Western Digital Corporation (NASDAQ:WDC) Evercore ISI 2nd Annual TMT Conference September 8, 2022 1:30 PM ET
Company Participants
David Goeckeler – Chief Executive Officer
Wissam Jabre – Chief Financial Officer
Conference Call Participants
C.J. Muse – Evercore ISI
C.J. Muse
Thank you. All right. Well, thank you for coming. My name is C.J. Muse with Evercore ISI. I’m very pleased to host the team from Western Digital. We have David Goeckeler, CEO; and Wissam Jabre, CFO. And we were just reminiscing, we actually went to Columbia Business School together. So it’s good to have you back in New York. So welcome, gentlemen.
David Goeckeler
It’s great to be here. Thanks for having us.
C.J. Muse
So I think Wissam, you have a statement to make.
Wissam Jabre
Yes, I want to make the Safe Harbor statement. 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’ll also be making references to non-GAAP financials and a reconciliation of our GAAP and non-GAAP results can be found on our website.
C.J. Muse
Excellent. Well, welcome. Great to have you.
David Goeckeler
Thank you.
Question-and-Answer Session
Q – C.J. Muse
I apologize. I’m going to start off with a near-term question.
David Goeckeler
That’s okay. We are here to talk about all terms so.
C.J. Muse
You had the benefit of reporting two weeks after your main competitor, and they recently updated. And so just wanted to start out with how are you thinking about September quarter guide within that context? And what are the puts and takes that you’re seeing in the marketplace today?
David Goeckeler
Yes. We did have the benefit of — and as we’ve talked about, a very dynamic time in the market, which a lot of things changing day-to-day and week-to-week, we had a little longer to kind of settle on where we were — we’re at in the quarter. We rolled everything into that, and it was kind of interesting. It didn’t take long before some of our peers started coming out with some of the similar points of view. But which wasn’t surprising given how dynamic the market is, and we feel good about where we’re at. I mean I talked a little bit about it yesterday as well.
The market continues to be dynamic. And I would say there’s incremental weakness from where we were a month ago as the market gets more difficult. But we feel very good about where the portfolio is, all the progress we’ve made over the last couple of years and how we operate the business. About all the new people that have joined us, including Wissam here, in general about where we are in the business.
C.J. Muse
Sounds good. I think maybe a point that I know you like to make, and it’s worth bringing up here is that when you think about Western Digital’s positioning this cycle versus the prior, it’s very different, different organizational structure, technology, customer concentration, liquidity, leverage cash flow. So I wanted to tee that up to you if you want to make any sort of commentary around that?
David Goeckeler
Yes, we’re a very different company than we were two years ago or 2.5 years ago. It goes quick. I’ve been here 2.5 years now. But a couple of arcs of the changes we’ve made in the last couple of years, and I think where it’s left us now as we go into a different part of the cycle. The first place when I came into the company that I wanted to make some changes was more focused on our product development. I’ve been developing products for a very, very long time. Progress is a function of focus and making sure people are very, very clear on what they’re driving. And that’s when we went to a business unit structure. We have two great franchises across hard drives and NAND technology. They’re sold to the same customer. They’re both used for storage, how you build them is very different. The technology involved is very different. So we had to drive focus, restructure the organization, brought in two leaders to really focus on each of those businesses, and it’s worked. We have a very different portfolio now than we did two years ago.
On the Flash side of the business, a big goal of the company has been to really penetrate the enterprise SSD market. It’s a great market. We have a broad portfolio outside of that. We already have the mobile pillar fully established. We have a great client SSD franchise. We have a gem of a business in our consumer franchise, direct or consumer franchise and the SanDisk brands. But we really needed to build out that enterprise SSD pillar, and we have. We broke through early last calendar year, and we built on that now qualified at multiple hyperscale customers, big OEMs. So, that’s a big — we have the ability to mix into that part of the business as we go through the cycle now. And also identified just as we laid out at our Investor Day, lots of different ways. We’re thinking about the business where we can drive better through cycle margin.
On the HDD side of the business, back in our product launch the day before our Investor Day, we announced a whole new suite of products, 22 CMR — 22 terabytes CMR drive, 26-terabyte UltraSMR drive. They to this day are still unique products in the industry. We’re alone in being able to reach these capacity points, we can talk more about that, about why that’s the case and some of the roadmap decisions we made many years ago that led us to this point, which I think is a great spot to be.
But on that part of the business as well, we’ve got — the innovation is back. We’re back leading the industry in capacity points, and that puts us in a great position. So that’s on the product side.
On the business development side, the way we manage the business, we’re very focused on gross margin. We’re very focused on profitability. We’re driving things like value-based pricing in the HDD business. So I think we’re operating the business differently. We have new financial leadership in the business. So I think it puts us in a much stronger position as a company.
And then finally, we spent two years focusing on our balance sheet. We’ve retired $2.7 billion worth of debt. We’ve achieved investment-grade ratings. So we’re just a much — we’re on a much more solid foundation as we enter a bit of a down cycle here.
C.J. Muse
It’s a great recap. I know a lot of investor focus is on strategic review, and I’m sure there’s not much that you can share, but would love to hear any sort of thoughts on that front, particularly around any sort of response from your supplier or customer partners as well as Kioxia?
David Goeckeler
Yes. We can’t say a lot about the people involved in the process because everything is under NDA. But — the process is well underway. I think when Elliott got involved in our stock, we had a great conversation with them, multiple conversations with them, and we — we decided on a public process, a strategic review. We reached an agreement on that. We’re executing the process. We’re well advised. And I feel very, very good about where the process is. I can’t talk a whole lot about what the results are or where we’re at in the process. We’ll have more to say about that when we reach that point. But — it’s well underway. As I’ve said before, Elliott is very involved. There are other folks involved in the process, and we’ll say more about it when we reach a conclusion.
C.J. Muse
Is there a timeline that you’ve provided publicly?
David Goeckeler
What we’ve said publicly is with the agreement with Elliott that we would — we’re kind of — if we’re not in process doing something more significant by the time of our annual meeting, there will be some will change our arrangement a little bit. But right now, we’re just working — we’re making sure we really execute the process very thoroughly, and we’ll get to a set of results we can talk about publicly.
C.J. Muse
Sounds good. So I was hoping to focus on end markets and geographic trends. So maybe starting with cloud. You’ve talked about inventory digestion, particularly in China. I’m curious if that has broadened to meaningful U.S. players? And I guess, maybe as an add-on question as we think about kind of the AI chip embargo to NVIDIA and AMD, is that a potential headwind that you foresee potentially for either of the China cloud players and/or the surveillance market in China?
David Goeckeler
So let’s deal with the first part of that question. So first of all, the China market has been very quiet. We’ve been talking about that since back in our December quarter, quite frankly, and it remains that way. And so that’s a big part of the market. And I’ve tried to think of a lot of words to describe it. And I think quiet comes up the best, which is there’s just not a tremendous amount of activity that’s going on there. We’re very, very close to it, but pretty much across all segments, whether it’s OEM, whether it’s the cloud providers, the smart video network, enterprise, we’re just not seeing the level of activity we typically see in that market now for several quarters.
How it relates to the U.S. hyperscalers, we’ve been talking about the U.S. hyperscalers have been pretty consistent on their demand. We are starting to see a bit of caution from the U.S. hyperscalers. I mean they’re basically big markets of one in many ways because they’re so large. So it’s hard to draw a lot of generalities across them. There are some of them that are still working through kitting issues, and so that’s impacting their demand. But I would say from a general sense versus kind of where we were a month ago, there’s a bit more caution on, hey, we may slow down a little bit here given the macro environment. We have yet to see it fully in the business, but it’s something we’ve got our eye on.
As far as the issues with the AI chips, I think it’s too early to tell. We certainly have not received anything like that from commerce, but about our portfolio. But what impact does that have on the ability for the China players to build out their cloud infrastructure? I think it’s a bit too early to tell on that one.
C.J. Muse
And how about on the PC and smartphone side of things, what is your visibility like into your channel and as well as all the way downstream in terms of how long this inventory correction might last?
David Goeckeler
Yes. I mean, so we certainly have a lot of visibility because we sell into all the suppliers at some level because we have a great client SSD portfolio. That’s one of the — that’s kind of the anchor point of our NAND portfolio. So I think the best way to describe it is we’re just going through a very, very sharp correction. We’re coming out of a time of expectations of an increased number of units being sold; and in addition to that, difficulty of managing the supply chain and getting all of the pieces. And we’re going into an environment where we’re dropping down to a lower expectation of the number of units going to be sold this year and especially in the second half. So, all of our customers are trying to navigate between those two points as quickly as they can. And so that’s leading into a very depressed market in this quarter.
How long is it going to last? I think it’s a little early to tell. And another couple of months, I think we’ll have more visibility as customers move into the fourth quarter of the year. Do they start consuming the product back again on what is true natural demand? Clear right now, the market is under what natural demand is as they work through inventory. So no doubt, a very, very sharp correction and a little bit too early to tell how deep it’s going to be and how long.
C.J. Muse
And so I guess, how does that inform your decision around utilization rates both on the NAND and the hard disk drive side?
David Goeckeler
So in the NAND business — so I just got back from Japan last week and had very detailed conversations with both the Japanese government on other issues, but also our JV partner. It was nice to be able to meet and face-to-face for the first time in a couple of years since I’ve been in this job, it was fantastic to be there. But we’re clearly adjusting our [bit] growth for next year given the current environment. We’ll do that by adjusting our nodal transitions in the fab, most likely pushing out the start of a new fab that kind of activity, which you would expect us to do. Clearly, the market was expecting a higher amount of growth in what’s going to happen this year given the correction.
Utilization at this point, we plan to run the fab fully utilized. I think that’s usually the best bet for an asset like a fab. We’ll reconsider that depending on what we see the length and depth of the downturn when we have more visibility. But for now, the main levers are looking at CapEx spend and slowing down bit growth, as we go through next year.
C.J. Muse
So greater review for the NAND side. And I guess, one last question on that before moving to the HDD. There’s obviously the dual-pronged effort of not bringing on too much capacity, but at the same time, staying on the cost curve. So if you do kind of delay capacity adds, what are you thinking around on the shrink or layer count increase side of things?
David Goeckeler
So the nodal transitions will — I mean BiCS5 is BiCS5, BiCS6 is BiCS6. That’s — those have all been developed over the last several years. It’s just going to be the intensity of what’s in the fab at any given time. And that’s all — that is all being worked through right now in a very detailed plan.
And so we have the ability to — we’ll start with looking at kind of bottoms up. What are each markets, what node do they require? How fast are they transitioning we’ll map that back into the fab and come up with the right mix. And there’s a little bit of trading off some older nodes for newer nodes, so we’re able to keep an eye on the cost declines as well as the bit growth. So it’s kind of a multivariable equation that we’re solving to make sure we get it right across all dimensions.
C.J. Muse
Got you. And how about on the HDD side. I think we had your large competitor here yesterday, and they’ve now cut their — or indicated that plans to cut utilization now twice. How are you thinking about running that part of your business?
David Goeckeler
I’ll make a general comment about it. I’ll let Wissam comment a little bit about the client restructuring we’re doing. It’s probably a little more fundamental. I think the HDD business is a little bit easier to go up and down. Although it’s a long development cycle, a lot of that is in the head. So once you build the head, it’s easier just to keep that and then the final assembly and test kind of take that up and down. I mean clearly, we do that on a quarter-to-quarter basis based on what demand is now. So there will be some under — if demand is down, there’s going to be some underutilization aspects of that business as well. But maybe Wissam can talk a bit about what we’re doing more fundamentally across the client business.
Wissam Jabre
Yes. So to mitigate some of the underutilization on the client side, we’re looking at — we’ve looked at the volumes where we were in fiscal Q4 and where we think the volumes are going to do over the next few years. And we’re in the process of restructuring our manufacturing capacity there, to reduce the capacity so that we — basically limit the underutilization or under-absorption costs. We should be done with this activity this quarter. I expect to start seeing some of that benefit starting next quarter.
David Goeckeler
Just one more comment on this because it is — it’s getting close to the NAND conversation in a little bit different way, which is — if we look at the HDD business, we are at this — we’re at the — we’re in the end stage of this 15-year transition of our capacity that’s been built from client to enterprise or cloud. And it’s literally been 15 years when I look at the utilization of all the different production facilities.
And you really kind of you kind of think about that in three different ways. You have actually heads, heads is a semiconductor process. We have two semiconductor fabs in California that produce those media, where we produce the media, the platters for the drivers and then you have all the final assembly and test. On the head side of it, that’s the first part where all the capacity is going to be consumed by cloud or enterprise drives. So on the head side of it, we’re actually looking to put CapEx into the business to be able to expand now to be able to support cloud growth.
The media piece of it, relatively balanced. We’re not quite there yet, but all the capacity we have, we’re going to need for the future or the number of drives we’re going to build for the cloud. Obviously, a 22-terabyte drive with 10 platters in it and 20 heads consumes a lot more than a client drive that maybe has a small fraction of that.
And then you have the final assembly and test where client, we just — the volume we produce is just huge, and that’s where we’re going to be restructuring and taking things down. So one of the consequences that we look at in the drive business now is very similar to what we talked about in the Flash business, which is we’ll look at how much CapEx we’re going to invest to actually increase our capacity in that part of the business based on where the business is today.
C.J. Muse
Makes sense. So I guess if we were to think about gross margins for HDD, I would think that tailwinds would be improved mix, reduced COVID pressure. Maybe headwind from the underutilization side, near-term costs related to the client HDD restructuring. What does that all kind of put together mean for gross margin trajectory from here? And what’s the time line to reach that 31%, 34% type of goal?
Wissam Jabre
Yes. So the 31% to 34% target is our long-term target, and this is really what we’re aiming for. And in addition to the various factors that you mentioned, obviously, we’re working on several others to basically improve the margin over time. There is that common — the commonalities in the business. So we’re looking at things like using the same heads for both client and capacity enterprise — drives, which basically reduces the number of the types of wafers that we need and improve the utilization, for instance, in the wafer fabs, we’re looking at common platforms from a hardware components perspective as well.
In addition to that, we are also focused on analytics and automation in our manufacturing facilities. And you also noted the portfolio and as we mix more and more towards the cloud, that would give us some tailwind.
C.J. Muse
And how about on the SSD side, I know it’s hard to pinpoint gross margins given the uncertainty around pricing, but cost downs is something where you have some visibility. I think implied cost down is rough [11%] down year-on-year for June. How are you thinking about the trajectory from there?
David Goeckeler
We’re committed to the 15% target. I mean every quarter is going to be up or down. We went through several quarters where we exceeded that significantly. We’ve now gone through a couple of quarters where we kind of caught back up in the other direction. When you look for the whole fiscal year, we landed right on the number we expected to land on. So that’s a number that has a long runway to it. It’s actually when we start the BiCS. When we started the BiCS6 design many, many years ago, it was an engineering requirement to meet that target. So we feel very good about the ability to meet that on an ongoing basis. Like I said, there’s going to be some quarters that are better. It’s going to be some quarters that are worse. But integrated over a multi-quarter period, I think we’re definitely comfortable with 15%.
C.J. Muse
Sounds good. I was hoping to now move to product cycle front. So enterprise SSD, I think your stated goal is to double your market share to 16%. And you alluded earlier to multiple hyperscale wins. So I guess, is there any way to kind of help us think about the cadence and breadth of these ramps and how we should think about integrating enterprise SSD kind of revenues into the model over time?
David Goeckeler
Yes. So we can talk about that a little bit more because it’s a fairly complicated market. I mean there’s many different enterprise SSDs in a hyperscaler. There’s boot drives, there are storage drives, there’s compute drives and we play in parts of those in different hyperscalers at different levels. So we feel really good about where we are in the portfolio, first of all. I mean getting over the hump of being qualified is a big deal. So we did that on our generation — our BiCS4 generation product. That was a product that was qualified at the first three hyperscalers and the OEMs. We’ve had good success with that product. We’re now transitioning to a BiCS5 based product.
So we go through the qualification process again. We’re in the middle of that now. That process goes a lot smoother than the first time, and it is going a lot smoother to the first time. So that will drive some lumpiness in the number in the near term because depending on where you are in the qualification cycle and the consumption cycle, you can see the number go up and down quite a bit. We saw that last quarter with 105% sequential growth. So now we’ll move to BiCS5 and while we’re going through the qualification, we’ll kind of dip down and then pick up again.
As we move into the BiCS6 generation, we’ll start expanding the coverage of the TAM. And we’ll, at that point, be able to build something for the compute swim lane per se of enterprise SSD. We’re right now in storage. So we will both increase the amount of coverage we have on the TAM as well as increase the number of customers that we have in the portfolio then that will drive the share gains.
And remember, we’re trying to gain share in a market that’s growing 30%, 35% a quarter. So when you do the math, that’s a significant amount of growth in the next three years.
C.J. Muse
And do you think the breadth of the wins that you have existing today is enough to get to that share target? Or do you need more design wins to get there?
David Goeckeler
Well, we’ll need to continue to execute in the parts of the — in the compute part of the portfolio. And then we’ll need to add the storage part of the portfolio we are now, we’ll need to add compute on to that as we — let’s say, as we move into BiCS6. So there’s definitely execution that’s required all across the whole three-year period.
C.J. Muse
Perfect. So maybe on the HDD side, you’re very bullish on 22 TB CMR. And I guess, can you speak to how you see that kind of flowing through the model? And can you also speak to the competitive landscape?
David Goeckeler
Yes. I think Look, this 22-terabyte CMR and the 26-terabyte UltraSMR product was really many, many years in the making. And I think — I think that our team did a really good job here. This was before I got into the business, right? There’s a long lead time on these plannings on — in this business, just given all the physical sciences involved in making hard drives work, very complicated space.
So I think the team saw that, look, when the industry gets to 20, there’s going to be an issue because we got to get from 20 — we got to get beyond 20. And given aerial density, the trajectory of aerial density, you start to run out of physical space. You can put 10 platters in a HDD, like the industry was at eight, you can see going to nine, finally went to 10. We’ve always led the industry in aerial density so we can get 2.2 terabytes per platter, so 2.2×10 is 22 terabytes. So how are we going to get to 2.2, first of all? That’s where we had to introduce technologies like ePMR, like so ePMR came in the ’16-’18 time frame, and it really wasn’t just for that generation. It was because we knew we were going to need it for future generations to get from 20 to 22 and 22 to 24 and so on and so forth.
Same thing with OptiNAND. We knew that to bridge this gap from 20 to 30 and 30 to 35 is maybe where HAMR technology was kind of targeted to come in. We’re going to be able — we’re going to have to build a better drive and innovate across parts of the drive technology stack to help us get bridge the gap. So OptiNAND came in.
Now we brought in UltraSMR. So SMR is a technology that’s been around for a long time. UltraSMR is really enabled with an OptiNAND drive in that, instead of SMR giving you 10% more capacity, UltraSMR gives you 20% more capacity. So that’s why we’re able to take a 22-terabyte CMR drive and turned into a 26-terabyte UltraSMR drive.
So we’ve had all of the sequence of technology that’s been developed over the last several years, and we’ve been layering it into the portfolio. And now that’s going to carry us from this — cover this 20 to 30, 35 gap and then HAMR will come in and then start pick up the portfolio and take it forward.
So we feel really, really good. This was a big focus two years ago, again, get the BU focused, execute this roadmap. And if we can execute this roadmap, we’re going to be in a really good position because we can see the industry is going to tap out at 20 and we’re going to have these steps now where we can move beyond 20 because we have all this other innovation we’re bringing in. And we’re not just counting on one big bet to fill the gap for us.
Turned out that was, I think, a brilliant strategy, very well executed, and it leaves ourselves in a position now where we have a very unique offer to our customers. We can offer them just a much better TCO proposition given all this innovation that we’ve developed. And I think that’s really the name of the game in any product company. You can innovate, you have the opportunity to go to your customers, you’re bringing them a better value proposition. That’s where we can get into things like value-based pricing and think about the portfolio differently than we have in the past.
So I think it situates us really well. All this will play out in the next year or so as these drives are all in qualification now. We’ll start to deploy at scale over the next couple of quarters.
C.J. Muse
Very helpful. So maybe a few quick kind of modeling questions, Wissam. How are you thinking about OpEx in this kind of uncertain environment?
Wissam Jabre
Yes. I mean, we’re — look, we’re — we’ve always managed OpEx very closely. We’ve always had good control over it. We’ve been disciplined in how we invest our dollars. When you look at the last couple of years, we’ve reduced our OpEx, but also — we also — you saw the rotation from SG&A into R&D. So we continue to do that.
In the current environment, we’re keeping even a more disciplined and stricter control on the spend. All the discretionary spend is pretty much reduced to a minimum. And we continue to focus on investing in the portfolio to — in the R&D basically to continue that innovation. But yes, it’s pretty much a very, very tight control.
C.J. Muse
And so should we be thinking OpEx flattish from here until things recover?
Wissam Jabre
I would say flattish, maybe a little bit down.
C.J. Muse
How about on the CapEx side? You kind of spoke to maybe a slowdown in the new capacity ramp. Does that change kind of the $1.6 billion cash CapEx guide for fiscal ’23 and/or the kind of normalized gross intensity of 8% to 10%?
Wissam Jabre
Yes. So the plan for FY ’23 was based on that 8% to 10% target for the company. And based on the near-term headwinds that we’re experiencing, we’re aiming to be lower than that. We’re — that the actions that we’re taking with our JV partners with respect to delaying some of the capital investments in addition to being very disciplined on the capacity enterprise investments in the HDD business. In order not to — not only not to overbuild capacity but also not to build capacity before we need it. So these two actions are very much focused on trying to minimize the capital investment for the year.
C.J. Muse
Makes sense. How about the IRS payment, $600 million, $700 million. Any update on the timing?
Wissam Jabre
So for the $600 million to $700 million payment, we’re still expecting it to happen in the fiscal year ’23, but there’s no real update on the exact timing. There’s some more work that’s basically still ongoing to get there.
C.J. Muse
Okay. And then on the tax rate, you guided 28% to 30% for fiscal ’23, a major step up from 12% in fiscal ’22. Obviously, it’s — it’s kind of scale dependent. When we get back to kind of a normalized environment, what do you think that the future tax rate looks like?
Wissam Jabre
So the increase in the tax rate relative to fiscal ’22 was driven really by a couple of factors. One is the tax law changes where we’re now required to capitalize R&D — certain R&D costs instead of expensing them and deducting them in the year they are incurred. So that’s the impact of that is approximately 12 percentage points. And then the remaining increase was very much due to the lower profit before tax that we’re anticipating for the year. And that’s based on our current tax structure.
Going forward, beyond FY ’23, expect us to see an improvement of approximately $30 million a year in terms of taxes. But if you sort of step back and look at it from an ETR perspective, if we’re going back to a normal time, we should still — we should be back into a, let’s say, high teens and work ourselves down to the low teens over time.
C.J. Muse
Perfect. So Dave, we have a few minutes left. I’ll leave you at concluding thoughts. What are some of the key messages that you want investors to take away from today? What are the key areas you think investors may underappreciate with regards to your story?
David Goeckeler
Yes. I just think there’s been so much change over the last couple of years with the pandemic. I came into the job right as the pandemic was starting March 9. I think the WHO declared the pandemic on March 11. My first official decision as the CEO was to send everybody home. A lot of change over the last couple of years and really a lot of change at Western Digital over the last couple of years. We are a very, very different company than we were just 2 years ago. As I said, about 70% of the executive team is new, and it’s all focused on — well, driving just that focus of execution on our innovation roadmap from — that’s really the first thing we focused on. Put a BU structure in place about two years ago now. It’s worked. It’s driven us to the point where the portfolio has never been stronger. The level of innovation we’re bringing to the market, I think, has never been greater. And we have a very, very balanced portfolio across all the markets that we serve.
And we have a very — a much more financial discipline in the company now about the way we manage it and how we think about managing the profitability. So — and also, we’re a much stronger company. We — as I said, we’ve retired a significant amount of debt, where we’ve achieved an investment-grade rating. So I think we’ve done a lot of work over the last two years and I’m really looking forward to playing the hand out now over the next couple of years as — we’re going through a downturn in the market, our goal is to execute better through the cycle and I think we’re set up to do that very, very well.
C.J. Muse
Well, best luck with that, and thank you both for joining us. I think we’ve run out of time.
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