Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Okay. Good morning, everyone. I'm Sidney Ho. I cover semiconductors semi cap equipment and IT hardware at Deutsche Bank. The next company we have is Western Digital. Western Digital is a supplier of both hard disk drives and flash memory. And today, we are very pleased to have Dr. Siva Srinivasan here, President and Head of Technology and Strategy at WD. So welcome, Siva.

Thank you, Sidney. Happy to be here.

Great. We'll make this session as interactive as possible for those who are in attendance here. If you have any questions, feel free to raise your hand and we'll run the mic to you. Before we start, I have the honor to read the safe harbor statement, so I'll do it. So Western Digital will be making forward-looking statements, and I ask you to refer to SEC filings for the risks associated with these statements. Western Digital will also be making references to non-GAAP financials and a reconciliation of a GAAP and non-GAAP results can be found on the Digital website.

So with that out of the way, why don't I kick it off with some near-term questions. I think inventory adjustment is one thing that everybody is trying to figure out, most of us understand the ongoing [ state ] of spending. But there seems to be more signs of inventory adjustments, broadening price market and [indiscernible]. Can you give us an update on where you are seeing some of these adjustments, how secure they are when compared to past cycles? And more importantly, how long do you [ think it will be ]?

Thank you, Sidney. By the way, you did a great job of reading the safe harbor. I think we should hire you for that. We announced earnings. I'm not here to either update or reiterate guidance, talking about trends going forward. You're absolutely right. Things started deteriorating towards the very end of calendar and that trend has been on. As you said, the China mobile slowdown was clear even at that time and that has persisted even more importantly in client PCs, client SSDs, there was inventory correction. There's truly a demand-driven shortage at that time the inventory correction was happening. Cloud is generally okay. Cloud is not any one company. There are -- of the titans, they are never in sync when one is accelerating, one is digesting. When one is digesting the next one is accelerating. They build out at different times. So they are generally okay, and that trend has persisted.

Okay. Maybe I'll just jump ahead. I'm sure we have a few more questions in point. But if I look at this cycle, why do you think WD is better positioned to weather this cycle than it was the last down cycle?

Yes. As you know, the memory business is a cyclical business. No one can exactly predict when cycle is going to go low or high. But you know it's always going to be happening. We went into this fully planning for this. As you know, we have had a complete management cycle, very, very strong division of focus and responsibility on the hard drive side and flash. We have had a very clear focus on platforms and product lines ready to go take [ it outside ]. Of course, as a corporation, we have paid down debt, over $1.5 billion in the last fiscal year, the time we stopped paying dividend over $2.5 billion of debt taken down in the last approximately 3 to 4 months. So we have been very, very focused on improving our performance through cycles. Cycles are going to happen. But how do we, as a true cycle do it well? And that's where this focus on technology leadership, product platforms, focus on execution, making sure corporate debt is in a better place [ where ] our balance sheet is. Put them together, we are where we are, and we feel very, very confident at the company.

Great. So you mentioned something earlier on the sale side. But really, I just want to drill a little more. That's the positive side of things in general that you see consistent demand from data center customers. What are some of the trends you're seeing in cloud? Especially, I'd love to hear your thoughts between the U.S. cloud versus China cloud. As you look in the second half of 2022 or even 2023, how confident are you that we are not going to see a broad-based inventory digestion in that particular segment?

So cloud, in particular, you need to keep this in mind, it is a secular long-term growth business. Without question, the cloud is growing. Whatever the short-term phenomena, if there is pandemic coming out of it, cloud growth. If there is new technologies, TikTok and volume goes out, cloud goes up. In general, given the data growth, cloud is, in general, going to go. Inside that, clearly, the titans are large. They are very large companies. And though they have an ability to affect demand supply in any one segment substantive. When one is expanding, that will not be in sync. They may be in qualification. The third one may be in digestion of what they like. So this is why we say, in general, we are doing it. Now in China, particularly, both the COVID-related shutdown and the geopolitical issues have had an impact. We talked about the China slowdown in our December quarter. That trend has persisted. And over time, you know they also have to bounce back. Now for us, particularly, our excitement in the cloud business comes from both the HDD and the flash side because in HDD, we have just introduced 22 and 26 terabyte. We are a step ahead of everybody else. 22 is already being qual and 26 is already sample. And 22, you can go into a consumer channel today and buy a 22 terabyte drive. Nobody has even come close to that. On the flash side, our NVMe drives are already qualified. Our market share is going up the big 5, the next-generation based NVMes are getting qualified. We feel a lot more stronger about our position in the cloud than we were in the past. So you put the 2 trends together, we are doing well, it's a secular long-term trend. Not all cloud titans work at the same time. Average it out, I'm going to say, generally okay.

Okay. No, that's helpful. The other topic that I guess I get a lot of questions on is on inventory. So with regards to the inventory on your own balance sheet, it's now sitting at about 105 days, which is not really that far off from the last piece over 110 days in 2019. How are you thinking about your own inventory days in few quarters given you tend to build more inventory? And do you see the risk that at some point you build too much inventory, you have to write something?

So you want to separate flash and HDD in this. And the question you're asking, I guess it's more towards flash than HDD. HDD inventory, we know in places where as our supply constraints have eased up, we are able to truly reflect and meet the end-user demand, which was not the case a couple of quarters ago when we had IC shortages, shipping shortages, those things are affecting. Now we are truly able to meet our customers in demand in a reasonable fashion. In the flash, clearly, customers are correcting their inventory position. We have manufacturing that we continue to do, we work very, very closely with our partner to make sure we are regulating supply both from the fab and into the end market. Given that end demand has gone down and the supply is reasonably -- it's coming down. It's come down substantively from the expectation of mid-30s mid growth to probably mid-20s to high 20s mid growth. Clearly, the supply has come down. But you know there is going to be some inventory buildup. Now let me be clear. Our customers are also listening to this. The last thing I want to tell you is, hey, I want to pile up inventory, you can come in. So we are not holding inventory. We are not trying to hold inventory in this. We will make sure that we balance this.

Okay. That's great. Maybe let's switch over to a little longer term, the different business starting with hard drive. So you had mentioned earlier that, that business probably is more stable and normalized state. Then you started ramping production of 22 and 26 terabytes, which to me, it puts you slightly ahead of the competition. How quickly do you expect those new drives to ramp up in volume? What does that mean for your margins of the business? And which is still below your long-term target, 31% to 34%.

Clearly, this is the question I was hoping you would ask, right? This is what excites me to talk about technology. We have had a very clearly articulated strategy as to how we want to do this. We are not trying to get home runs. We want to make sure we want to improve it as a whole system. You want to look at heads, media, firmware, system software, mechanicals, drive integration. Each one of them in parallel so that I can have a predictable road map. The result of that is that 20 is ramping, 22 is already shipping and is now in qualification. 26 is sampling and getting into customer sense. We got where we want to be. This is the kind of cadence you want to have. In parallel big enabling technologies, OptiNAND, triple-stage actuator, UltraSMR, these -- ePMR, these are seminal technologies that are now becoming much more mainstream, UltraSMR, in particular. Our ability to get 20% more bits because of the system-wide integration out of the same device. That 20% is a big deal. It's like an x node we are able to get done. We are able to do 22 and 26 at the same time. That gives us that leadership and predictability that I think will stay on. The road map is very, very strong. You can see our road map all the way to with conventional ePMR, UltraSMR and OptiNAND technologies going up to 30 terabytes. That gives us that confidence.

Got it. Well, maybe just stay on the roadmap side of things. With regards to UltraSMR, you talked about 20% increase, previously, it's only suitable for certain use right? And the adoption wasn't that great. But you seem much more confident about the adoption this time. Is it just the 20% more? Is the possible ownership is much better? Or is there other reasons why it's more broadly adopted?

So I want to start with 1 piece of data that sort of sets this up. When we exit this year, this calendar year, over 20% of our capacity enterprise cloud shipments will be in SMR, both in revenue and in bits. So that's about as strong a statement as we can make on how fast this is ramping. Cloud titans are qualifying. You're absolutely right. When you come back and say, "I have a 14-terabyte drive and with SMR, I can get another 1.4 terabytes", the whole software needs to be changed, they are not that particular. But when you come back and say, I do 20% on a 22-terabyte, I can give you 26 terabytes. There, wow, that is like 2 nodes that I can avoid with that 1 qual, and I'm able to get that now. That requires, obviously, the data manipulation coming in. They are willing to do it. We, by the way, do a lot of enabling work to make that happen whether it is database support, utilities, application nodes. These things we actually develop and we do it for SMR, we do it for the entire industry. We do it in open source and enable our customers. That has allowed our customers how to take that seriously. Multiple cloud titans have now qualified SMR, we are on to the races. And that's why we are so confident on this technology.

That's wonderful. Just on the road map. You talked about earlier, you have the 22, you have your 26. How many more generations do you think CMR has before you have to switch to the next technology, which I assume is ePMR?

Yes. To quote Mark Twain, ePMR has been exaggerated for a long time now. We've been talking about this. This is the nicest thing about our road map is, you want to make sure you have a good blend of breakthrough technologies and evolutionary technologies. And we have done -- so we see our path to 30-terabyte CMR with generation ePMR generation 1, ePMR generation 2, ePMR generation 3 and then SMR and OptiNAND on top of it. That is -- now that does not mean we don't believe in HAMR. HAMR will come in its time. It is, again, a revolutionary technology. We will be there when we do it. However, we are not forcing it. You want the lowest TCO to win. And we have these 2 coming in parallel. And right now, the incumbent technologies and their road maps is very strong. Our focus, as you would see, even during these tough times, even as we come out of it and because the cloud is in generally good state is to figure out, as you said earlier, how we get our margins up, how do we get our share of the value into our company. These technologies provide the platform where we can get that.

Got it. So on HAMR technology, again, I think at the Analyst Day, you talked about launching the technology around 2026, just based on the road map. So we shouldn't be thinking of that as a hard cutoff from CMR to HAMR, is that right?

So even now if you notice, 18 is running in volume, 20 is getting qual, 22 is getting done, 26 is going. Multiple nodes are running in parallel. We are not saying everyone goes immediately gets up. Same thing is going to happen with HAMR. HAMR will be introduced, allowed its time to cook a technology -- you remember when helium came, how long helium took before it became the main stream? We introduced at 8 terabyte. Really, 14 was the big node where helium took over the world. We need to give these technologies time to cook. In parallel, you want to have a strong road map that backs them.

So if you take a step back and think about CMR versus HAMR, what are some of the trade-offs that customers should be thinking, is there a long qualification time, testing time, all the stuff on people implementing HAMR?

You would expect this, right? First and foremost, these are extraordinarily demanding workloads. This is not the whole client hard drive, where about 10% gets written and most of the time, it sits still. These drives for next 5 years are going to be hit every minute of every day continuously, which means reliability is very important. For us to have the confidence in the reliability where we build enough drives to prove that, the customer developing the confidence, and there are going to be quirks with any technology. The fact that the customer needs to get comfortable with that, that qualification, ensuring that when you put this in a 55-, 60-degree centigrade ambient and you run it for 5 years will I be able to guarantee its reliability as well as they do today with CMR? That's going to be the long haul in the tent.

Okay. Maybe one last question on hard drive. So there has been a lot of emphasis on long-term agreements. I think that's mostly a hard drive comment rather than flash comment. Where do you see the value of LTAs in periods of inventory adjustments? It seems like these are not including pricing.

So LTAs in general, we now have gone from about 5% LTAs and hard drives to now approaching 30-plus percent in LTAs. But what they give you is a better picture of a longer-term trend, what mix that we are going to be taking, qualification slots, qualification times, volumes that gives you a much better idea of when their expansion plans are when their division digestion are going to be, so we can plan better. That's the biggest advantage of LTAs in the hard drive.

Okay. That makes sense. Well, maybe I'll pause here, if there are any questions in the audience, raise your hand, we'll -- I think we'll run the mic to you. Okay. I will keep going. So let's switch over to the flash business. A few weeks ago on your earnings call, you talked about just starting to have discussions with your JV partner cut back on capital spending. Can you give us an update on those conversations? And when should we expect to hear the outcome? When do you think those actions will help reduce the production growth?

Even though we say we're just -- it's probably not a technically correct statement because we talk to our JV partner 3 times a day, right? It is not that we are in continuous conversation. Is there an externally announceable conversation that we can have, that's probably the more justification. We have been -- we monitor our overall demand together and what capacity we need to be building in an intimate fashion with our partners. We've been together for 22 years. We have run this for a long, long time. We know each of our cadences. Now on a more normal basis, you do see this idea -- that the overall industry bit growth rate has come down. It has come down from where in the last downturn happened in 2019, we went into the downturn shipping 40%, 45% bit growth rate year-over-year. Clearly, we are not there. We have now dropped all the way from low 30s to now mid to high 20s is where the industry is headed. We know these trends well. So we adjust our capital accordingly. Now we want to take extra capital actions. You know very well by the time a tool gets ordered, tool gets installed, material qualified, material goes through and come out, it's a year. So we know how to manage this very well, and that's how we've been thinking about with respect to capital with our partners. We'll be very, very conservative, and we have always been. As you know, in general, I have been accused of this, Hey, you guys are not spending enough capital". We are extraordinarily capital-efficient with respect to our technology. That's a metric we very carefully watched. You've seen me talk about it in various meetings. Our capital intensity, meaning amount of capital dollars needed to produce the next 1% of capacity increase is the lowest in the industry, and we will continue to focus on that.