Western Digital Corporation (NASDAQ:WDC) UBS Global Technology Conference November 29, 2023 1:35 PM ET
Company Participants
Wissam Jabre – Chief Financial Officer
David Goeckeler – Chief Executive Officer
Conference Call Participants
Timothy Arcuri – UBS
Timothy Arcuri
Good afternoon. Actually, it’s probably still morning, but good morning. I’m Tim Arcuri. I’m the semiconductor analyst here at UBS. As the next session, very pleased to have Western Digital, and we’re very pleased to have both David Goeckeler who’s the CEO; and Wissam Jabre, who is the CFO. So before I start to ask questions, I’m going to turn it over to Tom to read some statements.
Wissam Jabre
Thanks, Tim, and happy to be here. So we will be making forward-looking statements based on current assumptions and expectations, and I ask you to refer to our most recent annual report on Form 10-K and other filings with the SEC for more information on risks and uncertainties that could cause actual results to differ materially.
We will also be making references to non-GAAP financials and a reconciliation of our GAAP and non-GAAP results can be found on our website.
Question-and-Answer Session
Q – Timothy Arcuri
Great. Thank you. So let’s just start with the high-level topic. About a month ago, you made a big announcement of the business split after being immersed in a long strategic review process. Can you please help us sort of better understand how was the process? What elements led to the conclusion? And why was now a good moment to announce the spin?
David Goeckeler
Okay. Great. Thanks, Tim, and we’re very happy to be here. Thanks for hosting us. So it was a big announcement. We’re very happy to be here. We’re very excited about the direction forward. Over the last 3 to 4 years, we’ve spent a lot of time really focusing on putting ourselves in a position to realize what we think the latent value in these franchises is. So we’ve done a lot of work on restructuring the business, bringing in a new team to lead the business, including Wissam here, investing in our balance sheet, getting some long-term overhang things out of the way, like a tax settlement. So we’ve basically been structuring the business to operate better and get the most out of it. And I think we’ve seen that in the downturn. We’ve gone through a historic downturn, unfortunately. But in that downturn, we’ve seen all of the changes we’ve made in the business really paying off.
We’ve outperformed our peers in each business, and that outperformance continues to expand as we go quarter-over-quarter. So we feel really good about where the businesses are. They’re ready to stand on their own. They’re executing extremely well. We went through a very thorough strategic review, basically, very public. We’re going through a strategic review. We’re going to consider all options for how do we recognize the value in these 2 great franchises. And I think we ended up in a very good spot, which is we chose the solution that we think is going to, given the time in the business and all the changes we’ve made in the business and the way they’re executing that, it is going to let all of you, all of us realize the true value of those businesses and let investors choose which or both franchise they want to invest in.
They are different franchises from a capital return point of view, from an investment point of view. And so we understand that there’re different profiles for those businesses.
So why now? We went through a very robust process. A lot of people came to the table, a lot of ideas were discussed. And we chose the 1 that it is fully within our control to execute. We have the businesses in a position where we feel like they’re ready to stand on their own. We have the teams around them that can execute those extremely well as independent companies. And the market is improving at the same time. We’ll talk about that, I’m sure. We’ve gone through a historic downturn. The worst is behind us. It’s now just a question of how fast we recover. So we’re very excited about that. We think we’ve got the right strategic direction forward. And we’re very excited to go execute on that over the next 9 to 12 months.
Timothy Arcuri
Can you talk about some of the changes or some of the improvements in each of these assets that have occurred, having them under the same umbrella such that when you re-separate them, that these assets are independently better than they were prior to the combination?
David Goeckeler
Yes. It was really — so a lot of the changes we’ve made over the last 3 to 4 years, we’re about bringing a lot of focus to each individual franchise. They have to be — they solve the same problem at the end of the day, storing data, but they do it in very different ways, different customer buying patterns, different technology roadmaps. It’s really important that each one is managed as an independent franchise. So we’ve done that, and we’ve got to the point now where we put that focus around them. First is business units, and brought in general managers. So we make sure that any dollar we’re investing in the business, we get the best return out of that. We then moved on and separated the operational assets or kind of organized in a way where it’s easy to kind of take these apart. There clearly were some synergies in the current model around how we go to market about a little bit on the manufacturing and procurement side, but we think those are very manageable to overcome with the better execution and the better franchises we’ve just built over the last 3 years. And when you net it out, this is a better position for value creation going forward.
Timothy Arcuri
I guess a question for Wissam. Number 1, when do you think we can get more information in terms of the capitalization of these assets? And number 2, sort of what’s the guiding principle and the framework for sort of understanding how the cap structure for each of these assets would be constructed?
Wissam Jabre
Yes. So we still have a lot of work ahead of us to get there. And as we approach the date of the separation, we’ll be hosting an Investor Day to provide much more details and describe all of this, of course. With respect to the guiding principles, we aim to construct capital structures that would provide the ability for each of these independent publicly-traded companies to grow and invest on a sustainable basis for the long term. And so we would be looking at the growth opportunities as well as the changes in profitability for each of the business through cycle to help us inform how best to think of this as well as the capital allocation strategy for each of them being balanced based on the markets and the profiles of each of the businesses.
And so, for instance, when you look at the hard drive business, it’s a bit more resilient with respect to cash generation with more opportunities to delever. It’s got a good growth profile. When you look at the flash business, with much bigger need for capital, it’s much more capital intensive, it’s got much bigger needs to invest in technology. And so each of the businesses have a different profile, and those profiles will be informing the capital structure for each of them to ensure that they’re successful.
Timothy Arcuri
So is it fair just on paper to just look at — you have 1 major HDD peer. Is it fair to just take your drive business and say, okay, well, that business should have a similar balance sheet to that peer? Shareholders, I would think would want a dividend also for that business because, to your point, it can pay one. And you sort of apply that to the drive business and then whatever is left over goes to the NAND business. And obviously, to your point, the NAND business cannot shoulder as much if any debt as the drive business could. Is that a fair just high-level framework for thinking about how these 2 businesses will be separated?
Wissam Jabre
Yes. I don’t want to talk ahead of myself here. The way to think of it is the — we understand very well the competitive landscape for each of the businesses, and we will be — and we aim to construct cap structures and companies to be independent, publicly traded, very well competitive in their own sectors.
Timothy Arcuri
Great. Okay. David, let’s talk about SMR versus HAMR, and let’s just talk about just the broad environment of the technology roadmap and what customers want. Customers only care that they’re getting a drive in their existing systems, and they care about the capacity and cost. So can you just talk about your decisions around the technology roadmap that you’re pursuing?
David Goeckeler
Yes. I mean I think you got it right. I mean, I think, it’s — we feel like we have a very big obligation to our customers. Storage is 29%, 30% of the TAM of all data center spending. So it’s a big segment. HDDs are 85%, 90% of that storage. We don’t expect that to change appreciably over any time that’s forecastable. HDDs are — provide a very compelling value proposition for the bulk of storage in the cloud. They’ve got a long future ahead of them. And what our job is in the industry is make sure we have a roadmap on the technology that we can continue to deliver higher and higher capacity points at lower TCO. And if we can do that, then we — our customers stay happy, and we’re able to generate free cash flow and our investors are happy, and that’s kind of what we’re doing. So we think very deeply about that technology roadmap that sits between those 2 things.
You’re right. The customer wants the outcome, right? The customer wants the 28-terabyte drive or the 26-terabyte drive or the 35-terabyte drive when we get there, whatever it happens to be, what’s on the inside is less important. And I think if you look at what’s happened in the industry over the last 3 years, roadmaps have diverged quite a bit. The drives that each player in the industry is building are fairly different. We have put together a roadmap that is very — has very — a lot of levers of innovation in it over the last 3 years. So we first introduced ePMR, so energy assist into the read/write head. So that was a big innovation, right? That gave us more runway on our ability to drive higher density products. That technology is now fully commercialized. We produced it at very high yields, the right cost points to drive the right economics for us and the right outcome from our customers.
We then commercialize OptiNAND. That gives us a control point in the drive where we can like put more software in the control plane, get more density out. That’s what leads to UltraSMR, where SMR is a technology that’s been around a long time. It always delivered about 10% more capacity on a drive. With UltraSMR, we get 20% more capacity. So we’ve been layering in these innovations to give us a long roadmap of ability to continue to deliver to customers highly reliable, high-quality drives at higher and higher capacity points. That strategy has been playing out over the last 3 to 5 years. I think it’s very well constructed, and the results are very clear. We are able to deliver the highest density drives in the industry right now, and we have a long roadmap up until 40 terabytes on that technology that’s already been commercialized.
We’re going to continue to run that play. If you look at our profitability, we have the highest profitability in the industry, and that level of profitability has been expanding over the last 5 quarters. So the strategy is working. It’s working extremely well. And at some point, HAMR will be folded into that roadmap is another innovation point that drives us higher and higher. And when that technology gets to the point where it has the reliability and the ability to produce it at the right cost and all of those kinds of things, we’ll fold it in. And our calculus many years ago was we needed these other innovations in the roadmap to get to that point. And I think that, that calculus is playing out to be absolutely correct, and we’ll continue to drive our roadmap forward.
And I think the big picture message is HDD technology has a long way to go. We continue to deliver a very compelling value proposition to the most sophisticated data center operators in the world. And so we have a lot of confidence in the HDD business to continue to grow for us to continue to innovate and deliver a very good business. And again, it gets back to your first question, why split? Why now? Because we want that value to be recognized, and it’s going to give everybody out there the ability to invest only in that business. That business is a different business from the amount of investment required, the capital structure of that business, the expectations of the investor community in that business is different than the NAND business.
And so that technology is very long roadmap, very good customer base, and we have an enormous amount of confidence in the roadmap that we’ve put in place, and we’re executing every quarter to deliver that value proposition to our customers.
Timothy Arcuri
So I guess, is it right to think that — I mean, you’re trying to solve some very advanced physics and material science problems. And when these problems exist, you want to have as many levers as possible to optimize capacity. Is that sort of the overriding…?
David Goeckeler
That’s way should think about it. I mean the hard drive is a system, right? There’s a lot of stuff inside of it where you can innovate. And the more innovation levers you have, the more ability you have, more optionality to drive higher and higher capacity points. Obviously, the read/write is part of it. The number of disks, another part of it. The control plane and what you do at a software layer is part of it. There’s all different components of that. And we’ve built a drive and we built that system where we’ve got a lot of different levers that we can continue to pull and drive that roadmap for a very long time. And you’re right on 1 thing that’s worth saying is this technology is very long commercialization cycle. So you’re talking really deep physics, material science, these are things that take decades to play out and commercializing the market. And so having as many innovation levers as possible to be able to really instrument that roadmap to deliver a consistent level of capacity increases and TCO declines to your customers is extremely important because that’s where we get the returns in the business, right?
Timothy Arcuri
And is there an intersection point where you’d say HAMR, for you, intersects the roadmap at a particular density?
David Goeckeler
Well, I mean, I think it all depends on — HAMR is a technology that’s been in development for 20 or 25 years, right? And I think what we’re watching right now is the final couple of years of getting to the starting line of when we start to transition to that technology. And once you get to that starting line, that technology transition is years and years that takes you before that’s then the dominant technology. And so when we’re able to — when we have confidence in the technology we have right now that we can deliver this very strong value proposition to our customers, it delivers the right amount of profitability to us. That technology has many generations to go as HAMR can be folded into that roadmap and gets us better economics, then we’ll do that. We’re not at that point yet. We don’t need that. We’re not — the technology we have right now is very clearly commercialized and accepted by our customers. And like I said, the profitability, just look at the numbers, it’s showing up.
Timothy Arcuri
And in terms of the cost curve, is it fair to think HDD cost curve longer term is going to be mid-teens? Do you think that we can sustain that?
David Goeckeler
As far as cost down?
Timothy Arcuri
Yes.
David Goeckeler
That’s probably a little aggressive, but it’s negative, right? It’s like high single digit, double digit down. And I think that that’s plenty of cost downs to continue to deliver a better TCO and expand the market. I think storage is an interesting market, drive the cost down, you drive elasticity, people store more data. Our customers tell us all the time, we want to store more data. You make it more economical, we can store more data. The way we do that is we drive — we keep driving innovation that drives those costs down. And like I said, good news is we’re talking about innovation that takes decades to commercialize, and we’re approaching the starting line of — and we’re past the starting line on things like ePMR and UltraSMR. We got things like HAMR coming up. And I think our ability to execute that roadmap in a very consistent way will lead to very good proposition for our customers where it starts and a very good outcome for our shareholders.
Timothy Arcuri
And since you are in both the NAND business and in the HDD business, are you seeing — just given how much pricing has come down in NAND, you seeing particular parts of the market where SSDs are pushing into segments of the market because and pricing has come down so much that it’s beginning to cannibalize HDD faster because NAND pricing has actually come down so much?
David Goeckeler
No, we’re not — I mean NAND is a great technology, right? There’s always new use cases for NAND. There’s always ways you can innovate in NAND and build clever systems that you put in parts of the market that deliver great value propositions. We’re huge proponents of NAND that is not coming at the expense of HDDs. HDDs are still bulk storage. It’s still the primary storage medium in the cloud, right? The part where it was a substitute was on the device side of it. And that substitution has been happening over the last 15 years, and we’re kind of at the end of that period, right? Not very many people buy a laptop anymore that have a hard drive in it. That’s all client SSDs, that’s fantastic. But if we look at just exabyte — the deterioration of exabyte in this downturn, nearline and enterprise SSD are about the same. In fact, I would say on the NAND business, one of the surprising things maybe to a lot of people in this downturn is going into this downturn, enterprise SSD was seen as the best market in the NAND business, like how fast are you going to get in there?
It’s the part of the market that suffered the most in this downturn, right? I mean we’ve essentially lost 3 years of growth on enterprise SSD compounded growth rate if you just look at exabytes deployed into hyperscale data centers. So I don’t see that mix changing appreciably. They’re complementary technologies. They’re both great technologies. They’re both growing. There’s no doubt the demand for NAND is growing a little bit faster than the demand for HDDs, but that’s okay. They’re both growing.
Timothy Arcuri
And you think the right longer term — we always try to zero on what the mass capacity market is going to actually grow at. What do you think the right long-term growth rate is for that market in terms of exabytes?
David Goeckeler
I think it’s mid- to high 20s, but it’s a little bit TBD with AI. We don’t know yet. I mean, AI is just being deployed. We’re at the point of AI now where we’re basically, the cloud is gearing up to make all of us enabled in everything we use every day to have AI capabilities. And I think — I mean, I think it is a beautiful thing about the cloud distribution model of software like the cloud brings all of this technology to all of us. We can all access it. And I think once that happens, we’re going to see — I think it’s going to be a tailwind for data growth in general. One way to think about it is like there’s an enormous amount of investment going on right now to automate the creation of data even more than it is today.
And so I think as you look at the market now, I think we’re in a mid- to high 20s growth rate on exabytes. I think we’ll see once we get this technology deployed, it’s kind of a second wave beneficiary is the way I would think about it of all the AI deployments.
Timothy Arcuri
Yes. I mean the bear would say — and I have these discussions with investors all the time, the bear would say, well, if you look at the last 5 years, the — I mean it’s fluctuated massively, but the CAGR has been in the mid-teens. It’s been 15%, 16%, if you look at it over the past 5 years. So if we’re in the mid-20s, that sort of already embed — yes. I mean AI ought to accelerate the market, but that’s kind of a long way from where we’ve been in the past 5 years. That’s what the bear would say, but…
David Goeckeler
Yes. Well, CAGRs are very dependent on the endpoint, right? So if you pick like we’re in a historic downturn. We’re coming out of a pandemic, where there was a lot of inventory creation. We went into cost of capital going out for the first time in 15 or 20 years. There’s like all kind of distortions on the market. If you pick that as the end point, you’re probably going to come up with a CAGR that’s lower than what if you draw a longer trend line from — we encourage people to draw a trend line from well before the pandemic, through the pandemic, we’re going to return to that kind of line. And I think it’s very exciting for the industry right now. We’re — that recovery is on. The question is now how fast is it going to happen?
We’re seeing — we’re past the bottom in both businesses. NAND prices are increasing, NAND demand is — we first saw demand increasing. Now we’re seeing pricing increases. Exact behaviors you want to see in the HDD business. We’re seeing demand come back. We have more visibility. We’ve talked about it now for a quarter or so. We expect sequential improvement as we move throughout the year. We’re not back to where we need to be yet, don’t get me wrong. We’re not happy with the numbers, but the trajectory is now in the right direction. And we’re coming off a historic low position. So I don’t think we know what the — completely know, especially in NAND, what the recovery is going to look like just yet, right, because we’re coming off a very low point.
But very clearly, in that industry, we need to see a significant recovery in pricing for the investment to come back to the business. And the overall demand picture isn’t changing, right? We’re not using technology less than we did before. We’re using more technology than we did before. So it’s not like we’re fundamentally not going to need the technology in the future. So the — we’re going to return to the trend line, question is how fast. And to your point, what is the trend line?
If you pick different points, you’re going to come up with different numbers. But I would encourage people not to pick the last year as the ending point and then go back a couple of years and draw a line between just those two.
Timothy Arcuri
Got it. It does seem you just — we haven’t talked about NAND yet, but you did just mention NAND. And it does seem like things are coming back a little faster in NAND than they are in HDD. And so I wanted to ask sort of where you think we are in NAND? I know you did say that NAND inventories are at a 4-year low. And I think there’s still some confusion because we still see there’s still $80 million worth of underutilization charges yet. Inventories are at are at 4-year lows. I understand that we’re in the early phases of things getting better. But can you just talk about NAND? And it seems to me like the business actually is coming back pretty quickly, actually, if you look at pricing?
David Goeckeler
You want to talk about timing of underutilization charges a little bit because some of that is the timing issue?
Wissam Jabre
Yes, exactly. Some of the — what you’re discussing is timing issues. We’ve always — over the last several quarters, we’ve been focused on managing the supply of our products in a very dynamic way. We look at where the demand for the products are versus where the inventory is, and how we manage also our cash flow. And so this is where, in many respects, that really paid off. By the end of September, we were at the 4-year low from the days of inventory in the flash business. We’ve seen approximately $400 million reduction in inventory in that quarter alone. And so as we sort of — as well provided for in terms of visibility for this quarter, we continue to see that underutilization because we continue to manage the supply of the — basically the fab outputs or the wafer starts in a dynamic way.
Timothy Arcuri
Cracking the back on.
Wissam Jabre
Relative to where we see the demand of the products. Yes, the plan isn’t really to sort of crack it back on completely. The plan is to continue to manage it in a dynamic way as we see where inventory looks like — what the inventory picture looks like and where the demand of the — of our products is.
David Goeckeler
So let me talk about the pricing a little bit to your question. So we’re in a point where the market has turned. And so there’s a wide disparity of pricing because there’s — it’s a big market, and it moves at different paces. So there’s everything from markets where people just sell wafers, right, which the price can change every day or even multiple times a day to pricing for retail products where price — again, price and promotion happens constantly to channel business where you can change the price every week, to OEM business where you negotiate it every quarter, to some customers have year-long contracts, a small number but there are some of those customers. So when the market starts to turn, you see the pace of each of these markets move. They move at different rates because they’re negotiated at different times. And so there’s no doubt what the — the trajectory is now going in the right direction. The question is how fast is it going to ripple through each market? And the further you go on that on the more liquid markets, they’re moving very, very fast. And now the question is how fast is that going to translate into, let’s say, the quarterly markets?
And we don’t know yet. But what we do know is we’re coming off of a very low point. And so they have to increase a significant amount to get back to what would be typical through-cycle margins. And you’re going to want to get back to typical through-cycle margins before you start to invest a lot of CapEx back into the business. So the prices have to come back a significant amount. I think peak to trough, they’re down over 50%. So very clearly just back to where you were, you had cost down, which is another way to think about the market, but you got to come back a significant amount.
And so we’re now in that process. I think that process will play out over the next several quarters. We’ll see how fast it goes, right? But in general, the recovery is on. And now it’s a question of the magnitude of it.
Timothy Arcuri
So I just wanted to — in the last time here, I wanted to talk about your NAND roadmap because you’ve always done a really good job. And on a per wafer basis, you spend way less than what your peers do from a CapEx perspective, and yet you’ve always had very, very competitive costs. So can you talk about what’s the magic there? I mean you have more of a — I kind of perceive it to be more of a brownfield approach versus a greenfield approach. Samsung, for example, takes a greenfield approach, you take more of a brownfield approach. But in answering the question, can you talk about the transition from BiCS6, which is a fairly small portion of your bits, and it seems like you’re going to jump to BiCS8, which optically you say, well, to go from a 112-layer to 3xx for BiCS8 is a pretty big jump in terms of technology. So how do you help investors sort of mentally think about mitigating the risk?
David Goeckeler
2xx, so 162 to 218. So look, but your question — the first part of your question, this is where the JV is so important. Like we invest as the largest player in the market, right, because Kioxia and ourselves, we have 1 R&D team, we have 1 technology roadmap. That technology is the foundation of our NAND business. If you get it wrong, if you get the costs wrong on that, it’s very hard to make it up on the product side of it. We’ve developed, I think, 17-plus generations of NAND. I mean, Kioxia invented NAND. So we have a team that has been doing this for over 20 years, and that team has had a very explicit goal of minimizing the amount of CapEx required to get incremental output, right? That’s a design goal when you go into this, right? So it’s not just how do I get the most bits, it’s how do I get the most bits at the least amount of CapEx with the right cost down. You got to get all 3 of those variables correct. We spent a lot of time thinking about that and have it as explicit design goals.
If you look at over like the last 5 years or so, you look at the numbers, to your point, we spend like 1/3 less than industry average on the amount of additional CapEx we put into the business. That’s a very, very good thing, right? That showed up a lot in the downturn, right? Our margins were significantly better than our peers.
So why do we do that? Because it’s a design goal. We’ve got a team that’s been doing it for decades, and we’re able to invest as if we’re the largest player in the market because of the JV, right? That is the magic behind the JV. We get economies of scale of being much larger than we are. And that’s why the JV is so important, and that’s why the JV has gone on for 23 years. And that’s why the JV continues to be very, very healthy.
Timothy Arcuri
Yes. I guess my question was more — my BiCS6 to BiCS8 question as well. BiCS5 is the workhorse right now for still to the production. And so it seems — it’s a mentally big leap to go from BiCS5 being the bulkier production to then say, okay, I’m going to go to BiCS8 so?
David Goeckeler
So how are we thinking about that? So BiCS8 performed extremely well ahead of schedule, very great innovation, wafer bonding, a lot of great advantages of that if we had more time we can talk about. So usually, in the portfolio, you move the entire portfolio forward now node to node. Like everything is on BiCS5, you need everything to BiCS6, then you move everything to BiCS8. Because BICS is ready, and performing so well. We’re making more strategic decisions about what part of the portfolio to take to BiCS6 and what part to just go from BiCS8. So you do that by product by product, by client SSD in a certain part of the portfolio, enterprise SSD products, products for gaming, which ones are you going to take to BiCS6, which one are you just going to go to BiCS8. So it’s more of — as opposed to a whole — the entire cohort moving forward, kind of more of a hopscotch approach. You move some parts of the portfolio here, you take some parts of the portfolio up there.
Timothy Arcuri
Got it. Well, we’re out of time. Thank you to both of you. Appreciate it.
David Goeckeler
All right. Thank you. We appreciate your time.
Timothy Arcuri
Thank you, both.
