Western Digital Corporation (NASDAQ:WDC) Barclays 2022 Global Technology, Media and Telecommunications Conference December 8, 2022 2:00 PM ET
Company Participants
David Goeckeler – CEO
Wissam Jabre – CFO
Conference Call Participants
Tom O’Malley – Barclays
Tom O’Malley
Welcome back. I’m Tom O’Malley, U.S. Midcap Semiconductors and Semiconductor Capital Equipment Analyst. Really happy to have David Goeckeler and Wissam Jabre here, CEO and CFO of Western Digital. Thank you for being here, guys.
David Goeckeler
Thanks for inviting us, and happy to be here.
Wissam Jabre
And what an interesting time to be here.
David Goeckeler
Very interesting time. Absolutely.
Wissam Jabre
Almost nothing to talk…
Tom O’Malley
I know, right. A lot of these conversations, we have been slower going, I’m sure that this one will be action packed. So thank you for making the time. Really appreciate it. So why don’t we start out with some disclosures, and then we can get into the questions.
Wissam Jabre
Thanks, Tom. Great to be here. 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 non-GAAP financials and reconciliation of our GAAP and non-GAAP results can be found on our website.
Question-and-Answer Session
Q – Tom O’Malley
Perfect. So with that, why don’t we start with just an update of the state of the world of the memory market?
David Goeckeler
Okay…
Tom O’Malley
More specifically, you obviously saw your U.S. competitor talk last week about historic declines on the pricing side, some of the weakest market that they’ve really seen in their history. You guys obviously haven’t revised, I’m not talking about that today. But I just want to hear your take on what’s going on and what you’ve seen over the past couple of weeks until I spoke?
David Goeckeler
Yes. So let’s start at a high level, talk a little bit about us. And then we’ll go through the market and we’ll go through the individual, replay it, because I think we do have quite a bit of visibility.
So first of all, I mean, cyclical business, this doesn’t surprise anybody. We’re in a down cycle. I think everybody knows that it’s particularly sharp one, we started talking about that several quarters ago. I will say feel good about everything we’ve done over the last couple of years prepare for this time. We’ve been making a lot of changes inside the company. We’ve invested in our balance sheet to be stronger, we knew a down cycle is coming. We’ve invested heavily in the JV, which is a huge part of our business.
And I think that our foundational technology is really showing through right now. And we have a much better portfolio. And you know, we’ve changed the organization structure and the leadership team inside the company, we have a lot more agility to kind of manage through that. And I think that’s showing up. So we’ll talk a little bit more about that.
As we start going through the markets. So first of all, let’s start with consumer, I would say the consumer was the first market we saw get soft, earlier this year. And we’re in that market, I would say stabilized. We’re in a seasonally strong quarter. Although we’re in a down cycle here, the memory market, as we saw made this comment a while back, we’re not canceling Christmas. So we still have a holiday season and so it’s still a seasonally good quarter.
Again, one of the things we’ve invested in a lot over the last couple of years is our brand, SanDisk, SanDisk, Professional, WD Black, and that part of the business is really shining in the NAND business right now. We’re maintaining our brand premium as far as share as well. So but we seen — we saw that business kind of maybe one of the first ones into a correction. And you know pricing is not great, pricing is kind of it is what it is. But the business is performing much more predictable than it was a couple of quarters ago. So that business seems to have stabilized a little bit.
The PC market, we talked about that a lot last quarter. It was probably the second big market, we saw correct, mid-summer, very sharp correction. In the September quarter, we saw customers taking way below product of the true demand. As we talked about in our earnings call we’re now seeing, I would say that market is maybe bumping along the bottom a little bit. We’re seeing a little bit of sequential growth in units.
I wouldn’t be surprised that goes wiggles up and down for a couple of quarters still. A good news there, we’re seeing elasticity kick in, in the NAND market 54% year over year increase in bits. We’re seeing that one terabyte dye come into the sweet spot of the market. So we see good demand there. When we start shipping back to true demand, whatever that is coming out of this, we’ll see some acceleration in that business.
And then the final, the final business that is going into correction is the data center. The big especially U.S. hyperscalers have moved into inventory correction mode, I would say midway last quarter. We expect that to be a two to three quarter process. We see that in — we see that more right now in ACD business quite frankly, in capacity enterprise.
We’re still selling a lot of volume in the enterprise SSD. That’s been a big — that’s been a good story for us. Over the last couple of years, we’ve talked a lot about a qualification in the hyperscale sector. That part of the business will go through an inventory correction as well. So, I’d say that’s the earliest one in it.
And then I would say the backdrop of all of that, on a macro perspective is China. China has been, very quiet, not a lot of activity in China and all of the markets for quite some time now. I think it’s encouraging to see what we’re seeing in China over just the last couple of weeks, seem to be coming out of the zero COVID policy. We’ll see how that translates into the business as we go through ’23. But it certainly would be good to see some activity come back there.
Tom O’Malley
Helpful. So that’s the State of the Union today, you’ve talked about some of the markets datacenter, you mentioned a couple quarters of recovery. But something that I think would be really helpful is just looking into the next year. What are your expectations from those end markets in terms of growth, and this is just on the demand side, when you’re looking into next year is your anticipation that you said two quarters for datacenter, do you see a recovery there?
How about on the consumer on the smartphone side, you obviously are doing a bit better than your competitors in some of the retail market. But just your basic assumptions, when you look out into next year.
David Goeckeler
Look, I mean, my — again, start at the highest level, I’ve said this many times, we’re more technology enabled and technology dependent than we’ve ever been before as a society. I think the pandemic show that we can all rely on technology much more than we were going into it. I think for all of us in the technology business, a lot of use cases that we were all very comfortable with working remotely, things like that, video conferencing, like these things came to every industry now.
I mean, I remember many years ago, talking about with the medical industry, would you ever go to the doctor remotely? And turns out like for several use cases, you can do that. And so I think everybody has adopted a lot more technology. We’re clearly going through a correction from a pandemic-induced surge in demand and also supply chain, a little bit of supply chain chaos where everybody was accumulating more inventory.
And now we’re going into — are we going in a recession? Are we going into recession, how long is it going to be? Inflation is higher, interest rates are up. So we’re going into a more constructive environment.
And I think all of our customers are correcting between this very high consumption and like what is true demand going to be by dipping down below it. So I think as we go through ’23, we’ll start to see corrections in all these markets. I think in — I think the data center market continues to grow. I mean we continue to have good growth there. There’s an inventory correction. I’m a believer.
One of the reasons I came to Western Digital. I’m a believer the cloud wins, the cloud wins in almost every scenario. We’re using more of the cloud because it’s just a fundamentally different way to distribute technology. And so I expect as we go through ’23, that market will come back. I think PCs, well, the PC manufacturers will get back to shipping to what true demand is. I think everybody is trying to figure out exactly what that is.
How long is the downturn going to last? How do I model it versus other downturns, so people are taking a very conservative stance? But I think we’ll see demand come back there. And the same thing with the mobile market. I mean I didn’t talk about that earlier. In mobile, in the NAND market, mobile is doing its job, which is it takes up a lot of supply.
So we stay qualified in all of those markets. Units are down. But in a down market, you want to be in those businesses, so you have a lot of home for your bids, and I think that will recover as we go through ’23 as well. Clearly, in the NAND market we’re going to have to get through the demand coming back and then the inventory coming out of all of our businesses. But maybe Wissam can talk a little bit about all the countermeasures we’re taking around CapEx, where the industry is really adjusting significantly below what true demand is right now.
Tom O’Malley
It’s a perfect lead-in. So we’ve talked on the demand side. you obviously have supply so as well, and I write these down because it’s the three tenants. You have three levers on the supply side. You got capital, utilization and inventory. So why don’t we start on the capital side because that’s most useful. So you’ve already seen, both from the JV and others, utilization cutbacks, talking about CapEx spend reductions into next year.
There’s a real fear out there that you may not have one rational player. Could you, one, address do you think this industry is more rational? And then talk about what you’re doing on the capital side to address the current market conditions.
Wissam Jabre
Yes. Well, let me talk about the capital side, that’s sort of more relevant to what we’re doing. We’ve taken down our capital targets or CapEx targets for the year by — our plan by around 20%. And so that basically impacts both the NAND side of the business, as well as on the HDD side. And when you look at our gross CapEx, we had planned for the year initially, to be at around $3.2 billion. Now we’re aiming to be at around $2.7 billion, and we continue to work through these things as weeks and quarters come — keep going.
With respect to other actions we’ve taken on this. Like, for instance, on the hard drive side, we have reduced our manufacturing capacity for the client business by around 40%. And so that basically takes out some of the fixed costs. In fact, we continue to focus on taking down our fixed costs on the hardware manufacturing side so that we can — as the cycle turns up, obviously, we’ll be able to be even more profitable.
With respect to the NAND side, also as part of the reduction, roughly speaking, for the year, our cash CapEx is — we’re planning to be around 30% lower than what we had planned at the beginning of the year.
David Goeckeler
Look, let me — I’ll take on your question about the industry. Look, I can speak for our company, right? I can’t speak for other people’s company. I really can’t speak for the industry in general. But when we look at investment, we look at bit growth, and we kind of know it from the inside of the nodal transitions and how hard they are and the investment required. We see pretty rational behavior across the board.
And so what we’re looking at from the inside is we’re seeing like an enormous amount of CapEx reductions pushing out nodes, even some players doing underutilization. That’s something that we still have an option to do in the future, and we may, depending on how demand signals come in for next quarter, but we can keep the volume up now because of the portfolio strategy. But everybody’s taking down CapEx. And bit growth is going to go down quite a bit.
So — and like I said, it feels really bad right now because the market is in a down cycle, but we’re all still using technology. We’re all still using technology more than we did before the pandemic. People still need to store a lot of data, and so I think that when you look at the structure over a multiyear period, it’s a pretty good setup for how we come out of this.
Tom O’Malley
Yes. I think the other lever that I want to talk about is the inventory side. I think you guys have been more aggressive, highlighting certain pockets at the low end of the market, not necessarily the low end of the client side of the market where you guys could be more successful. One, can you talk about why you’re able to do that? And what pockets of strength are you seeing right now? Because you’ve clearly guided, bid assumptions a bit stronger than some of your competitors in the near term, and you’ve called out clients. So where are you seeing that inflection in the market place in the late near term?
David Goeckeler
Yes. I think we think — I’ve been talking about since I got here, a very big focus on having a diverse portfolio. Very important to have as many outlets for our supply as possible and then mix to the best outcome for our shareholders. And so we’ve had a good start — we’re talking only about now. Let’s start with the consumer business, right? We have a very good consumer business. I think we have enviable brands in the market.
If you’re a photographer, and that’s your hobby, you’re going to go out and buy a very expensive camera, you’re going to buy a SanDisk professional card to put in that. That’s not the time to save extra $10 on buying an inexpensive card. So we have brand value there. We’ve built brands like WD Black over the last couple of years, for the gaming enthusiasts know that, that’s the high premium brands they want to give — deliver them the best experience.
So we have a consumer market that through cycle performs. And especially in times like this, the brand premium, that ability to — pricing is not great, but we still get brand premium, providing an outsize percentage of profitability in the portfolio. On the other side, you have markets that may be taken enormous number of bits, mobile. We’ve gotten qualified in enterprise SSD.
These markets are maybe a little more cyclical. But in a down market, you can still get a lot of volume going into those markets. And then maybe between those you’ve got the client SSD market, where we’ve built a very good portfolio in client SSD. We’ve managed the transition of that market from one technology, hard drives, to another technology client SSDs, we have that.
And then you mix in some IoT in that, some automotive, you mix in gaming. And we’ve got a lot of places where we can put our supply. And I think in the down market, that strategy of having a broad portfolio where we can get both volume and margin, is working for us. That’s an explicit strategy we put in place.
And then underlying all of that, go back to the JV. We’ve got scale, our JV partner. We’re very happy with our technology road map. It’s a very specific goal of ours to be able to get a bit growth at a low capital per bit. And again, I think in the down market, that strategy pays off. And it starts to shine, and you get that foundational technology supporting the margin in the business.
Tom O’Malley
It’s a perfect lead-in as well. I think the last I want to talk to was utilization. You’ve seen competitors already dial back utilization and talk about delays or at least push outs of technology road maps. One, can you talk about why being in the structure of the JV that you’re in helps you in these scenarios in terms of utilization where you can make decisions and still be a beneficiary of the broad based production?
And two, do you guys think that you need to delay any technology transitions given that you’ve seen others do it as well?
David Goeckeler
So the JV gives us scale. So I mean, in a business like our scale is extraordinarily important, and not just scale in manufacturing, but scale in R&D investment. So we — for our share of the bits we have to put in the market, we kind of punch above our weight because we have — with our JV partner, we’re one of the largest providers in the market. And that means we have — we invest together on the BiCS road map.
So we got their engineers, our engineers, making sure we build the best foundational technology, we can. We feel very good about that. High-quality, low CapEx — the lowest CapEx investment possible to get the bit growth we need. So that supports the business.
But then when we go to we look — we go to market separately. Obviously, we go to market separately. And then we have — we’ve been talking about these go-to-market synergies. We have the scale of the HD business plus the NAND business, we can go to market together.
We get some scale on that side on the go-to-market side. So when you add that all up, we’ve been able to find homes for our bids where it doesn’t make economics to draw down utilization. Just for us. Now that can change every week. We reserve the right to do that in the future. Like we get new demand signals every week. And if we think we need to take that countermeasure in the market, we will. Then the JV is structured in a way that we can make independent decisions about how we’re going to utilize the fab
And the cost of those decisions is appropriately allocated to each part. So it gives us the benefit of scale, and it gives us the flexibility of what we need to do in our market.
Tom O’Malley
So I have one more on NAND, and then I’ll promise we’ll move to the other side of the house. I haven’t heard you, at least in-person on call talk publicly about the Chinese restrictions thus far. One, can you just give me your take on what those restrictions mean in terms of the NAND market long term? Do you think that China can still be a viable player in this market given the restrictions that have come out?
And two, you’ve seen 1-year licenses given to non-domestic producers of China. So essentially, producers of China producing in China, but not Chinese entities. What do you think in terms of the outcome of those licenses will be? Do you think that you’ll see additional licenses granted? Or will that shift the market dynamic as well, both those sides?
David Goeckeler
So I’ll start by saying, like every country is going to look out for their national economic and security issues. And it’s our job to understand what those rules are and play by them. And we take it very seriously, and we stay very close to it. And it’s very clear that there’s been some very significant regulatory policy put in place. I think it will have a very significant impact on the market. I think it’s not yet completely clear how fast it will happen and how intense it will be.
But there’s no doubt, it’s a fundamental structural change to the market, if it holds like — it looks like it is now. And again, I think this is when you look through this very severe down cycle we’re in — again, I think we’re in like this unprecedented time of coming out of a pandemic and going potentially into a recession and going into a different fundamental monetary policy era.
And so we’re seeing this very sharp correction. But when you look through that, you see all the players in the industry, significantly reducing CapEx. And then you see this potential, very substantial structural change that’s happening because of government regulation. And I think you could see a very different industry as we come out of this.
Now the licenses on other competitors’ fabs in China. I don’t have any particular insight to that than anybody else in the room has. It’s just obvious there’s more to be concerned about if you’re — if that’s where you have major investments, you’ve got to pay a lot closer attention to what countries are doing to — again, they’re looking out for their national and security — economic and security interests. That’s a political thing. All of us in the business community need to stay close to it and try and interpret it. It’s still very early, but the early indications are it is a fundamental change in the market.
Tom O’Malley
Helpful. All right. I promised we’d switch that so we can go over the side of the house. So the HDD business units. So in terms of the correction, it felt like HDDs came a bit earlier, where you saw some signals of weakness, at least on the consumer side or on the client side. So can you talk about — are there any material differences between end demand on the NAND side of what you’re seeing on the HDD side?
Have you begun to see any recovery on the HDD side before the NAND side? And that’s part one. And two is you’ve obviously seen a material mix shift towards the near line end market. You had recently called out inventory at the hyperscalers. You’ve made those comments on the NAND side as well. There’s clearly some correction going on there. Can you just update us on that side of the house if you’re seeing anything different?
David Goeckeler
Yes. So let’s talk about client HDD first. I mean the pandemic gave us several signals on client SSDs that have now completely reversed. So the pandemic started, all of a sudden, everybody needed a new device. And all of a sudden, we had a surge — still 10%, 12% of that market was HDDs and we had a surge in this demand signal, we need much more — many more client HDDs. We went through that. And then maybe what was it 1.5 years ago now, not quite that long ago, we had this chia phenomenon where all of a sudden, we’re going to have cryptocurrency based on time and space.
And everybody needed an HDD, and we woke up one day and all the HDDs in the world disappeared. We’re trying to figure out — like people are buying HDDs like crazy. So another — a little bit of a false signal of demand in client. So now here we are. All that has cleared and client HDD, if you drew a line pre-pandemic of what the decline was. And you do it through the pandemic, you’d now find the client HDDs are below that trend line.
So the move off of HDD in the client has accelerated. We saw and can say a little bit about — I mean I think you said a little bit about we’ve now restructured that business. We’re fundamentally taking fixed costs out.
Wissam Jabre
Absolutely we’ve taken fixed cost out, especially on the client side because we don’t see the demand coming back. So we’ve reduced that capacity by around 40%. That has a benefit, obviously, from a cost perspective to us, approximately annualized $40 million to $50 million. We probably won’t see it in the short term, given that we are in the down cycle. But as the business starts coming back, it should give us a bit of a tailwind.
David Goeckeler
So we’ve had this long period of the rise of the cloud on the back of the decline of clients. And cloud is more exabytes, fewer units. Client was lots of units that are now falling away, and we’re making these adjustments in the business. We’re taking capacity out. We’re just — we don’t need as many units, we won’t in the future. So client HDD, I don’t think we’re going to talk about all that much in the future. The business is going away. That’s fine.
Now cloud is where all the action is. And first, let’s start with China. That kind of went into a correction. Some of it inventory driven, some of it is just macro driven. It’s just been very quiet for quite some time now. That’s persisted. We talked a little bit about maybe there are some reasons to be optimistic there, but it’s very early. We’ll see how that plays out as we get into ’23.
So the big action is in the hyperscale market, U.S. hyperscale market. They were consumed — same story, through the pandemic consuming, and turns out, building inventory. Now going through a correction, inventory correction, very sharp, just like we talked about the PC manufacturers. You got to get from up here to down here, draw a straight line between. And you’re just going to like reset very quickly.
And so we’re going to see a couple of quarters of very, very low demand, and then we’ll come out of that, and we’ll get back to the growth of the cloud. It was the last market to kind of go into the correction, I think it will get through it in 2 or 3 quarters. And then we’ll be back out of it. Like I said, I’m not worried about long-term cloud demand.
And in the meantime, we’ve taken structural fixed costs out of the business. When the volume returns we’re optimistic about that. And we haven’t even talked about the portfolio. We’ve got 22 terabyte drives. We’ve got 26 terabytes ultra SMR drives, the world’s going to SMR. We feel like we’re very well positioned from an innovation point of view. No matter what’s happening in the market, upmarket, down market, sideways, innovation, you’ve got to continue to innovate, you’ve got to continue to bring a better value proposition to your customers. That’s how you get rewarded, and that’s something we’ve spent an enormous amount of time on in both businesses.
Tom O’Malley
So similar characteristics, HDD market a couple of quarters, I think you said on the NAND side from the cloud side, very similar as well a couple of quarters. I was saving this question, we’ve covered SSDs, but I wanted to really focus on the data center side on HDDs. So that mix shift is now exacerbated where I think 65%, 70% of exabyte are now near line drives, data center related.
So you’re saying a couple of quarters. That takes us through the end of this year into next year. Is your assumption for cloud growth next year, a positive number or a negative number when you look at all of ’23? I know it’s a very difficult time to put a finger on it, but just your assumption going into the year, do you think you can see growth from cloud customers?
David Goeckeler
I think we can see growth from — it’s very difficult to put your finger on it because we got — there’s inventory on their side. But again, I think that year-over-year, you’re going to see CapEx investment on their side, you’re going to see the cloud grow. I’m not worried about the cloud growing in the midterm and long term. I think we just need — we need to get through this inventory correction. It is very severe. It’s not to be made light of. It is very severe.
On the NAND side, once we get through it, we’re going to have to get the inventory off of all of the supplier side, but we will get through it, and I think the inventory is set up to do quite well. We’re taking a lot of costs out of it right now, and I think that will be very good believer in the role of storage in all of our lives. And again, we’ve kept our foot on the accelerator of innovation. And I think the portfolio is in the best shape it’s ever been in. And we’ll grow out of it and will grow into a very good portfolio.
Tom O’Malley
From an industry dynamic perspective and also from a cost perspective, there’s been a long-term goal from the industry for a 30% gross margin plus HDD business, right? And you’ve seen in upswings — at least several quarters of sustainable profitability, largely is a function of mix shift towards near line. But can you just talk about longer term, is that a realistic goal?
This was clearly a massive portfolio of demand as you guys just talked about. You really were only the 30 — over the 30% mark for a couple of quarters. Is that an achievable goal? And why do you think that, that 30% gross margin target is the right one in the future?
Wissam Jabre
Yes. I mean our gross margin target for the hard drive business is still the 31% to 34% that we laid out at Investor Day. We haven’t moved from that. We do see — we do have a lot of actions that we’re taking to get us there over time. Obviously, we’re going to continue to innovate. Innovation drives a lot of things, including our ability to provide better value to our customers and be able to rely a little bit more on value-based pricing.
But also innovation gives us reduced cost from a platform perspective, for instance, and other types of actions that would help us from a manufacturing side. So anyway, you have the benefit on the top line, the benefit in the cost structure. And also all the actions we’ve been — we’ve taken on the client side, and we’ve taken — we continue to take further action with respect to our fixed cost to continue to chip down — chip at it and bring it down. And so those actions as the volume comes back, should help us start trending towards that long-term goal.
Tom O’Malley
Helpful. And I think we have time for one more here. I think I’d like to ask this question. And particularly like a company like you guys have so many diverse product sets, and there’s a lot of moving pieces in terms of supply and demand. What’s a key message that you want to give out to investors through this conference here? And what do you think people are missing on the story today? Obviously, with the stock trading the way it has, there’s clearly value that needs to be unlocked, but I want to hear what you guys have to say in terms of what people are missing?
David Goeckeler
We’re a very different company than we were two years ago. I mean, two or three years ago. Again, we’ve invested in the JV. We’ve invested in our balance sheet. We have retired $2.7 billion worth of debt. We’re stronger in this down cycle. We’ve built a better portfolio. We’re now qualified in the enterprise SSD market, which was a goal for the company for a long time. On the HDD side, our capacity enterprise road map, I think the decisions that have been made over the last five years of like we’re going to have to get from 20 to 30 and layering in ePMR and OptiNAND and ultra SMR.
Maybe everybody didn’t understand exactly when we launched each one of them, how they were all going to work, but now we’re seeing them all accumulate and give us a unique product set in the market. We’ve also built more agility into the company. We’ve organized differently. We have a different set of leaders. I think we have more agility.
We just saw we were able to sequentially reduce our OpEx very significantly when we saw this coming and position ourselves well. So I think in general we’re a more resilient, more agile company that’s in a much stronger position. We’re in a severe downturn right now. When you look through that and you see we’re going to come out of that we’re going to be in a very, very strong position.
Tom O’Malley
Well, I appreciate having you both here, and thank you for the candid thoughts amidst this tougher time, but thank you very much, guys.
David Goeckeler
All right. Thanks for your time.
Wissam Jabre
Thanks for the time.
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