Western Digital Corporation (WDC) TD Cowen 52nd Annual Technology, Media & Telecom Conference (Transcript)

Western Digital Corporation (NASDAQ:WDC) TD Cowen 52nd Annual Technology, Media & Telecom Conference May 30, 2024 9:05 AM ET

Company Participants

Peter Andrew – VP, Financial Planning and Analyst and IR
David Goeckeler – CEO

Conference Call Participants

Krish Sankar – TD Cowen

Krish Sankar

All right. Good morning, everybody. I’m Krish Sankar, the TD Cowen analyst covering Western Digital. We’re very fortunate enough to have Dave Goeckeler, the CEO and also Peter Andrew, Head of IR for Western Digital. I’ll pass it on to Peter to give some forward-looking statement disclaimer, and then we’ll go to Dave for the meat and bone.

Peter Andrew

So first, thank you very much for having us today, Krish. Let me just read a quick statement and then we’ll get right back to Q&A. During today’s conversation, we may be making forward-looking statements based upon management’s current assumptions and expectations. These forward-looking statements are subject to risks and uncertainties. Please refer to our most recent financial report on Form 10-K and or other SEC filings for more information on the risks and uncertainties that could cause actual results to differ materially from our expectations.

We will also be making references to non-GAAP financial measures, and a reconciliation between the GAAP and the non-GAAP financial measures can be found on our website. So, with that, let me turn it back to you.

Krish Sankar

Awesome. Thanks for that, Peter. And Dave, again, thank you very much for your time. Great to be here.

David Goeckeler

Thank you.

Question-and-Answer Session

Q – Krish Sankar

So clearly, it’s exciting time for Western Digital. A lot of things happening. You’re beginning to see a cyclical recovery in the business, you’re beginning to see some products take traction. Obviously, some special situation even is going to happen, things like that. So purely from the fundamental business side, I’m kind of curious, you begin to see demand start improving, pricing has been pretty good for a couple of quarters now. How to envision that for the broader business, both NAND and hard drives, and we’ll get into the specifics? But when you look through the rest of this year into next year, is there a way to think about demand versus price or one superseding the other?

David Goeckeler

So yes, I mean, we feel really good about where the business is. I mean, we can talk about the market we’re in and kind of the cyclical dynamics of that. But it really starts with the product portfolio. And I think if you look across both businesses, our product portfolio is in the best shape it’s ever been and it’s resonating very, very strongly with the market. If you look at HDD business, I think our ePMR, UltraSMR strategy and the drives we’re building are the lowest TCO, highest capacity products in the industry. That being very well received by customers that led the last quarter.

We now have the largest, fastest growing and most profitable dry business in the industry. So that’s a great place to be as we go into the second half and look forward to ’25 in the cyclical demand recovery we’re seeing. We’re seeing that demand come back into strength for our portfolio. Feel really good about the way we manage the downturn. It was kind of I don’t know what the best word is historic, but deepest we’ve seen in a long time, whatever you want to call it. But we were able to manage through that and also keep a firm eye on our investment and make sure we emerged with a very, very strong portfolio.

And on the Flash business, again, we’re now launching and I think going to lead the QLC transition and client SSDs. We have an emerging enterprise SSD portfolio where we did a lot of work before the downturn that now as that market comes back and I’m sure we’ll talk about that in a little more detail, we think we’re well positioned. Obviously, the consumer franchise and the SanDisk brand is still very strong. So, we feel very good about where the portfolio is and we’re seeing a cyclical recovery in the business. I think for us, we’re coming back into strength on the product side and we’re coming back into a business where we’ve reset the cost structure and we’ve taken some a lot of fixed costs out of the business and you’re seeing that we’re able to drive more profitability at lower revenue points.

So, we feel very good about going forward and looking into the second half where we continue to see good supply demand dynamics in both businesses, balance to tightness I would say in both businesses. And it’s just in general, we feel good about the results we’ve delivered. I think we’ve delivered best-in-class results in both businesses and we feel good about that going forward as well about how we’re positioned.

Krish Sankar

Got it. That’s very interesting. And if you look at like both the business over the last six months, it looks like the hard drive business troughed around August, September, NAND pricing troughed around August timeframe. It seems like on the NAND side, you’ve seen a very strong velocity in pricing improvement while hard risk has been much more measured, I would say since that cyclical trough. I understand forecasting this is very difficult into next year. But if you had to take an educated guess, I mean, do you how do you expect the momentum for both those pricing to continue?

David Goeckeler

Yes. So first of all, on the premise of your question, I mean, we in NAND, we were clearly, I mean, peak to trough, we were down over 50% on pricing. So, when you’re down that far, you got to see 100% pricing increase just to get back to where you were. So, it’s not surprising we had a stronger snapback than maybe you would have seen in other cycles where you weren’t down so low. And you’re right, it’s notoriously difficult to predict the cycle in this business. And the way I think about it, I’ll get back to your question.

But the way I think about it is what we’re trying to do in the business is we’re trying to have the best, most diverse product portfolio. We’re driving to have the lowest costs in the market as well. Like that’s really, really important in a market where it has commodity like pricing dynamics, not commodity products, products were very, very sophisticated, but kind of commodity like pricing dynamics, making sure you have the lowest cost position is always a very, very strong strategic position. And I think we have that in both markets. We can explore that in a little more detail.

And then build enough agility into the company so that we can respond to the market at the pace that it’s moving. And we’re in a market that moves very, very quickly. Sequentially, we see significant price changes in our market. So, it’s important for us to be able to move faster than the market. And that’s something we’ve done a lot of work on over the last three or four years is reorganizing the company, putting that agility in the system, get our costs in the right spot, get the portfolio in the right spot where the products are very attractive and then run that model and deliver the best through cycle profitability no matter where we are in the cycle. And I think we saw that in the downturn. We performed very well in the downturn and I think we’re seeing us perform very well as we come out of that.

Now going in, like you kind of preface your question, it’s very difficult to predict this market and we don’t like to talk about future pricing all that much. But it’s clear that the market is tight, right? We do see tightness across both markets. And I think in HDD, that’s probably a more fundamental situation where we aggressively took fixed cost out of our business in the downturn. So, we have, I think this is an industry that’s been going through this client to cloud transition for well over a decade. And the client business is where we needed the industry or just us needed to produce hundreds of millions of units to go into a market where you need to produce tens of millions of units. And that transition has taken a long time.

And I think we’re now the kind of downturn was finally like took just took the cost out of the system. We’re now ramping back as demand returns into a much more balanced environment where the ability to produce is more aligned with demand on an ongoing basis. So, I think that’s where we want our business to be. We want that balance in the business and I think we’re seeing that as demand ramps back.

And in the flash business, I think we’ve gone through several phases of the recovery. The first phase of the recovery was all the inventory on the supplier’s balance sheets moving off. That happened relatively quickly. We’re now in a phase where more fab utilization is coming ramping back up to meet demand. As we work through that, we’re going to get into the phase of more capacity is going to be required for more supply. And that’s an area where if you look at the amount of CapEx that we’ve been putting in the business given the downturn has been quite depressed for quite some time.

And we cut our CapEx 30% in FY23. We cut it another 50% in FY24. So, and that’s where we’re going to need to see better long-term profitability for that investment to come back. And so, I think we’re going to see how that plays out as we go through the second half and through ’25 about how this shapes up as a long-term demand situation to see how much when and if and when and how much CapEx will come back into to increase the supply.

Krish Sankar

And actually, and I think, Dave, you’ve been very vocal about this, about a disciplined CapEx, especially not just for you folks, but for the industry in general, given how deep the cyclical downturn was last year. And it seems like so far both you and your peers are being very disciplined in supply additions on the NAND side. How much of that do you think is some of your competitors so much focused on HBM that they’re not investing in NAND or do you think they’re both mutually exclusive events?

David Goeckeler

I can only manage our business. So, I don’t, it’s hard to talk about what the industry is doing. Other people are making different calculations for their business. But I think some of the dynamics I think we’re seeing in the downturn in the NAND business. NAND is an interesting business because on one side, there’s a lot of elasticity.

And if you drive the cost down, you’ll see more absorption and more demand. And then on our side of it, there’s still it’s a part of the semiconductor ecosystem where Moore’s Law, if you want to call it that is alive and well. We can produce a new node and we get 50%, 60%, 70% more supply for the same wafer. So maybe in the 2D era, you could just continue to roll the nodes forward and the market was just absorbed. There was enough elasticity to just continue to absorb all of that additional supply.

In the 3D era, I think maybe one of the lessons that we take from the downturn is it’s too easy to oversupply the market. You can ramp these big nodes forward. They take a lot of CapEx, but they also produce the scale of the industry is much larger now. So, they produce an enormous amount of additional supply. So how we think about that equation has to change and you can’t, the way we think about it is changing. You can’t just rely on this elasticity question is going to eventually absorb everything that you produce.

So, the way we’re looking at the market is trying to really understand that long-term demand a little better, much more bottoms up kind of analysis of all the big markets go through smartphone market, the PC market, the data center market, the gaming market, the IoT market, automotive. Look at all of it, look at what demand is going to be in the future, model that, predict it and have that guide how you’re going to invest more in this business and not just roll the nodes forward because you can.

Krish Sankar

I do remember, I think you’ve spoken about your technology roadmap, like BiCS 6 and then answer going to BiCS 8. And if I go back, look at like, I think a couple of years ago when you did the Analyst Day, for the time, one of the goal was to increase ESSD share. It seems like you’re progressing in the right direction. I don’t know whether you still hit the target of 20% or something. Maybe it’s a longer-term target. But how much of that is predicated on BiCS 8 versus how much of it is more driven by the end market cycles and things like that?

David Goeckeler

It’s not dependent on the nodes, right. So, we qualified our enterprise, NVMe, enterprise SSDs at multiple web scale providers just in time for the market to go into a downturn quite frankly and then they stopped ordering. Now the good news is as we go into the second half, we’re seeing that demand return, which is good. It’s kind of the last market I think where the inventory correction is coming to an end. As you said, we saw it in capacity enterprise HDD. Now enterprise SSD has been a couple of quarters behind that. But we’re starting as we go into the second half, we’re starting to see that demand return. That’s going to be a good tailwind for us as that portfolio still is qualified to those customers and we’ll have a chance to start to ramp those sales.

We also have a new product on the market, which is more we think compute focused PCIe Gen 5 enterprise SSD that was built for one of the web scale players, but we’re finding much broader adoption for that now as the AI. There’s much more AI demand driving enterprise SSD. We can talk about that in a little more detail. But as we look into the second half, we see enterprise SSD being driven by a couple of things. One is this return of data center demand that has been in this inventory correction for quite some time. And on top of that, we see this AI training infrastructure that is really pulling high capacity and high-performance enterprise SSDs, but really starting to drive the business as well and drive demand.

Krish Sankar

And I think, Dave, you touched upon this on the earnings call. Obviously, AI is such an exciting area. And if I look at both your businesses, it makes a lot of sense that both nearline hard drives and SSDs should see improving demand or increased demand because of AI. The pushback I get from some investors is that, it’s the same nearline hard drive, the same eSSD, but is used for AI or non-AI applications. How do you know exactly that it’s being segmented for AI or not? So, I’m kind of curious to know your thoughts on that.

David Goeckeler

So, I think, so first of all, in the general big picture, I think that AI, we’re in a cyclical recovery and we have this big secular tailwind now. We’re all trying to figure out to your point, try to decompose what’s the cyclical recovery, what’s the secular tailwind because the secular piece you want to understand does it how much does it drive sustained demand. I think on capacity enterprise hard drives, I think it’s primarily a cyclical recovery at this point. It’s hard to tease apart, but there’s just not enough deployment yet of the models to really drive an enormous amount of output from them.

And we’re more in the training phase of that than the inference phase on a broad scale. But we have a pretty strong belief that there’s two big picture dynamics. One is these large language models are just another way to take all the data you have stored and figure out a new way to monetize it and make it productive and use it for productivity enhancements or whatever it’s going to be. And so, the value of storing more data has gone up. And then you’re going to once the models get widely deployed, you’re essentially automating the creation of data and most of that data is going to be stored on hard drives. So, you have this kind of virtual cycle that’s going on.

So, we think it’s going to be a good secular tailwind for the drive business. It’s hard to decompose. If you asked me how much does it change the exabyte growth, we don’t know just yet. But I think right now predominantly what we’re seeing is a cyclical recovery in demand.

On the flash side, enterprise SSD side, I think it is becoming clear. We are seeing demand from customers that are building training focused, AI model training focused infrastructure. And there’s a process for how that works. And at certain points of the process, you need different kind of enterprise SSDs and different capacity points and different interface speeds. And we’re seeing demand for that as we go into the second half. We need to get a little deeper into it to be able to fully quantify exactly, how much it’s going to change the market from a TAM perspective. But it’s very easy to see that there’s a new use case that the world has developed for enterprise SSDs and people are building infrastructure to that use case. That use case is training models.

Krish Sankar

And then there’s obviously another part of the debate, which is kind of like, over time, will eSSDs cannibalize nearline hard drives? Or do you think there is enough piece of the pie for both of them to like swim in their own lanes and be happy?

David Goeckeler

Yes, I think that that term you use is a term we use inside the company swim lanes. Like you’re trying to figure out what the use case is that you’re driving. And we don’t see a cannibalization story. We see a complementary story. They’re used for different parts of the data storage ecosystem. And data that’s required and things like training a model or data that requires very fast access speeds, you’re going to put it on enterprise SSDs. Data that doesn’t require that is going to be on HDDs. It’s just an economic equation. As long as we can continue to drive better TCO in both technologies, I don’t see that fundamental architecture changing. If you’re storing an enormous amount of data, it’s extremely important for you to put the data on the right piece of equipment that’s the best economic value proposition for how you’re going to use that data.

And so, we do not see cannibalization of enterprise SSD across capacity enterprise HDD. We do see them both growing. We do see enterprise SSD probably growing faster because we have these new use cases like I just talked about, AI model training. Nobody used to do AI model training on HDDs, right? It’s a new use case. It’s enterprise SSDs. The data that those models turn out and the inference phases, I think primarily goes back on to HDDs that’s stored in mass scale data centers.

Krish Sankar

Very clear. That’s very helpful. The other thing is also the fact that, like you mentioned earlier, you’re beginning to see this nice cyclical recovery. There’s probably a structural aspect to it. Your margins are improving pretty nicely. You’ve been very disciplined on capacity. What are the kind of the leading indicators you would look forward to before adding capacity?

David Goeckeler

Well, I mean, look, I think it’s just very early to be having this conversation. We’ve just come through a downturn that lasted many, many quarters, right, five, six, seven quarters. We’ve had one quarter now where we’re starting to get back and generate free cash flow in the business. It’s not the time to be thinking about how we start investing a whole bunch more CapEx. So, we’re driving, our model is very clear, 35% to 37% through cycle on flash and we can get the HDD. But on flash, 35% to 37%, we’ve been below that for quite some time. We’re going to need to be above it for quite some time to be able to average out to 37%.

So, when we get above it, we’ve lived in that world for a while. We’ve had the ability to recover from this significant downturn and then we get conviction, as I talked about earlier, looking across all the markets we’re looking at that this is sustained demand for years to come like we can’t invest for something that may be one quarter, two quarter, three quarter. It’s got to be sustained demand to go out and put a bunch of equipment in a fab. These are huge capital investments. If we get conviction that there’s sustained demand for that additional supply, then we’ll start to think about that. But we are far, far, far away from that.

Krish Sankar

I want to ask about CapEx increase. Let me ask about OpEx then. Now that things are getting better, obviously variable cost might get added. So how do you think about OpEx going forward?

David Goeckeler

Yes. So, we’ve done a lot of work over the last four years. I think when I first came in the business, we were over $800 million a quarter on OpEx and now we’re at the low $600s million. So, we’ve taken a significant amount of OpEx out of the business just to be and at the same time, we’ve built the best portfolio we’ve ever had. So, I think our level of being able to put the right investment in the right place in the business at the right time to deliver the best products and drive profitability is exactly what we’re going for and again I think this is one thing I feel very good about. The company is just much more efficient. Any investment we put in the business, we have high degree of confidence what the return is going to be for that additional investment.

So right now, you’re starting to see us kind of rebound a little bit off the lows because we there was no variable comp in the system. I mean, this is a statement of how deep the downturn was. I mean, we’re not paying employees bonuses for 18 months, significant amount of cutbacks in the business. So, you can’t run a business like that on a sustained basis. So now this is performing better, variable comp pieces are coming back. We expect that to be a sustained thing. We don’t want to go back to where we were. But we’re going to be very disciplined about this.

We’re not going to grow OpEx faster than our revenue grows. We’re going to, the most important thing to me is to have confidence that when I make an investment in the business, I know what return I’m going to get from that. And like I said, over the last three or four years has been a complete sea change in the way we’ve organized the company and the way we track this and the way we’re able to measure it in the precision that we understand what is the value of the marginal investment we put in the company and what’s the value of the marginal investment we take out of the company and make sure we understand that extremely well. And then we’ll set the OpEx at a level where we think that we get the best long-term profitability of the business.

We are in growing markets. We have opportunities, right. I mean, I think one of the really strong impressive things about Western Digital is the R&D team. We have an incredibly enviable patent portfolio that a lot of people pay us money for to use. Our HDD team, I think we’re seeing the strength of our HDD team in the market right now and the decisions they’ve made over the last 10 years or 15 years of how to navigate an extraordinarily difficult technology transition and do it extraordinarily well. So, we’re in growing markets. We have opportunities.

We’re going to invest in those, but we’re not going to, we’re going to keep a very strong eye on making sure we are getting the right returns for the investments we make and it’s the best short-, mid- and long-term decision for the company. And I hope one thing that everybody has is a lot more confident that as the management team makes those decisions, there’s much more precision in our ability to generate long-term value creation for any investment we do put in the business.

Krish Sankar

Let me just pause to see if anyone has any questions. Go ahead, Erica.

Unidentified Analyst

[indiscernible] on their GPUs is from inference. So, I’m just wondering if that’s something you haven’t seen yet. And just obviously, if you think about the data that’s going to be refined and put back onto the model and hence onto storage, there might be less of that going back for inference and stored. And maybe there’s a timing difference as people sort of figure out what data they do want to store.

David Goeckeler

Yes. I think, so I think the comment is very well made. I mean, I’m not saying there’s not any going on. I’m sure there’s a fair amount happening. I think we’re, like, just getting to this phase though of it. We’re in these huge markets. Right? So, we’re just now talking about the AI PC and what it is and how it gets deployed. I saw something last night where somebody is now talking about the smartphone being called the and telephone because it’s going to be ready for AI and machine and artificial machine learning type thing. So that’s when I talk about the impact of it, I’m talking about very broad impact on huge markets where we can start to see it penetrating very, very deep into the ecosystem.

And I think that, that although there’s a lot going on, I think that phase is still in front of us. We’re going to be able to see how is the impact on the, what is the impact on these very, very large markets.

Krish Sankar

All right. I think we’re kind of out of time. So, but thank you for that day. Very helpful, super helpful. And thanks a lot, Peter. Really appreciate it.

Peter Andrew

Thank you. Appreciate your time. Thanks folks.