Western Digital Corporation (WDC) Presents at Morgan Stanley 2022 Technology, Media & Telecom Conference (Transcript)

Western Digital Corporation (NASDAQ:WDC) Morgan Stanley 2022 Technology, Media & Telecom Conference March 10, 2022 5:25 PM ET

Company Participants

Wissam Jabre - Executive Vice President & Chief Financial Officer

David Goeckeler - Chief Executive Officer

Conference Call Participants

Joe Moore - Morgan Stanley

Joe Moore

Great, well save the best for last.

David Goeckeler

Thank you.

Joe Moore

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

Wissam Jabre

Well, I will first read Safe Harbor agreement -- statement. So let me just ask Travis to hand me the --

Joe Moore

Actually I have here.

Wissam Jabre

Sorry.

Joe Moore

It’s okay.

Wissam Jabre

Thank you.

Joe Moore

I need that back.

Wissam Jabre

Of course. Thanks, Joe. Sorry about that. So we will be making forward-looking statements and I asked you to refer to our SEC filings for the risks associated with these statements. We will also be making references to our non-GAAP financials and the reconciliation to our GAAP, and non-GAAP results can be found on our website.

Question-and-Answer Session

Q- Joe Moore

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

David Goeckeler

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

Wissam Jabre

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

David Goeckeler

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

I think it’s a good time to look back on this. Actually, yesterday was my anniversary of two years in [Multiple Speakers]. Yeah, exactly. I think it’s working. I mean, the year before I joined calendar year ‘19, the company delivered $1.30 in EPS; last calendar year, we delivered $7.96 and another $195 million in COVID costs. So if you take -- so a lot of headwinds around cost, so we are performing better. We’ve upgraded the portfolio, we structure the company better. One of the things we did, as you know, is we split the product portfolio in two, put business units in place, brought general managers in so they could really focus on executing and driving the right roadmap decisions for the portfolio. And I feel like our technology roadmap is just in a vastly better position, which we can talk about more detail.

So I feel good about where we’re positioned. We’re not done. Nobody is putting up a mission accomplished banner on the work we have to do. But I feel like we’ve got the team in place, we’ve got the structure in place, we’ve got the portfolio, we’ve got the routes to market, and we’ve got the customers to really execute and get everything we can out of these franchises.

Joe Moore

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

David Goeckeler

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

Wissam Jabre

Yeah, of course. And so the updated outlook is non-GAAP, and that it basically does not reflect or excludes around 250 million or so of charges related to the contamination event itself. And so that’s -- that would be reflected only in GAAP figures. We could expect it to be this quarter.

Joe Moore

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

David Goeckeler

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

Joe Moore

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

David Goeckeler

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

Joe Moore

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

David Goeckeler

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

Joe Moore

And I think the capital efficiency is always a point that gets lost here today. Since the SanDisk IPO, the negative story has always been that CapEx is too low relative to competition. If you could hold share for 20 years with CapEx being too low, that’s [phonetic] being a bad thing. Can you talk a little bit, you mentioned the SSD portfolio, I guess I know, you’ve done a lot to rebuild enterprise SSD, but your share probably still isn’t quite at the target level. You know where do you stand with that?

David Goeckeler

So the explicit goal of the NAND portfolio is to give us as much optionality as possible, where we place our supply. And then if you have a lot -- if you have as much optionality, given in the OpEx envelope, we have to spend on it, but you have the most optionality, then we can mix the portfolio where we get the greatest return. And we have some very, very fundamental and strong parts of the portfolio. Our client SSD portfolio is very strong, very good position. Again, I think that’s a result of the synergy of the company. That’s been a complete transition of client SSDs to client flash -- our client hard drives to client flash. The company has played that transition extremely well and parlayed that into a very strong position in client SSDs, the foundation of the portfolio. We have a strong position in consumer. It’s always good to have a captive franchise in your portfolio. The SanDisk brand is very, very strong. We have a strong position in mobile. Gaming has been very good for us. But the one pillar of the portfolio that we needed to build out was enterprise SSD, it is a big TAM, it’s an important TAM.

Just like on client, where our customer was transitioning from a drive to NAND, in the data center, we have the opportunity where they’re highly complementary technologies, they’re not substitutes. So both drives and flash are going to be consumed in a significant way in the cloud and at the big cloud customers. And our opportunity is really to get that enterprise SSD product to a point where the biggest data center customers in the world trust our technology. We build our own controller. It’s been a big goal of mine since I came here and I think, really, calendar year ‘21 was a breakthrough for us. We started the year with a qualification -- with our first qualification at one of the big web-scale players, we deployed throughout the year at that player. As we went throughout the year, we qualified at the second and the third and then also two big enterprise OEMs in the storage space.

So we walk into calendar year ‘22 with qualifications, three web-scale players, two big OEMs, whereas we walked into ‘21 with only one web-scale player. Now, so we’re building out that part of the portfolio. It’s a multi-step story. I think our share last time I left was around 8%, so you might ask why isn’t a higher because you have all these qualifications. Well, now we need to get to BiCS5, right. Now we need to take the step this year, we have the qualifications. Now we get the controller on BiCS5, we have more bits, and then we’ll start to see the share ramp again. So it’s a multi-step story. The qualification is the big piece of that and we feel very good about where we’re at.

Joe Moore

Great. And then you talked about starting price negotiations for the less transactional parts of the business. And what’s your general sense of the state of NAND right now? How much inventory do your customers have? People have seemed -- other than a brief window round Chia, people have seemed comfortable with their ability to procure NAND. Does that mean they are not holding as much inventory, there are other things, just your general assessment of what the setup is for those negotiations.

David Goeckeler

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

Joe Moore

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

David Goeckeler

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

Joe Moore

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

Wissam Jabre

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

Joe Moore

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

David Goeckeler

The contamination issue is resolved. It is not light of sight, it’s resolved, it’s remediated, we know what the root cause is, additional checks have been put in the process. So if we should get some material into the FAB, we would know it ahead of time. So feel very good about the work that’s been done by Kioxia and our team to get that under control.

Joe Moore

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

David Goeckeler

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

Joe Moore

Yeah. I mean, you did have one headwind that I sort of didn’t expect market share was just at the capacity, enterprise market strengthening so much early in the year or market you have your exposure to.

David Goeckeler

So the performance enterprise.

Joe Moore

Performance enterprise.

David Goeckeler

Yeah, we definitely have a -- versus some of our competitors, we have a mix. There’s parts of the TAM we don’t address. That performance enterprise market, the company exited three, four years ago.

Joe Moore

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

David Goeckeler

Yeah, so a lot of very good work over the last 18 months. And I think it’s a reflection of a larger trend that’s going on in the market, which is the drive industry is returning to growth, because everything is moving to enterprise and capacity enterprise drives. And over the last decade, we’ve seen this fall off of clients and the economics of the industry were defined by the fact that there was a lot of invested capital that had to be absorbed. We’re coming to the end of that era. And I think you’re seeing a bunch of elements in the market that show that margin has improved over the last four or five, six quarters. We having more long-term agreements with our customers where it used to be quarter by quarter, a lot more discussion of CapEx investments and being disciplined about CapEx investment in the industry. And so I think all that showed up in better margin in the product, which is what we were focused on.

Now, we’ve had the costs kind of coming up faster than we can absorb. It started with COVID costs and logistics costs and now we have component costs on top of that. So we’ve got a couple quarters here where we’re going to see the numbers back down below 30. And we’re very focused on a bunch of different levers that can get them back which is -- I mean, start with innovation, like continue to innovate, drive better TCO experience, better yields on the product, all those kinds of things is always a thing you focus on to get more margin. Focused on the cost side, really spending a lot of time, getting closer to our suppliers and getting more predictability of supply, it’s not just getting supply; it’s getting supply in a linear fashion to keep the factories on a smooth operation. When you’re vertically integrated like we are, you can’t have like one quarter that’s way bigger than the others because you can’t -- you’re just not set up that way. So getting the linearity back into it and then we’ll work on price as well, to see if we can pass some of this along to our customers.

Joe Moore

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

David Goeckeler

I think we have to, yeah, yeah.

Joe Moore

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

David Goeckeler

Yeah, I mean, I’m really excited about our HDD roadmap, I think the team has just done tremendous work. You’ve been seeing a series of innovations that together add up to a roadmap to 30 terabytes. So first one was energy assist, it was really important to get that commercialize. That had been in the labs for almost two decades, people working on how do we build more areal density using energy assist. The fact that we have that out there and commercialized now at scale is a big step. We’re over 2.2 terabytes per platter as far as what we can put on a drive platter, which is a very good spot to be that allows us to deliver 20 terabytes on nine platters.

Then you had OptiNAND, which is a new control plane that allows us to have more control over the drive, get more efficiency out of that. And then the third step of that is going to be SMR, which is a new way to shingled magnetic recording that requires some work on the host side and we’re seeing customers now really start to adopt that. And when you put those three technologies together, it allows you to have a roadmap to ‘22, ‘24, ‘26, ‘28 that we feel very, very good about.

In fact, SMR is going to give you 10% to 20% more capacity on a drive, and is when the drives get to 20 terabytes, that’s significant. And we’re seeing very good adoption now on SMR, where if you go back a year ago, it wasn’t quite there. We expect to exit this year with about 20% of our exabytes on SMR deployments, so that’s really good adoption and that’s going to drive the industry to fill that gap between 20 to 30. And when you get the 30, you need Hammer technology to come in and carry it forward. So we’re heavily invested in Hammer as well. And when we need that technology, it’ll be there, but we’ve got line of sight to many, many steps to deliver, not just more density to our customers, but as we go to a continued better TCO equation.

Joe Moore

Okay, great. So I do need to ask, I’ve been trying to pull companies, any issues with Ukrainian supply chain whether neon gas, palladium from Russia, anything like that, that you can see impacting you?

David Goeckeler

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

Joe Moore

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

Wissam Jabre

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

Joe Moore

Right, yeah. It definitely seems like you guys have done a great job putting the company on a stronger financial foundation.

David Goeckeler

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

Joe Moore

Yeah. And it was like six quarters ago, I was writing notes about that you guys wouldn’t preach covenants and now you’re much, much.

David Goeckeler

Hopefully, you’re not going to write that. I don’t think that [Multiple Speakers]. We are really -- I’m very anxious. Having lived through the last two years and getting back to a capital return policy, we want to get to our target debt levels, but we do believe that the company -- I talked about the results at the beginning, going from $1.30 to $7.96 of earnings over two calendar years, we do believe the company has better through cycle earnings potential than it did two years ago.

Joe Moore

Yeah. And you have made some tough decisions. I mean, you suspended the dividend, which was a well-thought out thing and I think it’s allowed you to put the company in the stronger position now. If there’s any questions from the audience? No. So if not, maybe you could just summarize, is there anything that we missed that I should have asked you about and any key messages you want people to take away?

David Goeckeler

Okay, I think I’ve said it a couple times. I really feel good about where the business is. I think we’re executing much better. I think the technology franchises that we have -- I think in any technology company, it starts with your products, and your product roadmaps and how you’re investing in technology. That’s why when I went to restructure the company, I started with general managers to make the right decisions about our portfolio, I think that has worked. Like I said, I think our ACD roadmap is very, very strong. I think that the breadth of our NAND portfolio is as strong as it’s ever been and that gives us a lot of optionality in the future. And then our just the foundation, the company is in much better position. So I feel good about where we’re at.

I think when we look at it from a macro perspective, from demand, we look across our markets, we continue to feel strong about the cloud. Our customers give us good signals throughout the year. The PC market is doing well. I think we were maybe even a little stronger than we were expecting. After an extremely strong year last year, 5G continues to ramp, enterprise storage is looking better. So I think when you look at across the markets we serve, the customer relationships we have, the breadth of the portfolio and just where we are, as I think about the difference of where we were going into calendar year ‘21 versus where we were going into calendar ‘22, we’re in a much, much stronger position and look forward to a very, very good year.

Joe Moore

Great. Well, thank you very much.

David Goeckeler

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

Wissam Jabre

Thank you. Thanks, everyone.