Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Okay. Let's get started. Good afternoon, everybody. Welcome to the Goldman Sachs Communacopia Technology Conference. My name is Jim Schneider. I'm the semiconductor analyst here at Goldman Sachs. It's my pleasure to welcome Western Digital and CFO, Kris Sennesael, to have this with us today. Thank you, Kris, for being here. I appreciate it.

Yes. Jim, thanks for having us here at the Goldman Sachs conference. And maybe before we start, I'll just make a small disclosure here. So today, I will be making some forward-looking statements based on management's current assumptions and expectations, including with respect to our product portfolio, business plans and performance, market trends and dynamics and future financial results. These forward-looking statements are subject to risks and uncertainties. So please refer to our most recent financial report on Form 10-K and other filings with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially from our expectations. I will also be making some references to non-GAAP financials and a reconciliation of our GAAP and non-GAAP results can be found on our website as well.

Fascinating. So maybe start off top level. Kris, over the past 18 months or so, industry has done a great job of pushing for higher pricing while limiting production levels at an overall industry level. Maybe walk us through the progress that has been made, where you believe supply-demand sits today and then in terms of overall industry utilization.

Yes. That's a great question. And so to be clear, I can't really speak for the industry, right? And so I only will speak as I see it as it relates to Western Digital. And I think it's very clear that demand in the demand environment is very strong and it's strong and it's getting stronger by the day or the week with a lot of positive news. Although I feel talking to investors and friends, I feel there is maybe a little bit of a misconception. There is kind of like this maybe misconception that there is a huge demand-supply imbalance. And maybe we all wish that was true, but I don't think that is the case. I think supply is tight. But we believe that, again, with very strong demand, we will be able to supply in line with the demand. And just to put some perspective on that, in February, when we had our Investor Day, we outlined a growth forecast for the storage business. And on a base case, we indicated 15% CAGR year-over-year growth for storage on an exabyte basis with potential upside all the way up to 23% year-over-year growth on a CAGR from 2024 to 2028 as AI accelerates and AI kicks in. I think the good news based on all the more recent updates that we have received, AI is really kicking in. And so we are getting a lot more comfortable to see strong demand up to the 20%, 20-plus, 23% CAGR in terms of exabytes. The other good news as well on the supply side is that we feel well positioned and comfortable to be able to supply in line with that strong growth. And the main reason how we do it without increasing unit capacity is through areal density, right? And areal density has multiple facets to it. First of all, we're increasing the high end of the capacity per unit through multiple technology and product upgrades that we have planned out. In addition to that, we're also moving the average of the capacity per unit that we are shipping today. Today, the average for us is on or about 21, 22 terabytes per unit, right? The highest capacity unit that we ship today is 32. So we have long ways to go not only to increase the 32 to eventually 36 and eventually 44 terabyte, but also move that average from 22 closer to the top end that we have. And when you combine all of that, we feel comfortable to -- in a continuous tight demand-supply environment to ship the volumes to our customers that they need.

Even without increasing your volume, if you assume that you're kind of like near full utilization today?

That is correct. So the vast, vast majority of the growth will come through areal density. Now of course, in addition to that, we are going to continue to drive operational efficiencies in our own manufacturing facilities and throughout the supply chain. We work on yield improvements. We work on automation. We work on OEE improvements. We actually collect a lot of data in our own factories. We have machine learning and AI algorithms on top of that, that really helps us to create a little bit more output as well. We work with some of our suppliers to get some additional supply as well. And we are spending only about 4% to 6% of our revenue in CapEx, right? CapEx that goes to media and heads. We do a little bit of CapEx even in the back end in testers, while, of course, we're also working on test time reductions. And so a combination of all of that will further increase the supply. But again, the vast majority of it will come through areal density.

Fair enough. maybe talk about pricing for a moment. If you think back 6 or 12 months ago, what is the willingness of your customers to accept higher prices today relative to back then? And can you talk about whether that's simply pricing on a per drive basis? Or are you also talking about like-for-like pricing on a per exabyte basis as well?

Yes. So as it relates to pricing, the way I've been talking about that, and I will repeat today is we're in a stable pricing environment. And what do I mean with a stable pricing environment? I look at it on an ASP or a price per terabyte or ASP per exabyte, whatever you want to look at it. And so if you look at it, the last couple of quarters, that has been stable, meaning on a sequential or year-over-year basis, it has been on or about flat. Now it could be up 1%, could be down 1%. So it's kind of a stable environment. And so we really think and our customers really think in terms of price per exabyte or price per terabyte. Obviously, as we ship higher capacity units with more terabytes per unit, the price per unit goes up, but it's on or about at the same price per terabyte or exabyte.

Is that stability sustainable, you think?

So the good news here again is that we do have a lot better visibility in the future and in our business. As you probably know, with 4 of our 5 largest customers, we have POs for all of fiscal '26. With the fifth out of 5, we have LTAs and a lot of teeth in the LTAs. It's almost as good as purchase orders for all of fiscal '26 that has quantity and price commercial arrangements in it. With 2 out of the 5, we actually have POs covering Q1 and Q2 of fiscal '27. And we have ongoing discussions with most of our large customers even beyond that, right? We now start talking about 24 months or 36 months out. And based on that visibility, again, we feel good about the growth in exabyte. We feel good about a stable pricing environment as well.

Very good. Let's say we get ourselves into a situation where some place down the line, where the industry has overshipped in demand and customers look to cut orders. How does your build-to-order strategy sort of protect you in that sort of situation? And to what extent is there a cushion for you in a future potential down cycle?

Yes. So first of all, I mean, currently, there is no overshipping, right? I mean, given the very tight demand-supply environment, there is no overshipping. We have some visibility at our customer level. Some of our customers are down to a week or less than a week of inventory. So I think -- so we're in a pretty good spot right now. Again, demand continues to be strong. Demand is being secured with longer-term commercial arrangements. And this is a planned economy. This is how we've been talking about it more recently, right? Our customers, they plan ahead 2, 3 years. They know how much storage capacity they will need, they go and secure land, get permits, build buildings and facilitize the buildings and build out those storage units. Sometimes you might see some variability in our revenue on a sequential basis based on deployments. Sometimes deployments get pulled in, sometimes a permit didn't come through and a deployment get pushed out. But overall, I think there's very, very strong demand. Again, we have POs and we have LTAs. Having said that, if there is demand variability, which we don't see for the next 1 or 2 or 3 years, but if there is demand variability, we're going to work with our customers, right? It doesn't make sense if the customer, for whatever reason, doesn't want the product now or there is some slowdown couple of years down the road, it doesn't make sense to go and force product upon the customer. They're just going to put it on their shelves and you're going to pay for it later. We'd rather have in this partnership relationship, fully transparency and visibility, work with each other. If one customer doesn't want the product, maybe another customer wants the product, maybe we can adjust our manufacturing, scheduling like in line with the customer. And so that's what we do. In addition to that, as I said, like we are very, very careful, right, in bringing on additional capacity, right? Again, investments in heads and media, some investments in the back end, yes, but we're not really extending unit capacity. We're growing the revenue through areal density.

Fair enough. I want to ask you one last thing. Just strategically, we hear a lot about every couple of years, it comes up the debate between flash and HDD in terms of cost competitiveness. Where do you believe we stand today in terms of cost per bit delta between the 2 technologies and also TCO between the 2? And where do you think that goes in the medium term? And any reservations about a closing gap there?

Yes, that's a great question. We get that a lot. And so there's a couple of data points there. If you look at the installed base of storage capacity, right, roughly 80% of that is hard disk drive. 3% is tape and 17% is SSDs, flash, whatever you call it. Now you can say, okay, that's backward looking. But we also have visibility in the next 2 or 3 years, right, based on discussions with our customers, based on the purchase orders and the LTAs we have with our customers, based on third-party research. And we see even going forward, the new capacity that's being brought online on or about 80% of that is hard disk drive. And so -- and the main reason why it's 80% hard disk drive is the economics behind, right? We are on or about 6x lower cost and cost of acquisition, right? And now flash SSDs, they have some other advantages in terms of power consumption and density. But when you look at the total cost of ownership, we are 3.6x, right, lower total cost of ownership. And that's why the bulk of the storage is being done on hard disk drives. Now there are some good reasons to use SSDs and flash. That's why, call it, 17% or 20% or on or about, right? The storage is being done on flash and SSDs, right? They have faster throughput. They have other performance advantages. And by the way, their business is growing. This business is growing fast. Now people confuse a little bit, I think, when they see that business is growing fast, they think it's by taking share from hard disk drives. But no, the overhaul business is growing fast. Hard disk drive is growing fast. SSDs is growing fast. There's no -- we don't see any market share gains or losses because we don't see much changes to the 6x cost advantage on cost of acquisition or we don't see much changes to the 3.6 cost advantage on a TCO basis for hard disk drives.

Great. Let's talk about the market for a moment. Over the last several quarters, you've gained pretty meaningful nearline market share over your largest competitor. Do you feel that you can at least maintain this market share level even as you're kind of accelerating your time to market for HAMR?

So we're not really that much focused on market share. We're really focused on our customers, right? And we want to create those deep customer engagements. We want to partner with our customers. We want to make our customers more successful by delivering them high-quality, high reliability, high-performance product. And that has worked out pretty well for us. But I do believe it has worked out pretty well for our closest competitor. And so we're not that focused. And yes, we feel good about our position with our customers. Again, we have a best-in-class technology and product road map. We are -- we just introduced our latest, but not the last version of ePMR technology in March of 2025 that came at a CMR version of 26 terabyte and an UltraSMR version at 32 terabytes, which is the highest capacity hard disk drive you can buy in the industry. In addition to that, we are -- and we've been very vocal about that. We are still working on one more generation, probably the last -- I will never say last, but probably the last generation of ePMR that will come out in a CMR version at 28 terabyte and an UltraSMR version at 36 terabyte. And and we are targeting qualifications in first half of calendar year '26 and then ramp in the second half of calendar year '26. And good progress is being made there. I think we're actually a little bit ahead of schedule. And we're still kind of leaning in on the engineering community to potentially get to higher capacity points as well. And then in parallel, we work on our HAMR strategy, which, by the way, we've been working on that for more than 10 years. Really good progress has been made. We -- for now, from a timing point of view, we target qualifications in the second half of calendar year '26 and then volume ramp at scale with high-quality, high-reliability products in the first half of calendar year '27. And that's at 36 up to 44 terabyte capacity per unit. Good progress has been made. The areal density, we are there. I can ship you a couple of hundred or a couple of thousand 44-terabyte HAMR drives, if you want.

Please do.

But we still have some work to do, right, on quality and reliability, which is very important to our customers, right? This is a new technology. And so we want to make sure if and when we start ramping that in high volume, the quality and reliability is secured. So there is no problems 1 or 2 or 3 or 5 or 7 years down the road. We also still have some work to do on manufacturing yield, right? We want to be able to ramp the new technology in volume because ramping it and shipping 100,000 units is not really ramping in my mind, right? So we want to continue to work on that, making sure that if and when we ramp it in the first half of '27, we can do it in a favorable economic way to us and making sure that there is no hiccups for our customers.

Okay. Wow, you answered my next 8 questions, maybe that is. But I do want to maybe rewind for a second and just kind of go back to ask you. So relative to ePMR and UltraSMR, you mentioned those capacity uplifts for the next-generation drives. What portion of your total shipments are coming from those 2 technologies right now?

Yes. So UltraSMR is in the 40% to 45% of our nearline shipments right now and moving up towards 50% by the end of calendar year 2025. The customers love the product because, again, the customers want more exabytes, right? And one way to get to more exabyte is qualify UltraSMR. It's a proven technology. It gives you 20% more capacity in a reliable way. Again, 2 of our 5 large customers have ramped. The third one, we finished qualification, and now we're moving on to a fourth customer for qualification. Now in addition to that, some of the smaller customers already have adopted UltraSMR as well. And it's a proven technology. It's great performance. It gives you more exabytes.

Okay. You mentioned your HAMR schedule. Going back a few quarters, I think it's fair to say that we saw your largest competitors struggle a little bit to ramp that technology with their lead CSP customer. Do you believe you have a smoother transition with your ramp as you do that? And has the additional time and development given you more confidence in sort of executing the technical and operational aspects of that transition?

Yes. I think that's definitely our strategy, right? And so again, we know how to ramp new technology. We just did it in March. We shipped -- we shipped 800,000 units in the first quarter of our new ePMR generation. In the second quarter, we shipped 1.7 million units. This quarter, we will ship more than 2 million units. This high quality, high reliability, no supply issues, customers love it, right? And so we're going to repeat that when we launch and ramp up our next generation of ePMR. And we want to do something similar in the first half of calendar year '27 when we ramp HAMR. So we're not feeling rushed. The customer is not pushing us. The customer is not rushing us either. We want to make sure the quality and reliability is good, the manufacturability and manufacturing yields are under control. And when we feel good about that, and we're on schedule with that, right, to ramp it in the first half of '27.

Great. Just in terms of customers, is there any sort of framework or kind of size you can put on your exposure to the largest 4 or 5 hyperscalers? Is it fair to say they represent sort of more than half your business at this point?

Yes, I think that's fair. I think in our last 10-K, we disclosed that our 10 largest customers, which, of course, includes the 5 largest, was on or about 68% of revenue, right? And so several of those large customers now have crossed into the plus 10% range. And again, those are great customers, right? Those are the most innovative, most successful companies on the planet with very deep pockets. They are committed to make AI a reality. They're investing a lot. They themselves have strategic partners throughout this whole ecosystem. And it's really encouraging for us to have a seat at the table with them to strengthen again the engagements we have with them and being recognized as a strategic component in this whole ecosystem because you don't have AI without data, you don't have data without storage, right? And so they fully understand that. It's a critical component, and I think we're well positioned.

Just to ask you briefly about your client and consumer businesses. Sort of what's the long-term trajectory you see for those businesses? Do you think they're sort of in a kind of a long-term state of decline? Or do you see them kind of maintaining as a certain chunk of your revenue for a while longer?

Yes. So in the last quarter, cloud was approximately 90% of total revenue. That means client and consumer. And so client is the PC, a little bit of desktop business and consumer was on about 10% of total revenue. Investors don't pay too much attention to it anymore because it's only 10%. But still, we believe that business will continue to grow. Now the cloud business is probably going to grow faster than the consumer and client business. And as a result of that, as a percentage of revenue, it might continue to go down from the 10% is today. But overall, that is still more than $1 billion of revenue. The gross margin profile of that business is improving because we also see a stable pricing environment in that part of the business. We continue to drive the cost down. And so hence, we also have gross margin improvements in that part of the business. And it doesn't require a lot of OpEx. So from an operating margin point of view, that's a very solid profitable business. Again, where we continue to see growth, maybe not as fast as the cloud business, but continue to see growth.

Okay. Financials, we got 25 minutes in. I didn't ask you about the financials yet. So let me do that, starting with what you just brought up this gross margin. So one question that I get from investors most frequently is the trajectory for gross margins in your business. Can you maybe kind of provide some perspective about how much natural room you see over the next, say, 2 years to expand gross margins from here? And what are the drivers? Is that pricing, cost, mix, otherwise?

Yes. So really happy with gross margin starting with a 4 handle. I mean a couple of years ago, people were thinking about hard disk drive was something in the 20s, and that's what it was. And then eventually, we got into the low 30s, mid-30s, high 30s. And at least Western Digital, we crossed into the 40s, low 40s right now. And so I think that's really good. Again, today, it's a totally different business, right? Again, 3, 4, 5, 10 years ago, it was client consumer. There was a little bit of cloud. Today, it's AI, data center cloud, total different ball game, a total different value proposition, totally different set of customers. And so we're in the low 40s right now. We only guide one quarter at a time, but I've indicated, yes, there is some more juice to be squeezed. I think there is still some further improvement on gross margins. And when I think about gross margins, I think you summarized it really well. There's 3 elements, right? There's price, there's cost and there is mix. On price, we already discussed. We see a stable price environment, which is much better again than what we've seen historically. Historically, we've seen on or about a 7% year-over-year ASP erosion on an ASP per terabyte basis, right? Today, it's stable. And not only today, I think the next couple of quarters, years, it looks like it's going to be stable. I mean, eventually, I mean, there could be some ASP erosion, but currently it's stable. We're doing a really good job on driving down the cost, right? And again, multiple elements there. Probably the largest one is areal density, getting to higher capacity drives, right? That really helps from a cost per terabyte. But in addition to that, the teams are executing really well in driving down cost in our own manufacturing environment as well throughout the supply chain. And so great execution there. And then mix, mix is trending in the right direction, right? And when I think about mix, it's about mix towards higher capacity drives, mix towards more UltraSMR mix shifts, including our platforms business. We haven't talked too much about that, but we have a platforms business that is accretive from a gross margin point of view because we add more value there as well. And so combination of all of that, I think, gives me confidence that there is more gross margin improvements to come.

Very good. Now between you and your main competitor, there's a 4 percentage point difference in your target financial models. To what would you attribute that difference? And could you maybe address the level of confidence you have in achieving a somewhat higher goal than you've laid out?

Yes. So again, I can't really speak to my competitor and their model and their probably target model that they laid out. But it's definitely -- the way I look at it, it's definitely not an apples-to-apples because we did not lay out a target model on the February Investor Day, right? We laid out a base case model, almost like to be considered as a floor.

A floor.

A floor, right, not a target, a floor, right? And that's why we are operating well above the floor right now, right? And so -- and again, maybe to summarize what we said at the model, growth in exabyte at 15% CAGR base case potentially up to 23% with AI CAGR. And as I said before, I think we are definitely trending towards the high end of that exabyte growth. We also indicated a 7% or in our model, we assumed a 7% ASP erosion. But as we discussed earlier, that's trending kind of more flattish, right, stable. We've also had a 38% gross margin floor. And as we discussed earlier, we are now in the 40s -- low 40s with further potential expansion from there. We've also indicated on or about 14% OpEx. But if you look at currently, we are more in the 13% or sub-13% OpEx to revenue. And -- and that is despite the fact that we're not starving the business, right? We are investing in technology and product road maps. We are investing in our next-generation ePMR. In parallel, we are investing in HAMR. But we do see as revenue continue to grow strong, further leverage in our model and OpEx as a percent to revenue could continue to go down from our current levels. And so that translates into very strong bottom line growth and also very strong free cash flow.

I want to ask one question on your LTAs with hyperscaler customers. What portion of your business is kind of covered by those agreements? And maybe talk about the terms under which they operate, whether that is volume commitments, pricing, revenue and just kind of other things that are tied into the contracts?

Yes. So we have not disclosed that, but you can do a little bit the math itself, right? Earlier, I said that the top 10 is 68% of the volume. Now we only have those LTAs and POs out many, many quarters, although the # 6, 7, 8, 9 and 10, we have good growth there as well, and they also start putting in orders a lot more ahead of time, right? But with the top 5, you can do the math there a little bit how much that covers. And I'm not going to discuss in detail the commercial arrangements we have with each and every customer. But when you think about POs, yes, POs have quantities and price in it, right? And again, with one customer, it's an LTA, but it's -- you can consider the LTA something similar as a PO as well. So -- so there is a lot of teeth into those LTAs and POs that we have out there.

Okay. Very good. Last question, capital return. Maybe outline the plan at a high level. What are your thoughts on dividends and buybacks today and once you reach your net leverage target?

Yes. Yes. And so maybe to wrap it up, right, I think we have strong top line growth. We continue to expand gross and operating margins that translate a strong bottom line that translate in combination with good working capital management and strong free cash flow, and there is still further opportunity to increase the free cash flow and improve the free cash flow margin. So I think we feel really good about that part of the business. Secondly, we have strengthened the balance sheet, right? At the separation back in February of 2025, the balance sheet became a lot stronger. Post separation, we've further done some debt reduction. And so at the end of last quarter, we still had $4.7 billion of debt, $2.1 billion of cash. So that translates in $2.6 billion of net debt at -- on or about $2.6 billion of EBITDA. So we're down to 1 turn on net debt-EBITDA leverage ratio. So we've indicated at the Analyst Day, we target 1 to 1.5, but I'm actually comfortable we even go below the 1, right, and further strengthen the balance sheet. Keep in mind that we still have 7.5 million of SanDisk shares that we have indicated at a certain point, we will monetize prior to the 1-year anniversary of the separation. And that's worth almost like $0.5 billion at today's prices. So that is fantastic. So there is still some potential for further deleverage of the balance sheet as well and get below 1 turn as well as EBITDA, of course, continues to grow as well. So what do we do then with the excess cash? Well, we've initiated a shareholder-friendly capital return policy, and we've stated that all the excess cash will be returned back to the shareholder through a combination of our dividend program and the share buyback program. The dividend program was initiated 2 quarters ago at $0.10 per share per quarter. At the time of initiation, it was 1% dividend yield, but now it's down to 0.5% and nobody is complaining. But we are committed to our dividend program. And so there is going to be for a certain period of time, some accelerated growth to get a stronger dividend program. And then once we get to a more comfortable level, there will be further growth, but more in line with our free cash flow growth. So that's the dividend program. In addition to that, on, I think, May 13, the day after I joined Western Digital, the Board authorized a $2 billion share buyback program. We immediately switched that on. And just in 1.5 months in last quarter, we did $150 million, right? This quarter, I've indicated it's going to be 3 months of activity and a meaningful step-up of what we did last quarter. And we're committed to this program. I mean there's no hesitation to buy back stock at today's prices or anything, right? So -- so very strong capital return and returning excess cash back to the shareholders.

Great. With that, out of time. Kris, thank you for being here. We appreciate it.

Thanks for having me.