WDC - Western Digital Corporation (WDC) Presents at Morgan Stanley Technology Media & Telecom Conference
2023-03-07 16:15:17 ET
Western Digital Corporation (WDC)
Morgan Stanley Technology, Media & Telecom Conference
March 07, 2023, 11:35 AM ET
Company Participants
Dave Goeckeler - CEO
Wissam Jabre - CFO
Conference Call Participants
Joe Moore - Semiconductor Industry Analyst
Presentation
Joe Moore
Hi, everybody. I'm back. I'm Joe Moore from Morgan Stanley. Very happy to have with us today the management team of Western Digital, Dave Goeckeler and Wissam Jabre. I'm going to quickly read this research disclosure, and he's going to read one, and that's it. We have about half the meeting left to actually talk about the business.
But for important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.
Dave Goeckeler
Sure. Thanks, Joe. Good to be here. We will be making forward-looking statements, and I ask you to refer to our SEC filings for the risks associated with these statements. We will also be making references to non-GAAP financials and a reconciliation of our GAAP and non-GAAP results can be found on our website.
Question-and-Answer Session
Q - Joe Moore
Great. Well, maybe just jump right in. I think, I know you can't talk about the strategic review process, but can you just talk about generally the case for the synergies between the hard drive business and the solid state business? How critical do you think those synergies are? And what are the puts and takes of running the two businesses combined?
Wissam Jabre
Yes. So Joe, thanks for having us. It's great to be here. Yes, I thought a lot about this when I first came to the company, it's almost three years ago now this coming week. So -- and I do believe that there's significant synergies between the two businesses, the way we go to market, the scale we have across a very diverse set of routes, everything from a multibillion-dollar consumer business where we do hundreds of millions of transactions a year to selling to $1 billion worth of equipment to the largest technology companies in the world. Every OEM, mobile player and then a big distribution business.
So I think that scale and the way we can address the customer is unique and the fact that we have two large franchises to put through that go-to-market engine, I think that shows up in the results. I think in the last quarter, we just delivered in the NAND business that started to show up in ways that we could talk about maybe later a little bit.
Also, the way we do R&D and the way we have expertise across a broad range of technologies that showed up in the products and things like OptiNAND, we can talk about more detail. But then we've got two separate franchises and there are different technologies and the way you build them is different.
And so that's why we kind of organized the company the way we have over the last 2.5 years of where we need focus, we drive focus on product development, how we build products, how we manage the P&L. We've gone to segment reporting, all the kinds of things give the visibility in the business. And when we have synergies, we've left the businesses together and we -- I think we can recognize those.
Now the strategic review is about, is there a better organization in the business that would lead to other synergies that are greater than the ones we experienced today. So it's like everything in life, it's a relative process and trying to understand if we organize the business in a different way.
Would we get synergies that are greater than the synergies we have today and I think that's the process we've been going through for the last eight or nine months in cooperation with a number of people that are part of the process, of course, all under NDA. We can't talk about what's going on there when we get to the end, we'll talk about that.
And if we reach a conclusion where we have very deep conviction that there's a different organization or strategy for the company that is going to deliver better results. We'll go to that. We're completely open to that. We'll go to that, and we'll talk about it at that point.
Joe Moore
Okay. That's a very helpful answer. Maybe we could talk a little bit about just the challenges that you're facing right now. I mean I look at this like this -- I think the business is materially undervalued relative to the long-term earnings power, particularly on the memory side. But I think this is going to be a brutal 2023 in a lot of ways.
And so obviously, there's a range of outcomes that could happen. But how are you thinking about protecting yourself from a more challenging scenario? And in particular, focusing on the debt agreement being restated and the convert that you've talked about, how does that position you to kind of batten down the hatches and be prepared to just get through this year?
Dave Goeckeler
First of all, it's a very challenging market environment. That's not news to anyone. And we have both franchises at the bottom of the cycle at the same time, which creates challenges. Obviously, we sound -- talk about all the countermeasures we've taken.
But we've obviously, spent a lot of time thinking about this, a lot of time modeling the business about what we think a recovery looks like, about what the bottom looks like and how do we need to position ourselves from a financial -- how do we get ourselves in a financial position that we can weather that, and we believe the business is undervalued as well. And when we come out of that, we're in a better position. So maybe Wissam can talk about all the things we've been doing over the last three or four months.
Wissam Jabre
Yes, of course. And so I'll start with the operational actions. We've taken a lot of actions on CapEx to start with. We basically reduced our CapEx plan for the year by more than 40%. If you look at our gross CapEx, we're pretty much initially at the beginning of the year, we're planning around in the, let's say, $3.2 billion range. We're now closer to the $2.3 billion and continue to take more action.
On the cash CapEx, this is basically, as I said, reduced by more than 40% to help us preserve cash, but also maintain the competitiveness of the business. On the manufacturing side, on the hard drive, we did the restructure, we've taken a lot of action to reset the cost structure with restructured our client manufacturing footprint. In addition, when you look at our fixed costs, for instance, in the manufacturing space for the hard drive business, it's down almost 10% to 15% by the end of last quarter relative to where it was at the end of fiscal '22.
On the flash side, we did announce a reduction in our wafer starts starting January. We've taken the supply down by around 30%. The focus there is to look at the demand picture and manage our supply to the demand of our products as we get more control on our inventory.
And then if you look at our operating expenses, we've taken from the end of the fiscal year '22 run rate, at the quarterly basis, we were probably running at around $760 million. Last quarter, we were at around $660 million. So that's around $100 million down by quarter. We still have further actions to take. We did -- we are planning and aiming to exit fiscal '23, basically Q4 '23 at sub $600 million per quarter run rate on the operating expenses.
There, again, we're really focused on very high-value R&D projects to maintain the competitiveness of the business, the development of the technology that differentiates us, but also manage the profitability. And then when you look at liquidity and credit, as you mentioned, we did amend our credit agreement to give us more flexibility with respect to our covenants for the next seven quarters.
In parallel, we raised a little bit less than $900 million in the form of delayed drew term loan, $875 million, plus the $900 million convertible preferred, which gives us -- strengthens our liquidity as we go forward, in addition, of course, to the cash on the balance sheet at the end of Q2, which was around $1.9 billion plus an undrawn $2.25 billion of revolver. So we look at the business and we pretty much manage it very dynamically to weather the storm and to give us the liquidity to continue to operate comfortably.
Joe Moore
And I guess, in particular, on the convert issuance, the reason for doing it is pretty clear, you take to 2024 convertible repayment kind of off the table as an issue. What's the strategic of working -- the strategic importance of working with a strategic partner like Apollo and Elliott on that deal?
Dave Goeckeler
So you're right. I mean we looked at all the sources and uses of capital over the next several years, and we've positioned the business for -- when we come out of this recovery, we're in good shape. We feel really good about where the portfolio is at on both sides.
We've been working on that over the last several years. So -- and now we're making structural changes to get our cost in a better position. But the advantage -- so first of all, we went through this, we raised this pervertible convert when they're middle of a strategic review process.
So it was very important to us to make sure that we preserve a significant amount of optionality about the way that strategic review processes come out. We don't have that -- we don't -- we're not ready to announce what the answer is, we're still doing work to finalize that. But we want to make sure that we -- when we went through this process, we didn't do anything that decreased our optionality.
So working with Apollo and Elliott, we were able to do a very highly customized piece of paper that kind of gave us a lot of options about the way this could play out. And they also bring significant financial expertise and resources into the company that we look forward to working with them on an ongoing basis.
Joe Moore
Great. So maybe if we could shift to talk a little bit about just the state of the NAND business. You guys have taken a relatively draconian action of lowering utilization. That's something that didn't seem like you were going to do three months ago.
I guess, what changed? We looked at -- obviously, the [ SAA ] data is imperfect in some ways, but the month of January, it didn't look like there was much NAND being shipped just in general. So like what are the conditions that you're reacting to with that utilization? And how are you thinking about the puts and takes, practically?
Dave Goeckeler
Yes. So one of the things I think has been very important in the business is put more agility into the business. That's one thing I've been very focused on and the way we've organized it, the leadership we brought in is like we have to be able to move faster than the environment we're in. Otherwise, we just get taken away with where the environment is going.
So we stay very, very close to what the market is. And if you go back to where we were three months ago, you look at our December quarter, we did have bits up 20% quarter-over-quarter. The margin was relative to the market in good shape. And so at that point, when we looked at the business, we didn't see a need to do anything as far as underutilizing production because we still saw the volume up.
As we saw the March quarter start to change, and we expect now bits to be down, we want to make sure inventory doesn't get out of control. So we pulled back on the fab, right? And this is a decision we'll make on really a week-by-week basis. We load the fab every week. So we have a chance to make this decision very frequently, and we'll stay very close to it. And as we see the volume come back, we'll make a different decision about how we load the fab.
Joe Moore
Okay. That makes sense. I guess as you step back and think cyclically about this, we just got out of a cycle where we peaked. Gross margins peaked in NAND lower than I might have thought. We're certainly troughing lower than I might have thought.
What do you think this all tells us about the next cycle? Because in the next cycle, we will have more consolidation because the Intel and Hynix businesses get put together, China has uncertain outcomes, so you have maybe one fewer participant that's putting a lot of money in cadence that you've seen? I know it's hard to say, but like how are you thinking.
Dave Goeckeler
It's very difficult to say. I mean I think what we're trying to do is put ourselves in the best position possible, right? We say for -- the NAND business, it starts with the technology road map if you don't have the right fundamental technology at the right cost point then it's very, very difficult.
And again, I think that 1 of the things this down cycle has shown one thing we continue to focus on with our JV partner is capital efficiency in our technology road map to make sure that it's a very explicit design goal that every incremental bit we get is the most capital efficient it can be. And I think our technology road map has displayed that for many, many, many years.
So we're going to stay focused on making sure we continue to do that as we move through BiCS6 into BiCS8, no matter what the cycle is, that sets us up for a better outcome. The product strategy stay very diversified in our product strategy.
Again, we have, I think, a very enviable consumer franchise with SanDisk, SanDisk Professional, WD Black, which is a brand we've built over the last couple of years that's doing extremely well in gaming. Through the client SSD business, mobile, IoT and automotive and then the work we've been doing over the last couple of years of being qualified at the large hyperscalers on enterprise SSD gives us a lot of diversity and able to kind of place our bits in a mix that gets us the best return.
So clearly, the industry is going through a very severe downturn. I have customers that tell me like, look, we've been through this many, many times, the faster it goes down, the faster it comes up. There's all kinds of different ways people think about it. But what we're trying to do is position our business so that we get the best return possible with the best fundamental technology and then the best portfolio mix that we can get the best return for our NAND business, no matter where we are in the cycle.
Joe Moore
Yes. I think it's been somewhat an underappreciated element of the story of - your relative gross margins are actually quite good relative to the peer group. To your point, the end market exposures you have are good. And the capital intensity of the business has been low for a long time.
And people -- the bear case for SanDisk for 20 years has been CapEx is much lower than peers and like for the last 20 years, you hold market share, it's a good thing. Can you talk about that, like generally? And then more specifically, you mentioned the BiCS6 and BiCS8 roadmaps. How comfortable are you that you can stay in that good position going forward?
Dave Goeckeler
Well, we're very comfortable. I mean, I think this is the thing -- one of the reasons the JV is so important and it's been so long lasting. I mean we're 23-plus years now in the JV because it works. And it gives us scale on our -- it doesn't -- it's not just scale on production, which we get scale in production.
The fabs we have in Yokkaichi and Kitakami, very, very large sites. But it's one common R&D road map. So we have the ability to have twice as many engineers for our scale in the market, working on our technology road map, been doing that for 23 years. The teams work hand in glove. You would think it's just one team.
And so -- and a very focused goal of that team has been capital efficiency. It's not been -- it's built the highest performance product. It's to do all of those things and do it in a way that's extremely capital efficient and no decisions are made based on that. And so it's paid off, as you said, year after year after year, we're very capital efficient.
There's been a lot -- one of the things that's always been interesting for me in the NAND business is people talk about is some kind of layer race, it's not a layer race. So like fewer layers is better. If you -- that means better capital efficiency, less cost into your business. And I think that's showing up in the downturn that we have a very capital-efficient business, and it shows up in the margins. It supports higher margins across the portfolio.
So we feel very good about where that's at. We now have BiCS8. BiCS8, we talked about on our earnings call. I didn't bring it with me today, but the team 1.5 months ago, it gave me one of the first BiCS8 USBs that's out of the fab and working. So we've commercialized that technology now, and we feel very good about it.
We still have to get through -- BiCS6 will be a shorter node for us, and then we'll go straight. There never was a BiCS7, I always have to explain that. So four, five, six, eight, but eight is arguably a couple of quarters ahead of schedule, and we're very excited about where that technology is at and how it's yielding.
Joe Moore
And I guess how do you ensure that you stay on those trajectories in a challenging environment?
Dave Goeckeler
Well, you continue to invest in R&D, as Wissam said, I mean we're doing a lot of things to optimize our business. So we're in better shape when we come out of this. And one thing we stay very focused on is make sure we invest in the R&D to drive the fundamental technology forward, whether it's the NAND business or the HDD business, you can't take your eye off the ball of having the fundamental technology. It's the foundation that the rest of the business is built on.
Joe Moore
And I guess just a final NAND question, for me, at least. As I look at the disparity of NAND businesses right now, there's a pretty wide range of gross margin depending on what you do. If you're shipping to Tier 1 smartphone manufacturers, gross margins seem like they're very, very far into the negative if you ship into storage and cloud market seems quite a bit better. What does that tell us going forward? It doesn't seem like that low-end margin can get too much worse without people idling fabs, but does the premium that you get for the higher quality markets diminish over time?
Dave Goeckeler
Well, I think different markets give you different things. I mean -- and you're right, this is why people are idling fabs is because there's -- either there's not demand and there's not elasticity or that, that demand is not worth serving so you pull back on utilization. But some markets are very, very high-volume markets, but they're much more cyclical.
Other markets maybe are not as high volume. Consumer market is a good example. The consumer market is going to be better through cycle margin but it's not going to be the peaks of the high, and it's not going to be the depth of the low, and it's a stabilizing influence across the whole portfolio. That's why we spend time building brand.
If you go out and you buy a $1,000 camera, you're not going to buy the cut rate card to put in it, you're going to buy a SanDisk professional card to put in it, right? Because you know it has the quality and it's delivered every single time.
So different markets deliver different things as far as volume, as far as price, as far as margin at different points in the cycle. And I think that's why it's so important to have a diverse portfolio, so that you can mix across that portfolio given where you're at in the cycle and where the demand is.
And why we worked so hard to build out this enterprise SSD pillar. It's a big market. It consumes a lot of bits. It's a big growing -- everything is -- every market has different growth rate. It has a high growth rate. So the fact that we can sell into enterprise SSD, we can sell into client SSD, we're qualified at premium mobile suppliers, and we have a very large consumer franchise where we sell worldwide and have premium brands puts us in a good position to mix at a different level across that portfolio, no matter where we are in the cycle.
Joe Moore
Great. If I can pivot to the hard drive business, if you could just talk generally to the challenges you guys are seeing there. Are we past the worst of it, do you think? And in terms of -- because you have seen kind of general commentary that as difficult this December was that there may be some improvement. Can you just talk generally to the issues in hard drives?
Dave Goeckeler
Yes. Hard drive is -- we saw the correction happen in waves across the different franchises we have. It started in consumer, then moved to PCs and finally moved state data center. So it's got -- it was kind of the last one in. We're in the depths of -- last quarter in the hard drive business was the lowest revenue quarter we've seen in, I don't know, a decade or more.
We had to go back before the HGST Western Digital merger to find a quarter that low. So you have two really big factors as you've got China has had depressed demand for quite some time. We're optimistic about that coming back as we move throughout the year, but it's still depressed.
And then you have the big hyperscale suppliers that are coming off of a pandemic where they were consuming an enormous amount of product and now we're more cautious on their own -- how they're using their own capital, and we see that across many different dimensions have pulled back and are going through a rather significant digestion phase.
Those two things together, those are two very, very big pieces of the drive business. So I think we probably have another quarter or so to go. But we think the December quarter was the low quarter and we'll see incremental improvement on that as we move throughout the year. But it's going to be a couple of quarters before it's back to where it was.
Joe Moore
Okay. And how are you thinking about market share? I mean it seems like in 2022, you held your own reasonably well. I know you weren't happy with every aspect of 2021. But last few quarters, you've been tracking or doing better than your primary competition. Can you talk about that?
Dave Goeckeler
Yes. Share has changed. So there's been a lot of share shifting in the last couple of quarters because the revenue is so low in one particular order or one customer buying and another customer not buying can like have share go up and down quite a bit. But when you look at it over a six or a 12-month time frame, it's pretty level.
And that's the way we manage the business. We're managing the -- we've talked about this extensively. We're managing the business more for profitability than we are for share gains. We want to maintain our fair share of the market. But we're really focused on -- we've got a lot of R&D in this business.
We've driven a lot of innovation over the past couple of years, whether it's OptiNAND, UltraSMR, ePMR, we now have market-leading products in the drive business, again, which we think puts us in a very good position as the market comes back throughout the year. And we want to make sure that we drive the right value pricing environment for that because we are working with our customers, we are giving them a very, very good TCO proposition.
And we want to make sure that we continue to drive the profitability of the business. We can continue to invest in R&D, and we're not so focused on just gaining share.
Joe Moore
And can you walk us through a little bit the technology road map? I mean it seems like you're shipping 22 now qualifying 26 terabyte UltraSMR. Can you just talk to your confidence that you have a competitive road map? And then maybe talk a little bit to the HAMR migration.
Dave Goeckeler
Yes. This -- when I came into the business three years ago, the team kind of sat me down and we went through the HDD road map. And I really -- at heart, I'm a product. I came up through the world as a product, right. I built product my whole life. So I really wanted to understand where we are on the product road map.
Three years ago, the team kind of told me, look, the next -- we've got clear line of sight to 20 terabyte, right? You can just kind of the way you put drives together, you can put 10 platter in the form factor, we can get two terabytes per platter, 10 times two is pretty clear. What you get. And at that point, we're going to start running out of real estate.
And then we've got this new technology, HAMR. That's going to really give us more density, but that's a number of years away. That's like a 2025 and beyond type technology. So we've got this gap of how do we drive from 20 to 30, and here's how we're going to fill that gap. And they started telling me about ePMR, so we're going to increase aerial density for platter to 2.2 terabytes per platter, so now nine times 2.2 gets you to 20 and then 10 times 2.2 gets you to 22.
Then we're going to do this thing called OptiNAND, where we're going to change the control plane. We're going to put more software in drives, so we can optimize it better. We have this technology SMR, where you can change how you record the bits on the media. And we're going to -- you put all these together, we can have this thing called UltraSMR, where we can get an extra 20% with OptiNAND -- ePMR plus OptiNAND and SMR gets you ultraSMR, which is plus 20%.
So now you can start looking at the road map and now we have 2022 and we have '26, and we'll be able to drive aerial density a little bit higher. And we have this very stepwise plan using this new innovation to drive this 20 to 30 until we get to HAMR and then that's available.
Now HAMR has been in the lab -- HAMR has been under development for over 15 years. And what I would say is we're in the final stages of that development. You're starting to see it show up at customers a little bit. But before it's still a couple of years away from reaching mass production, I think everybody in the industry would agree with that.
And so we're in that same 15-year plus development time frame. When it's needed in 2025 and beyond, it will be there. But until we get there, we have all these other technologies we've been working on over the last five or eight years, that when you start layering them together, individually, may not understand what they all mean.
But when you put them all together, what they do is they give you that bridge from 20 to 30. And it allows our customers with a high degree of confidence, all these technologies have been commercialized now, and they're being qualified for deployment in the largest, most sophisticated data centers in the world.
So I feel extremely positive about where our drive road map is and kind of the deep level of thought over the last decade that went into kind of building this plan that gives our customers an enormous amount of confidence that they can continue to drive higher density storage into their data centers.
Joe Moore
I'm not a hard drive guy, but it feels like, to me, it's a little bit similar to the conversation about layer count in NAND, where people want the headline of higher layer count, some ways, [ HMR ] is something new, and we need to move there quickly. It feels like to me you guys are almost agnostic to the timing. You just want to have the best returns at every capacity.
Dave Goeckeler
Exactly. We want to have the right -- we want to be able to take our -- it's about being able to allow our customers to build the most sophisticated data centers in the world. I mean we take our role in the technology stack very importantly, 29%, 30% of the entire data center TAM is storage. A huge percentage of that storage, 90%, plus or minus, is on hard drives, it will be for a long time.
So continuing to drive that road map is a big responsibility of the industry so we can all benefit from the cloud and all the great things that are going on. So yes, I mean, I think we've had a team that have been doing this for many, many decades. The technologies that go into the hard drive, physics, material science, this is very, very complicated stuff.
It takes decades to mature and making sure we have the right technology with the right capacity point at the right time. That's the essence of how you manage a product road map. And I think the team has done it extremely well.
Joe Moore
Great. Let me pause here. I have a couple more questions. I want to see if we have questions from the audience first before I go forward. Here we go.
Unidentified Analyst
Just an awkward question on the SSD space, where we're starting to see some of the cloud players build their own SSDs, and they've obviously done the same in CPUs.
And do you see that, I guess, number one is how much of a threat is that if they decide to go in-house completely? Secondarily, kind of how do you see that evolving?
Dave Goeckeler
I don't -- it's not really a threat because you still have to buy NAND, right? So you have the opportunity to now sell two things to the customer. You can sell them enterprise SSD, you can sell them NAND for their own SSD. I think most customers are not going to -- on most of anything, you're going to want multiple sources for everything you do.
So I think it just creates more optionality for us, and ways to work with them on a broader portfolio, quite frankly.
Joe Moore
Is anything changing there? Because it seems like a lot of the NAND companies have built their own controllers because it works well to be tailored with your own NAND and things like that, someone taking more of an ASIC approach to controllers to try to buy cheaper raw NAND. Is that easy to do? Is it something that's changing at the margin?
Dave Goeckeler
I can say it's not easy to do. Building an enterprise SSD is extremely difficult. There's not very many companies in the world that has actually done it and has gotten qualified in the places. Again, the most sophisticated data centers in the world is extremely difficult to build a product that can go into those and you just kind of put it -- you deploy it and forget it.
They're going so fast as far as how much they're building, the qualification process is extraordinarily rigid for good reason. And I think to get through that process, having gone through it now and been successful. The team was working on it before I got there. And then I kind of like helped in the last year of get it over the line. It's an extremely daunting process.
Joe Moore
Great. Well, I think we should probably just wrap it up there. We just have a few seconds left. So Dave, Wissam, thank you so much.
Dave Goeckeler
Thank you, Joe. Appreciate it. Thanks, everyone.
Wissam Jabre
Thanks, Joe. Happy to be here. Thanks, everyone.
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Western Digital Corporation (WDC) Presents at Morgan Stanley Technology, Media & Telecom Conference