's a great time to be joining Western Digital.

Great. So look, I mean, when I came in, I looked at the company and these two franchises together give us a much bigger share of wallet at our bigger customers. It allows us to offer a diversified portfolio to them. It gives us some synergies around go-to-market, especially scale in the channel, scale in our Consumer business. There is some technology synergies we saw with OptiNAND. The fact that we could get those two engineering teams together and innovate around a very important problem for us. So I feel good about where the company is positioned. But we could have executed better, and we've spent a lot of time over the last two years really getting the right leadership in place and getting the structure put in place in the company that we could really produce and get the most out of the franchises we have. I think it's a good time to look back on this. Actually, yesterday was my anniversary of 2 years in the business.

Yes, exactly.

The year -- I think it's working. I mean the year before I joined, calendar year '19, the company delivered $1.30 in EPS. Last calendar year, we delivered $7.96 and another $195 million in COVID costs. So if you take -- so a lot of headwinds around cost. So we are performing better. We've upgraded the portfolio. We structured the company better. One of the things we did, as you know, is we split the product portfolio in 2, put business units in place, brought general managers in so they could really focus on executing and driving the right roadmap decisions for the portfolio. And I feel like our technology roadmap is just in a vastly better position, which we can talk about in more detail. So I feel good about where we're positioned. We're not done. Nobody is putting up a 'mission accomplished' banner on the work we have to do. but I feel like we've got the team in place. We've got the structure in place. We've got the portfolio. We've got the routes to market, and we've got the customers to really execute and get everything we can out of these franchises.

Great. I know there's quite a bit of interest in the earnings update that you guys issued last week, I guess. Can you talk a little bit to that? It looked like revenue and EPS came down, seems like it was entirely a function of the lost production of NAND. Can you talk about the overall economic impact?

Yes. So first of all, it -- the change in our outlook was 100% on the Flash business. The HDD business is tracking exactly as we expected, when we went into the quarter. We're not done yet, but we feel good about where that business is. But very clearly, we had an unfortunate situation in the fab, which has now been remediated and fully understood, and the fab is back to fully operational, 100% operational and -- but we had a 7 exabytes loss of share. Some of that in this quarter, some next quarter and then a little bit in CQ3. And so we had to respond to that with essentially -- pricing changed a little bit, especially in the transactional markets. Obviously, volume was impacted. And when you net it all out, that's what you saw as the impact on our numbers. Maybe Wissam, you want to talk a little bit about the charges we also incur?

Of course. Yes, of course. And so the updated outlook is non-GAAP, and that is basically -- does not reflect or excludes around $250 million or so of charges related to the contamination event itself. And so that's -- that will be reflected only in GAAP figures, expected to be this quarter.

Okay. And to the extent that it looks like your flash gross margin might actually be a little higher than the initial expectation, is that simply a function of the transactional pricing that you referenced?

It's -- yes, it's a function of the market responding. I think we saw a very immediate response, when we put out the press release about pricing changing, so -- in some of the more transactional markets, so that's what's reflected there. And now we're in the process of negotiating pricing for next quarter, which we'll see how that all turns out in the next month or so.

Yes. Okay. So maybe if we could drill down on the NAND business a little bit. You guys have made good progress on the portfolio. I guess, maybe if we could start a little bit with just the importance of the JV, and I know that's something I can't fault, maybe, with what was happening before you got there. The JV relationship had gotten frayed. I know you've really put a lot of energy into rebuilding that. And it's really important because together you have leading scale. And if you're not operating together cohesively, you don't. So can you just talk a little bit about the nature of that?

I mean, this is one of the great things about joining the company. Anytime you join a new organization, you get to meet new people and learn new things and really getting to understand the JV and how important this is and our partners in Japan and how well this actually works. And you're right. Over a long period of time in any relationship, this is a 20-plus-year relationship, there's some ups and downs. But I have invested quite a bit in making sure that this relationship is very, very strong. And it is. I mean, on an engineering basis, you probably wouldn't know that there's 2 different companies. I mean, we jointly invest in the same roadmap, which gives us tremendous scale in the NAND business, which is important. I think the most important thing in the NAND business is your fundamental technology. Is your fundamental technology strong? I think you've seen our performance of the roadmap and cost downs over the last couple of years. We really feel good about our technology. And the teams that work on that are just hand in glove with each other, day to day, working on our technology roadmap. And then, we invest in a lot at the executive level. I talked to my peer, every couple of weeks and make sure we're really, really tightly engaged on what is a very, very important relationship for both of us.

That's great. And on the state of that underlying fundamental technology, can you talk about the progress of BiCS5? You've had a nice volume ramp there. I know it takes a while to get qualified on some customers. Where are you in that process?

Yes. So we're -- we crossed -- we had crossed over -- last quarter, over 50% of [ BiCS ] coming out of the fab or BiCS5, which is good. First, let me talk a little bit about the BiCS5 node itself. If you look at the technology that we have and you boil it down, a really, really important thing that we have is our cell technology. And then you take that cell technology and you expand it in vertical -- horizontal directions and vertical, and you build NAND out of it. But that cell technology is very, very strong, and it allows us to build a very good product when you scale it. And BiCS5, in particular, was designed as a very capital-efficient node. I think if you look at the history of the JV, an explicit design goal of the team is CapEx per incremental bit. And if you look at the amount of CapEx that we have had to spend to fuel our portfolio, it's -- we're in a very, very strong position. And BiCS5, in particular, was designed to be a very capital-efficient node. Essentially, you can use a lot of the same tooling in the fab that was used for BiCS4. And so that transition is going quite well. We've moved up to -- as I said, we had bit cross over last quarter. And we're now working on all the work on controllers for client SSDs, for enterprise SSDs. That will play out as we go throughout the year. The node usually ramps into things like mobile and consumer in those types of markets.

I mean, I think the capital efficiency is always a point that gets lost here since the SanDisk IPO. The negative story has always been that CapEx is too low relative to [indiscernible]. If you can hold share for 20 years with CapEx being too low, it stops being a bad thing. Can you talk a little bit? You mentioned the SSD portfolio. I guess, I know you've done a lot to rebuild enterprise SSD, but your share probably still isn't quite at the target. Where do you stand with that?

So the explicit goal of the NAND portfolio is to give us as much optionality as possible, where we place our supply. And then, if you have a -- if you have as much optionality, given in the OpEx envelope, we have to spend on it. But we have the most optionality, then we can mix the portfolio, where we get the greatest return. And we have some very, very fundamental and strong parts of the portfolio. Our client SSD portfolio is very strong, very good position. Again, I think, that's a result of the synergy of the company. That's been a complete transition of client SSDs to client -- our client hard drives to client Flash. The company has played that transition extremely well and parlayed that into a very strong position in client SSDs. It's a foundation of the portfolio. We have a strong position in Consumer. It's always good to have a captive franchise in your portfolio. The SanDisk brand is very, very strong. We have a strong position in mobile. Gaming has been very good for us. But the one pillar of the portfolio that we needed to build out was enterprise SSD. It's a big TAM. It's an important TAM. Just like on client, where our customer was transitioning from a drive to NAND, in the data center, we have the opportunity where there are highly complementary technologies. They're not substitutes. So both drives and Flash are going to be consumed in a significant way in the cloud and at the big cloud customers. And our opportunity is really to get that enterprise SSD product to a point where the biggest data center customers in the world trust our technology. We build our own controller. It's been a big goal of mine since I came here, and I think, really, calendar year '21 was a breakthrough for us. We started the year with a -- with our first qualification at one of the big web-scale players. We deployed throughout the year at that player. As we went throughout the year, we qualified at the second and the third and then also two big enterprise OEMs in the storage space. So we walk into calendar year '22 with qualifications, 3 web-scale players, 2 big OEMs, whereas we walked into '21 with only 1 web-scale player. Now -- so we're building out that part of the portfolio. It's a multistep story. I think our share, last time I left, was around 8%. So you might ask, why isn't it higher because you have all these qualifications? Well, now we need to get to BiCS5. Right now, we need to take the step this year. We have the qualifications. Now we get the controller on BiCS5. We have more bits, and then we'll start to see the share ramp again. So it's a multistep story. The qualification is the big piece of that, and we feel very good about where we're at.

Great. And then you talked about starting price negotiations for the less transactional parts of the business. What's your general sense of the state of NAND, right now? How much inventory do your customers have? People have seen other than a brief window around Chia, people have seemed comfortable with their ability to procure NAND. Does that mean they are holding as much inventory as they are other things? Just your general assessment of what the setup is for those negotiations.

I think, if I step back, when we walked into this year, we thought the second half of the year was when the market would get -- the supply/demand balance would be better and we'd see pricing firm up. We now have, obviously, had an issue where a significant amount of supply has been taken out of the market, so you would expect that to impact the market a little bit earlier. I don't want to -- obviously, I'm not going to talk about specific pricing because we're still in negotiations. We don't know until we're done. But I think, from an inventory perspective on that, there's nothing out there that tells us that it's in a particularly unusual spot, that you would draw any conclusion from it, that it's a big headwind or something. I think that, from the conversations we have with our customers, we have long-term share agreements with almost all of our customers, and we continue to see the demand for the bits that we have.

And then it seems like there's a pretty positive mix benefit, potentially, when you lose this much production because you don't need to serve those transactional markets as much. Do you think that's right? Do you think that's something we should see next quarter?

Yes, there's no doubt that we don't have as much volume as we used to, so we're going to mix it in a way that has the most value. And obviously, you want to maintain good customer relationships in that. These are long-standing, very solid customer relationships. So we want to have that dynamic in there as well. But the basic premise that we have more -- we have fewer bits to supply the market, and so we're going to mix that to the best of our ability.

Okay. And you may have mentioned this, but the charge that you took, the $250 million, do you expect any of that to recur in the June quarter? Any further charges?

The majority of the charge will be in the third fiscal quarter. There will be some spillover into the fourth quarter, but the largest portion of it is this quarter.

Okay. And you have line of sight at this point to resolving the contamination?

The contamination issue is resolved. [indiscernible] it's resolved, it's remediated. We know what the root cause is. Additional checks have been put into process. So if we should get some material into the fab, we would know it ahead of time. So we feel very good about the work that's been done by Kioxia and our team to get that under control.

Okay. Great. And then hard disk drives, you mentioned, is kind of tracking to the original guidance that you gave. Can you talk a little bit about the dynamics in that market? I felt like you guys getting qualified for 18 terabyte, more broadly, in hyperscale would give you market share momentum through the year. And you had that for a little while. Then, kind of, there were some headwinds that, that started cropping up. Can you just talk generally to that market share situation?

So I mean, we fell behind on 16. I don't think that's a secret. I've been very open about that. That was the situation a couple of years ago. Our big focus on 18 was to get back on our front foot and lead that capacity point, which we did and more. Almost, just as importantly, we qualified energy assist at scale. And we learned a lot, going through that process. So that's going to help us not just on 18. But when we look at our roadmap, from 18 to 30, which is, kind of, the way we think about it, like we have to have a roadmap for many generations, that technology insertion at 18 is extremely important and pays off for many generations, just like OptiNAND inserting at 20 pays off for many generations, and we can talk more about that. We gained a lot of share, when we -- the first quarter we inserted, as you would expect. Things have, kind of, gone up and down and rebalanced a little bit. And I expect you're going to -- I think things will go up and down a little bit each quarter, but I think it's going to be a pretty balanced market.

Yes. I mean you did have one headwind that I, sort of, didn't expect. Market share was just that the capacity -- enterprise market strengthened so much early in the year or market you have exposure to.

So the performance enterprise. Yes, yes, we definitely have a -- versus some of our competitors, we have a mix. There's parts of the TAM we don't address, that performance enterprise market, the company exited 3, 4 years ago.

Okay. Great. Gross margins in Drives. You got that improved a lot from, kind of, mid-20s back to over 30%. Now, you've got these component price increases. Can you just generally talk to where -- the path to getting those gross margins back above 30%?

Yes. So a lot of very good work over the last 18 months. And I think it's a reflection of a larger trend that's going on in the market, which is the drive industry is returning to growth because everything is moving to enterprise and capacity enterprise drives. And over the last decade, we've seen this fall-off of clients. And the economics of the industry were defined by the fact that there was a lot of invested capital that had to be absorbed. We're coming to the end of that era. And I think you're seeing a bunch of elements in the market that show that. Margin has improved over the last 4, 5, 6 quarters. We're having more long-term agreements with our customers, where it used to be quarter-by-quarter. A lot more discussion of CapEx investment and being disciplined about CapEx investment in the industry. And so I think all that showed up in better margin in the product, which is what we were focused on. Now, we've had the costs, kind of, coming up faster that we can absorb. It started with COVID costs and logistics costs, and now we have component costs on top of that. So we've got a couple of quarters here, where we're going to see the numbers back down below 30%. And we're very focused on a bunch of different levers that can get them back, which is -- I mean it starts with innovation, like continue to innovate, drive better TCO experience, better yields on the product, all those kinds of things is always the thing you focus on to get more margin. Focused on the cost side, really spending a lot of time getting closer to our suppliers and getting more predictability of supply. It's not just getting supply. It's getting supply in a linear fashion to keep the factories on a smooth operation. When you're vertically integrated like we are, you can't have like one quarter that's way bigger than the others because you can't. You're just not set up that way. So getting the linearity back into it, and then we'll work on price as well to see if we can pass some of this along to our customers.

I mean it seems to me, I mean, the controller prices are going up for both you and your competitors. The COVID costs are an issue for your competitors, too. So it seems like at some point you should be able to start passing those costs through, a little bit more?

I think we have to.

Yes. Yes.

Okay. Can you talk a little bit about the roadmap in hard drives, your optimism around the OptiNAND technology and SMR? And then, can you talk about the path, longer term, to HAMR into 30 terabytes?

Yes. I mean, I'm really excited about our HDD roadmap. I think the team has just done tremendous work. You've been seeing a series of innovations that, together, add up to a roadmap to 30 terabytes. So first one was energy assist. It was really important to get that commercialized. That had been in the labs for almost 2 decades. People working on how do we build more aerial density, using energy assist. The fact that we have that out there and commercialize now at scale, is a big step. We're over 2.2 terabytes per platter, as far as what we can put on a drive platter, which is a very good spot to be. That allows us to deliver 20 terabits on -- terabytes on 9 platters. Then you had OptiNAND, which is a new control plane that allows us to have more control over the drive, get more efficiency out of that. And then the third step of that is going to be SMR, which is a new way to shingled magnetic recording. That requires some work on the host side. And we're seeing customers now really start to adopt that. And when you put those 3 technologies together, it allows you to have a roadmap to 22, 24, 26, 28 that we feel very, very good about. In fact, SMR is going to give you 10% to 20% more capacity on a drive. And when the drives get to 20 terabytes, that's significant. And we're seeing very good adoption now on SMR. Where if you go back a year ago, it wasn't quite there. We expect to exit this year with about 20% of our exabytes on SMR deployments. So that's really good adoption, and that's going to drive the industry to fill that gap between 20 to 30. And when you get to 30, you need HAMR technology to come in and carry you forward. So we're heavily invested in HAMR as well. And when we need that technology, it will be there, but we've got line of sight to many, many steps to deliver not just more density to our customers, but as we go, a continued, better TCO equation.

Okay. Great. So I do need to ask. I've been trying to poll companies. Any issues with Ukrainian supply chain, whether neon gas, palladium from Russia, anything like that, that you guys see impacting you?

No. We've looked at this very, very closely. It's, obviously, a very tragic situation. But from our business perspective, we've got multiple suppliers for any gases and -- very, very low risk.

Okay. Great. That seems to be a consistent response from everybody we talk to. Okay. And then for Wissam, on the January earnings call, you guys brought up the idea of reevaluating capital allocation. Can you talk a little bit about that, where you guys stand, in terms of cash balance, cash return and things like that?

Yes, of course. I mean, over the past couple of years, we've reduced the debt level by $2.4 billion. That gives us quite a bit of financial flexibility. Of course, our first priority is to continue to invest in the growth of the business and then continue down the path of paying down our debt. But as you've heard from David, over the last couple of years, the business also improved the through-cycle earnings, and so that gives us some more confidence around what the capabilities are, going forward. And so we're looking at reassessing that targeted debt level as well as leverage and looking forward to reengaging on a capital return at some point in fiscal year '23.

Great. Got it. It definitely seems like you guys have done a great job putting the company on a stronger financial foundation.

It's been a big goal for the last couple of years. I mean, really, we feel -- as I started, we feel really good about the franchises we have, about the markets we're in, the customers we have. I think there's been an enormous amount of work on the last couple of years on the technology roadmaps, about where they're at. We've talked a lot about HDD. We talked a lot about enterprise SSD. Those are both -- I have a lot of confidence in that. Now, we're adding -- we're super happy that Wissam is here and upped our game in finance. We've also just hired a new operations lead out of Singapore in the last 2 weeks. So we really feel that we've got the team in place. We've strengthened our balance sheet. We feel really good. Like I said, we're not done. We still have a lot of work to do, but we feel good about where we're at. And by the way, we're going to -- we're heading toward an Investor Day here, hopefully, in the next couple of months, to spell this out in a little more detail for everybody.

Yes. And it was like 6 quarters ago, I was writing notes about, that you guys wouldn't breach covenants, and now you're in much [indiscernible].

Hopefully, you're not going to write that note again. I don't think [indiscernible]. I'm very anxious, having lived through the last 2 years, of getting back to a capital return policy, where we want to get to our target debt levels. But we do believe that the company -- I talked about the results at the beginning, going from $1.30 to $7.96 of earnings over 2 calendar years. We do believe the company has better through-cycle earnings potential than it did 2 years ago.

Yes. And I know you made some tough decisions. I mean, you suspended the dividend, which was a well-thought-out thing. And I think it's allowed you to put the company in a stronger position now. If there's any questions from the audience? So if not, maybe you could just summarize. Is there anything that we missed that I should have asked you about? And any key messages you want people to take away?

Look, I think I've said it a couple of times. I really feel good about where the business is. I think we're executing much better. I think the technology franchises that we have. I think in any technology company that starts with products and your product roadmaps and how you're investing in technology. That's why when I went to restructure the company I started with general managers to make the right decisions about our portfolio. I think that has worked. Like I said, I think our HDD roadmap is very, very strong. I think that the breadth of our NAND portfolio is as strong as it's ever been, and that gives us a lot of optionality in the future. And then our -- just the foundation of the company is in a much better position. So I feel good about where we're at. I think, when we look at it from a macro perspective, from demand, we look across our markets, we continue to feel strong about the cloud. Our customers give us good signals throughout the year. The PC market is doing well. I think we were maybe even a little stronger than we were expecting. After an extremely strong year, last year, 5G continues to ramp. Enterprise storage is looking better. So I think when you look at across the markets we serve, the customer relationships we have, the breadth of the portfolio and just where we are, if I think about the difference of where we were going into calendar year '21 versus where we were going into calendar '22, we're in a much, much stronger position and look forward to a very, very good year.

Great. Well, thank you very much.

All right. Thanks, everyone. Thanks for your time.

Thank you.

Thanks, everyone.