Western Digital Corporation (WDC) Earnings Call Transcript & Summary

All right. Why don't we go ahead and get started. Good morning, and welcome to the first day of J.P. Morgan's Technology -- 52nd Annual Technology, Media & Communications Conference. My name is Harlan Sur. I'm the semiconductor and semiconductor capital equipment analyst for the firm. Very pleased to have Wissam Jabre, Chief Financial Officer of Western Digital; Peter Andrew, Vice President of Financial Planning and Investor Relations, also here with us today. I'm going to turn it over to Peter, who's going to read the safe harbor statement, and then we'll go ahead and kick off the Q&A. Gentlemen, thank you for joining us this morning.

Thanks, Harlan, and thank you for hosting us today. Before we begin, we'll be making forward-looking statements in today's discussion based on management's current assumptions and expectations. These forward-looking statements are subject to risks and uncertainties. Please refer to our most recent financial report on Form 10-K and our other filings with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially. We will also be making references to non-GAAP financial measures and a reconciliation between the GAAP and non-GAAP financial measures are available on our website. So with that, let me turn it back to you.

Yes. Great. Again, thank you for joining us this morning. So I'm going to start off with sort of the near-term to midterm demand environment, sort of the cyclical dynamics of the sector. After a sharp downturn in storage and memory, the industry is at the early stages of an upturn, right, in your HDD and SaaS businesses. Prior to that, the team has been undershifting market consumption for, I think, almost 8 consecutive quarters to the second half of last year. After this 7, 8 quarters, demand is picking up, pricing is improving. How does the team see the business environment as we transition into the second half of the year and move into calendar '25?

Harlan, happy to be here. Thanks for having us. So on the business side, we've continued to see improvement in the demand environment. When we look at the flash business, we did last quarter, we're starting to see improvements in the enterprise SSD side. So cloud is coming back. And as we go into the second half, obviously, we have the consumer and client seasonality of the business that we expect to continue to see, in addition to continued improvement and enterprise SSD on the cloud side, which could have a bit of upside for us. On the hard drive. The cloud demand has come back with a lot of deployments on the data center side. What we saw in the March quarter is a return to normal revenue patterns than we continue to anticipate improvements sequentially for the remainder part of the calendar year. So all in all, we feel good about the demand environment on both businesses.

The team issued a letter to customers at the beginning of April, outlining the strong demand increase, along with supply constraints and the resulting potential increase in pricing for both HDD and flash. Has the supply situation actually become tighter since you put out the letter? And some sources suggest that the supply tightness will persist into next year, given the team's improved visibility and market demand trends, capacity discipline. Do you anticipate that demand could continue to exceed supply into next calendar year?

So when we look at on the hard drive side, I guess on both sides of the house, we're seeing tighter supply. So in our hard drive business, we've taken action to resize our manufacturing footprint. And so that, basically, we resized it to where we see the near and medium-term demand going, but we continue to see tight supply there. We've been working closely with our customers on build-to-order, which would allow us to get a bit more visibility and predictability and also, allows our customers to get more predictability and when they would get their products they need. On the flash side. In a way, similarly, we're seeing demand outstripping supply for the rest of the calendar year. And so thereto, we continue to be proactive on where we want to place our bids so that we continue to optimize our profitability. But from a demand-supply perspective for our business, we see demand continue to be higher in supply this year.

AI and accelerated compute did have been big drivers of the semiconductor industry recovery, right? It's created roughly $30 billion to $40 billion of GPU and AI ASIC semiconductor revenue demand that wasn't around 2 years ago. By the end of this year, for example, we forecast that 18% to 20% of all industry DRAM wafer starts will be targeted for high-bandwidth memory that goes into AI servers. Hard disk drive is used to store the massive data repository is used to train these complex AI models. We know that enterprise SSDs are used in the critical loop like for both training and inferencing computations. Can you quantify the incremental demand pull from Gen AI on both nearline HDDs and also enterprise SSDs? I know, for example, some of your competitors have said that there's going to be 3x more NAND content in AI servers versus general purpose servers. Does the WD team have any sort of similar metrics?

What we see is we think AI will be impacting eventually various parts of the portfolio, be it on the consumer and client on the edge as well as in the fore in the enterprise SSD side. On enterprise SSD, last quarter, we saw the beginning of the sort of return of the cloud. And as we get into the second half of the year, we're potentially going to see the beginning of the AI impact on the enterprise SSD -- from enterprise -- sorry, from AI workloads. So we have a few products that are already qualified where we're seeing those customers coming back and asking for higher capacity points for those qualified HDD, SSDs. But we're also sampling the PCIe Gen 5 BiCS6, which is our next technology -- our newest technology node in terms of enterprise SSD where we see potentially some of these products qualifying is starting to ramp in the second half of the calendar year. So from the trading to inferencing as well as storage and retention, when we think of the storage and retention, there's -- obviously, that drives quite a bit of demand for the hard drive business. But at this stage, I would say we don't see it yet in our results. What we're seeing is just a stronger demand from the normal type of business. But we expect as we get more and more of the AR workloads becoming a pervasive solution. But we see a bias to the part of it with respect to the demand picture.

Yes. I know your question was mainly focused on servers, but also remember that AI is likely also going to touch the cell phone, the gaming and a lot of the other end markets where we also have a big exposure from our flash business.

That's right. As I've talked to investors, and again, we're early days, right? And I think this is still -- the use cases are still sort of playing themselves up. But there's a little bit of concern at the margin around will there be cannibalization, right, of nearline cloud-optimized, HDD being replaced by enterprise basis. I can tell you that based on some of the observations that we've seen, the answer is no, right? Capacity-optimized ACD, still the most optimal, most cost-effective solution for storing these huge data repositories of just the raw data, right? And Enterprise SSD is situated a lot more closer to the compute clusters, right in a part of that. And so is that kind of how you guys see it as well? It's very complementary and not so much one cannibalizing the other?

Yes, that's how we see it, Harlan. We don't see cannibalization. We see various -- basically, we see different use cases, more tied to whether it is [ enterprise ] SSD or the hard drive. And so as we think of demand, actually, we see a positive bias on both enterprise SSD and hard drive.

Yes. And also, don't forget for hard drives. I know the question is framing an inference. But remember, there's just general collection of data.

That's right.

I think as we look into the future, more and more people are going to store more data. Just in case in the future, they're going to want to use that to put into those inference engines. In addition, remember, with all these models, they're going to produce software. They're going to produce video, images, who knows what that you're going to want to store. So I think even if you look at the 2 other ends of the training and inference, there's great opportunities for HDD.

As we look into the second half of this calendar year, I know Wissam, you said the team is confident on driving sequential growth in nearline or capacity HDD. Given your expanding lead times, better feasibility, how are you seeing the potential exabyte growth looking into next year? Because I know the team has talked about normalized exabyte growth of around 25% on an annualized basis. But we're coming off of a low base. It feels like demand is strong. Could the 25% exabyte growth be conservative looking into next year? Just again, given the dynamics of coming off the bottom of the cycle, strong demand trends. Could we see an overshoot to that 25% growth profile next year?

So look, it's a bit too early to necessarily talk more specifics about next year. But where we see the exabytes on the nearline side where we see the exabyte demand is 20% to 25% range. Obviously, we're going to experience peaks and troughs through-cycle. And so there will be times where the demand will be higher than that, at times, it will be lower than that. But what we see from the long-term demand is the -- our growth is 20% to 25% range.

On the flash side, from an industry perspective, I know the team has been anticipating mid- to high-teens percentage increase in calendar '24, bit demand growth and a modest, mid-high single-digit percentage increase in industry, fab supply output, indicating continued strong supply and CapEx discipline by you and your peers. Given that you've got a little bit more visibility into the second half of this year, is this how you still see industry supply and demand dynamics playing out for this year?

Yes, we still see a similar type of dynamics, as you described them. And as we get into the second half of the year, if I sort of bring it to our business, we do have a strong presence in consumer and client and second half of the year is a -- it's a great -- obviously, the seasonality of what would drive that demand for us. And as I mentioned earlier as the cloud demand comes back, we continue to anticipate upsides from the enterprise SSD side, so we could potentially see higher numbers there. Having said that, we've said a few times now that we continue to focus on being proactive on where we place our bets because we do want to continue to improve the [indiscernible] and profitability of our business. So there could be some variability there, but that's really a high level, how we see the second half.

I feel like one of the big differentiators, we've been covering WD for a while. We're covering SanDisk for a while as well. And I feel like the flash portfolio of the WD team is very differentiated, right, relative to your competitors. And what I mean by that is the team still enjoys a very, very strong presence in clients and retail, right? The SanDisk brand, still #1 in the world, right, in retail. And I feel like that was an added venue for the team to deploy bits in an environment where you could selectively choose highest profitability pools, right, as you sort of manage through this downturn. I do think that SanDisk -- I do think that WD does have the highest client and retail exposure relative to all of your NAND flash, your flash peers. But is that the case? Is that considered to be a big differentiator for the WD team having that client and retail portfolio?

I mean we see -- we do have a good presence on the flash side and consumer and the client. And yes, the SanDisk brand is a premium brand that is well recognized when it comes to flash. And so that has actually helped us quite a bit as we were sort of weathering the deep cyclical downturn. But we continue to also create good depreciation within that product portfolio to enable us to continue to have strong presence in consumer and clients.

As it relates to -- the team has been very disciplined. You've been maintaining sort of flattish sequential bit shipments now to the last few quarters, including this quarter. Can the team actually expand bit shipments in the second half of the year to align with what looks to be, as you mentioned, seasonally stronger second half of the year? And just an overall better enterprise demand pull? Can the team expand good supply in the second half to kind of match that demand curve?

Yes. When you look at our supply we've built a little bit of inventory exiting March, and we also anticipate a bit of inventory build in the June quarter. But that's all to get us prepared for the second half. We're comfortable with the supply at the current point, given the environment and where we see the second half demand coming. So there's no -- I don't see any issues with us being able to supply the products need as well as obviously deliver to the demand.

On profitability. The team has maintained very strong focus on through-cycle profitability in response to this downturn, right, ?and implemented some structural actions, right, like when your HDD franchise and some temporal actions like modulating utilizations. As you mentioned, reallocating bits to higher profitability applications and segments. Take us through the structural and temporal actions and how they've benefited the WD team as industry fundamentals now are also starting to improve.

Yes. So on the hard drive side, which structurally reduced our manufacturing footprint, which basically helped us reduce our fixed cost. And so as the business and as the demand and cloud demand comes back, we anticipate to generate better profitability at lower volumes. And actually, as we've demonstrated in the March quarter, our hard drive business delivered 31% gross margin, which is already sort of at the lower end of target range, but we've gotten into the target range. And when you think of it, it's really at a lower revenue than we've delivered similar types of gross margin in the past. In the past, the 31% gross margin would have required much bigger top line revenue. So that sort of was helped by some of the restructuring of our manufacturing footprint. On the flash side. Throughout the cyclical downturn, we reduced our output to limit the inventory build and also obviously, conserve cash. And as we sort of start seeing demand coming back, that sort of is going away. And so from that perspective, there, I would say, the demand for our products relative to where the supply is, helped the pricing, helped improved our gross margins. And then when you look at the total company, we've also taken quite a bit of action to resize our operating expenses. And so that also will help positioned us in a much better place as we see demand come back, revenue come back, gross margins being at a higher point. And so we should start seeing our operating margins also benefiting from that.

I mean the other key thing, and there is the product portfolio, especially in the HDD domain. I mean if you look there, we've got the best product in the market. As the cloud is transitioning over to SMR drive, we've got the highest capacity, highest volume and the best cost structure, and you're seeing that flow through, especially in our HDD results.

Following up on that. Like you said, drove within your through-cycle HDD gross margin target range of 31% to 34% last quarter, both with and without underutilization charges, foreseeing continued growth in exabyte unit shipments, continued cost downs. How should we think about your gross margin trajectory exiting this year into next year? And with the structural adjustments that you just talked about, right, it seems that the team can see a through-cycle gross margin profile that is actually higher than your current through-cycle range of 31% to 34%. I'm just wondering if the team can also address that as well.

Yes. So March quarter as I mentioned earlier, we've gotten into the target range where we're not at a point where -- I mean, I'm not here to update our target model on the fly. But we continue to focus on the profitability of the business. And as Peter mentioned, obviously, we have a great portfolio on the hard drive side. We continue to commercialize our road map in ePMR, OptiNAND, UltraSMR, which really provides the best CTO and the highest capacity points for our customers. And as we continue to execute on that, I mean, this is a technology that we've been manufacturing for many, many years. It's well understood. It's high quality, it's very reliable. And so that will help us continue to drive better profitability as well.

And also those margins are through-cycle margins.

That's right.