Western Digital Corporation ($WDC)

Good afternoon, everyone. Welcome to the next fireside chat here. I'm Samik Chatterjee and I cover hardware and networking names at JPMorgan. With me, I have the pleasure of hosting Western Digital and from Western, Kris Sennesael Chief Financial Officer, I hope I could announce that right, but please if I didn't. Let's talk about the industry first before we get into any western data questions. But do you want to read out the safe harbor first?

Yes. And Sameek, thanks for hosting us here. Great conference so far. But before we go, I have to make some disclosures that today, I will be making some forward-looking statements based on management's current assumptions and expectations, including to our product portfolio, business plans and performance and market trends. These forward-looking statements are subject to risks and uncertainties. So please go read the 10-K and other SEC filings that provides more information on risks and uncertainties that could cause actual results to differ materially from expectations. We might also be talking about some non-GAAP financials and the reconciliation you can find on our Investor Relations website.

Okay. I saw that Ambrish just walked in and saw you reading the safe harbor, so he's probably happy as well. Let's start with the demand drivers for the industry. I think generally, everyone's been surprised of the demand drivers and how much it has exceeded expectations consistently. Just talk about what are the biggest drivers you're seeing right now in terms of driving the exabyte growth and why we could potentially have this exceed expectations more consistently going forward as well.

Yes. It's a great time to be in the hardest drive business. And when Irving, our CEO or myself or anybody of the company goes and talk to the customers, they come back with good news and better news. And it looks like every time we talk to them, the demand is stronger for longer which is good. And so just to put it back a little bit in February of 2025, we indicated that we expect the market to grow mid-teens on an exabyte compound annual growth rate over the next 3 to 5 years based on what we see in the cloud. And we indicated that if and when AI kicks in, the growth could accelerate into the low 20s. And so fast forward to today and at our last earnings call, we've actually indicated that we now expect exabyte growth to be higher than 25% compound annual growth rate over the next 3 to 5 years. And so what's driving that? First of all, the base is still there. So the cloud, right, 8 billion people loading, pictures and video up into the cloud, sharing it to social media and so on, that continues to be very strong. In addition to that, every enterprise on the planet, including WD, we understand the value of data, and we're not throwing away any more data. We store all the data we can capture in our manufacturing side, in our engineering operations, throughout the company. And I think every other company on the planet is basically doing that. In addition to that, we definitely now get a better understanding of AI. And AI has different facets as well. First one, of course, is training train of the multi-model models that is out there that is not only tax base, but also pictures and more and more video-based. The training is still ongoing because all the big players continue to develop their next-generation model and store a vast amount of data. They also work on retraining, relearning of the models and leverage all the data. But now in addition to that, we've definitely moved in inferencing. And we estimate that roughly 2/3 of the compute power in 2026 will actually be used for inferencing. And so what -- how do we benefit from inferencing? Well, what we noticed is that all the chat box all the way down to Agentic AI that is using inferencing, the output of that is being stored and the vast majority of that output is being stored on heart test drives. They want to know what's being generated. They want to know the history, and they want to know as many characteristics around that. And so that's driving a lot of more data storage. In addition to that, and that's the last one, and that's still early days, you have the physical AI, right, which is autonomous cars, robotics and in the future, Humanoids. What do those devices have in common? They have multiple cameras attached to it, and they want to try to capture video as much as they can and store that and feed that into their training models as well. There is actually not enough data available there to train the models that they now use AI to create synthetic data to complement the real world data to further optimize the algorithms. And so when you put this all together, we now are convinced that exabyte will grow more than 25% on a compound and will grow right the next 3 to 5 years.

Got it. Okay. Very comprehensive. So maybe then how is that driving the engagement with your customer chain. So for example, you've talked about in the past, long-term agreements built to order. Like what did those historically looked like before you start to see the wins what do those look like now? How is AI and the demand that you're seeing changing the engagement with the customer in relation to these agreements?

Yes. So first of all, We definitely have changed our customer engagement model, and we do have a lot deeper customer engagements right now, especially with the hyperscalers, right? And so the relationship has changed from a supplier customer relationship 3-plus years ago to a really strategic partner. And all our customers, the hyperscalers fully understand the critical value of data in the critical part that hard disk drives and storage plays in their overall AI data center build out. So that is very important. We also have, again, much deeper customer engagements. They share their technology and product road maps. They share and give us much more visibility about their demand for storage multiple years out. In return, we have done the same, right? We share our technology and product road maps with them. We've invited them to our factories. We share our capacity and manufacturing road maps with them. And they fully understand that it takes 52 weeks to produce a hard disk drive, 9 months to produce the wafers that become the heads and then 3 months to put it all together, including testing. And so we have told all our customers or the larger customers, we expect 52-week orderly time for purchase orders because it takes 52 weeks to produce a hard disk drive. And so in addition to that, our customers also wanted to secure more supply further out. And that's why we have entered into LTAs with our larger customers for calendar year '27 with some of them for '28 and even less of that '29. For us, again, those LTAs are frameworks, right? Those are not take or pay heart agreements, they are there to create more visibility from the key customers to us and commitments that we make to them those LTAs have a volume component and a price component in it. They're slightly different by customer. And again, there is still some flexibility there. The most important thing is creating better predictability, better visibility on both sides.

Got it. Going to the 52-week lead time that you referenced. I mean one of the questions, and I'm sure you've got this from investors as well is you start investing in the capacity today, you're shipping out 52 weeks later what happens if the customer's demand profile changes, right? And you're getting into these LTAs, but not necessarily that these are take-or-pay contracts. So how do you get the confidence about adding capacity when you have lead that extend to 1 year almost at this point? And are you -- how do you get confidence on not -- that you're not adding capacity at a peak?

Yes. So first of all, again, for us, it's very important to continue to get that visibility multiple years out, right? That helps us to plan our business and so far, as I just explained, the demand signal is stronger for longer, right, which is good. Now when we look at that, we look at that, do we have to add unit capacity to support plus 25% compound annual growth rate for the next 3 to 5 years? The answer is no. We know how to support the strong growth in exabytes of our customers, not by adding unit capacity, but through technology and product transitions, right? As you probably know, currently, our average terabyte per unit that we ship in near line is on or about 23 terabyte per unit despite the fact that we do have -- the highest capacity we have available today is 32 terabyte units, and we shipped a lot of them already. And we've indicated that we are currently in qualification for the next-generation ePMR drives that go up to 40 terabytes, right? Qualifications are going really well, and we are going to ramp volume production in the second half of calendar year '26. And then in parallel, we have been working on HAMR for 10 years. We're now in qualification with 4 customers. Qualifications are going really well, and that goes up to 44 terabyte drives and the ramp will happen in calendar year '27. In addition to that, we have a technology and product road map that will get us to 50, 60, 70 eventually plus 100 terabyte drives. Right? And so we have plenty of room to -- as we execute on our technology and product road maps as we collaborate with our customers on qualification and adoption of those higher capacity drives, we can continue to execute and deliver and supply 25-plus percent more exabyte on a compound annual growth rate basis.

Got it. So maybe that's on the volume of the storage side, storage exabyte growth side. Let's talk about pricing, but maybe let's start with a different angle, which is pricing has pricing structure has changed for the industry. It's a much more favorable pricing environment. Can you go into the competitive landscape of the industry structure today and how much do investors need to bank on rational competition between the players to see a favorable pricing environment continue in the industry?

Yes. And so I can't speak for my competitors, but you know the competitive landscape. It's basically 2 large suppliers and a third player out there. So that's the competitive landscape. The way we go at pricing, it's a value-based pricing, right? As we execute on our technology and product road map as we continue to innovate, right, and move to higher capacity drives, we provide more value to our customers. higher capacity drives, give them better rack density, lower real estate cost, better power consumption and more exabytes, right? And so there is more value for our customers -- and we want to get paid for that, right? And so that's why we continuously increase our pricing per terabyte. If you look at last quarter, our average blended average ASP per terabyte was up 9% on a price per terabyte year-over-year. And again, as we continue to further deliver more value to our customers, we see further opportunity to increase the pricing on a price per terabyte basis.

Okay. Okay. Maybe let's talk about the technology approach you have relative to some of your competitors or your primary competitor. You have a multipronged approach on the technology front, your doing you're ramping hammer, you're ramping ePMR, which is different from our competitor, where there's much more of a single focus on the technology front. Why the multipronged approach and how does it impact event financials when you think about OpEx spending or R&D? How are you sort of thinking about the strategic rationale as well as the financial implications of it?

Yes. First of all, our customers rightfully so, are very careful to store your data, my data, everybody's data. They are very conservative about that. For them, quality, reliability, they don't want anything to go wrong with your data. And so they are somewhat conservative. And so we listen to them, we work with them. And let me go back a little bit. I think there was maybe a misconception in the industry that ePMR drives will max out at 28, 30 terabytes per unit. We clearly proved that was a misconception that was wrong. We are shipping in high volume, 32 terabytes right now. We are in qualification with the 40 terabyte that will ramp in production in the second half of calendar year '26 and we believe we can further improve ePMR all the way up to 50 or 60 terabytes in the near future. For now, we think it will cap out there. But who knows, maybe engineers will find ways to further stretch that out. In parallel, for the last 10 years, we have been working on our HAMR technology. It's in really good shape. We are, as I said before, in qualification with 4 customers, and that comes up to 44 terabytes per drive when we launch that in volume production in 2027. And then, of course, we will continue to expand the capacity per drive into the 50, 60, 70 all the way up to 100-plus terabyte as well. So that's what we do from a technology transition. As you probably know as well, ePMR and HAMR comes in 2 flavors. We have the CMR and the Ultra SMR flavor. Ultra SMR gives us 20% more exabyte versus CMR, mostly done in firmware, software adjustments. And again, our customers want more exabytes. 2 large customers are fully adopted Ultra SMR. The third one is now ramping Ultra SMR, but we have been talking to all our other customers and say, you want more exabytes let's collaborate on the adoption of Ultra SMR, and we have a plan now to convert almost all our customers or the larger customers to ultra with qualifications finalized by the end of 2027.

Okay. I mean -- so maybe just trying to think about the financial implications here. You migrate most of your customers to Ultra SMR, you have a cost benefit there. But on the flip side of it, how should we think about R&D expenses to support these multiple platforms that you're working on?

Yes. So of course, if we would only focus on one platform, that would be a little bit result in lower operating expense. We choose to support both of them because, again, we believe there is more value for our customers there. They love the PMR proven technology, which has been out there for 10 years. They understand the quality, the reliability. We know how to scale it in a very condensed way. And so yes, we have to deal with some higher operating expense right now. By the way, we also not only investing in higher capacity drives, we're also investing in improving the overall performance of the drive, increasing the bandwidth as well as the speed of which the data comes in and out of the hot disk drive. We get a really good feedback from our customers on that with our high-bandwidth drives as well as the dual pivot technology. Of course, that requires some operating expense as well to support that. But we believe, again, that the value creation we can realize by investing, focusing on innovation is the right strategy to do that. Operating expenses going forward, there's definitely leverage in the model, right? I mean revenue is going to grow a lot faster than our operating expense. We don't need much more operating expense, yes, there is some inflation and merit and some other adjustments. But -- the operating expense will continue to come down as a percent of revenue at a good pace.

Okay. Okay. So maybe let's move to focusing a bit on ePMR. Even as you're ramping hemo clearly is a differentiation for you because when investors look at gross margins, your gross margins are actually ahead of your P despite ramping HAMR more recently compared to your peer company. Why can't your competitors replicate what you're doing with ePMR, like what does that competitive moat look like? And what prevents competitors from copying or applicating what you've done?

Yes. I mean I think it's an architectural and strategic product road map and technology road map decision. Our competitor decided not to continue to invest in ePMR and invest on HAMR and that's their decision. Again, there is -- I mean it's only to and a third smaller player, right? We don't see new entrants. We don't see new investments into the hard disk drive business. We have our technology road map. Again, we believe that is a really smart, good decision. HAMR is a great technology, and we're all in on HAMR, right? And for us, HAMR is the path I plus 100 terabyte drives. But hammer dust come with some incremental cost. You have to add a laser to each and every head -- so there's some incremental cost. You have some incremental cost on the substrate. Again, it's the right thing to do. We're all in on HAMR. We are making good progress. We're ahead of schedule. But we do believe that there is still a little bit of longer life with ePMR in a very cost-effective way again, a product that our customers knows very well, scalable, reliable and we will continue to execute in parallel, ePMR and HAMR.

Okay. Okay. No, that's good. So that's a good segue. When you talk about the 100 terabyte drives, you outlined the road map to it from a technology perspective, which will be driven by Hammer. What are you looking at in terms of internal milestones to track progress to it? And what are the hurdles that you think you need to overcome if you in terms of the path to that 100 terabyte drive.

Yes. Again, we're feeling really good about that. And when you think about how do we continue to increase the capacity per drive -- there's 2 ways of doing that. One, which is the most important one, is to increase the aerial density, right, and find ways to store more terabytes per platter, right? Currently, we are approaching 4 terabytes per platter, but we have a path to get that to 5, 6, 7, eventually 10 terabytes per plate, right? We know in the lab how to do 10 terabytes. It's still going to take us multiple years to ramp that in high volume, but we know how to do that, right? And so aerial density is the most important factor. In addition to that, we know how to add more platters per unit, right? And that's not an excuse for aerial density. -- aerial density has to be at the industry-leading levels. for moving all the way up to 10 and more eventually. But adding more platters per unit also gives you a cost advantage as well. And so we will continue to find ways to add more platters as well. And so -- now how are we getting to better aerial density, you need to make investments on your head technology, right? The wafer nano manufacturing and had technology that does the REIT and right functionality as well on the media, right? And media is substrate. Do you use aluminum or glass, right? And currently, in PMR, we use aluminum in HAMR, we will use glass substrates. And then how do you condition your substrates and turn it into media for magnetic recording and work on the recipe there. And so -- we -- there's a lot of science, chemistry magic that happens there, but we have very smart engineers, which again have figured out most of that. Now it's just about making sure we continue to execute on it, deliver on it. In many cases, you just need time to prove it out, make the improvements over time, make sure the quality, reliability sustainable. And then, of course, you have to work on manufacturability in your factories as well. And all of that is being done in parallel. It's really hard to do that, right? Again, that points to the high barriers to enter in the heart is drive space, but we know how to do it and keep focusing on execution.

Got it. Okay. So you have these 2 parts, ePMR, ammo you have the 40 terabyte ePMR being qualified, you have the hammer being qualified. When you go to a customer with both, what are you likely to see in terms of customer allocation of share, how do they pick and choose between EPM or what do you think likely will happen when you go to a customer with both of those options?

So customers don't think about recording technology. They want scalable, reliable exabytes, right? And however, you can get that to them, right? Obviously, with ePMR, again, it's a technology. They have been using for more than 10 years. They understand the quality, the reliability -- we have gone through multiple ramps of previous and next generation of ePMR, they feel very comfortable around that. HAMR. It's a new technology. Again, they don't have any experience with HMR drives that are 5 or 6 years old in their fleet, right? They don't. Nobody has right? And so they are probably a little bit more careful there. They want to go make sure as you go through qualifications, they spend a little bit more time making sure they understand the quality, the reliability, how the drives behave. And so that's why it takes a little bit more time. But again, to answer your question, they don't care about the recording technology. By the way, again, back to the question of the LTAs, the LTAs we have are exabyte based. They don't specify the recording technology. They so to speak, couldn't care less. They want high-quality, high-reliable exabytes. Let me just pause here and see if anyone in the audience has any questions.

Thank you. You said earlier that you feel confident you don't have to add unit capacity to support the 25%-plus CAGR in exabytes. At what level would you feel like you do need to add unit capacity in order to support that?

Yes, that's a great question. And so we've indicated that we expect exabyte to grow now at plus 25% and -- and now the question is what is plus 25%, but I'll leave that up to you. And so -- but I'm comfortable with the plus 25% that we don't have to add unit capacity. Again, I'll give you some examples, right? Today, we ship 23 terabyte. That's the average, right? If I can get to 44 terabytes, right, that's almost over 23%, almost 100% more exabyte per unit, right? Now again, we need to qualify the 44s, we need to ramp the 44s there is a certain adoption curve. You have to move customers over and over. But 44, right, shortly after that, we will get to the 50s and the 60s and the 70s and the 100-plus right? And so if I look ahead over the next 3, 5, 5-plus years, and I look at my technology and product road map, I don't see a need to add more unit capacity and still support very strong exabyte growth year-over-year.

Great. And just a quick follow-up, if I may. Whatever that number is much higher than 25%, is it fair to say that the hyperscalers haven't shown you that level of stronger for longer yet?

No. Every time we talk to them, they come back with stronger and longer, right? Again, a year ago, we were -- they gave us a certain view of the demand for the next 2, 3 years. And it was like, yes, but we don't know exactly year 4 or 5, right? And as we have multiple discussions on a continuous basis over the last 12, 18 months, they now single a much stronger demand each and every time we talk to them, and they are willing to almost commit further out in 2021, 2022. One more question in the front here.

Can you just talk about some of the innovation on the high-bandwidth technology? Just interested kind of how that shifts, hard disk drives potentially in the data center and whether it can expand the kind of share of the total storage spending?

Yes. So today -- like if you look at data centers, right, roughly 80% of the data is stored on hardest drives and on or about 20% is stored on SSDs. Despite the fact that SSDs is a lot more expensive in terms of cost of acquisition and even in terms of total cost of ownership. That was the case 12 months ago. And today, that's even a lot worse. -- right? Their cost of acquisition has gone up a lot. Their total cost of ownership has gone up a lot. And so our customers don't like that, right? But there is a reason why on or about 20% is stored on SSDs because they have a performance advantage in terms of throughput and speed, right? And so our customers came to us and say, "Can we work on this? Can we collaborate on this? Can you help us? Can you improve the performance of your hard disk drives. And we have smart engineers that looked at it and studied it and found solutions. And we've basically found a combination of 2 solutions. One is high bandwidth drives, which is mostly a firmware, software solution to create a better performance. And then in combination with the dual pivot, which is a hardware solution. And when you combine both of that, you will have more throughput and a bigger pipe, more bandwidth that will, over time, increase the performance 4x and eventually 8x compared to what we have today. And the customers are very excited about that. We are already sampling with 2 customers the high-bandwidth drives, and we see a lot of traction there. And so as we execute there, right, there is a possibility for us to so to speak, encroach into that SSD segment. We're never going to wipe that out completely, but it creates an opportunity for us to move into a warmer layer of data.

Let's move to for the last few minutes just discussing hammer a bit more and really trying to focus on HMR. So in the past, you mentioned when you were ramping 18-terabyte or 20-terabyte platform, that you start with about 60% deals at ramps when you get to a more mature phase that ramps about 18%, 19% is that a good trajectory to think about HAMR that you ramp starting with 60 and you get to a majority of '18, '19? And how much time before you get [indiscernible]

Yes. No, I think the story is slightly different. I mean a couple of years ago, yields -- overall yields were in the right? But we've really focused on automation in the factories we captured a lot of data and initially used machine learning applications on top of that. And now we use more advanced machine learning, call it AI applications that has really helped us to drastically increase the overall yield from somewhere in the low 60s to somewhere now in the low 90s. Now of course, every time you go through a technology transition, you go a little bit through a learning curve in terms of yield, although in -- if it's moving from 1 generation ePMR to the next generation of that has gone really smoothly. It's a little bit more challenging if you move from 1 recording technology, ePMR to the next generation hammer of recording technology. That is not easy to do. That is challenging, but we know how to do that. Again, the good news for us, based on our strategy and technology and product transition, we are not in a rush. -- we want to take our time. We want to make sure, again, that the customers are comfortable with the quality, the reliability of the product and ourselves are comfortable with that. And then we are going to ramp it in the factories not feeling rushed because we have the 40 terawatt ePMR, right? But we will take our time go through the learning curve and make sure that if and when we launch [indiscernible it is kind of neutral to accretive from a gross margin point of view.

Got it. Great. Okay. So I was going to follow up on that, but let me just wrap it up with a question in terms of pricing then. You did report 9% pricing, as you said. Now when you think about the go forward, obviously, you reprice these LTAs, you can pricing benefit, why should we expect pricing to accelerate from here on, given that generally a waterfall would indicate you have more LTAs coming up with better pricing over time, why shouldn't pricing accurate from the you've seen last quarter?

Yes. So again, from a pricing point of view, we feel good, right? The demand is strong, the supply is increasing, but we think over the next 3 to 5 years, demand supply will remain tight. And it's up to us to execute on our technology and product road map, provide more value to our customers by moving to higher capacity drives and then eventually as well, increasing the overall performance through the high bandwidth drives and the dual pivot. And as we provide more value to our customers, get paid for that. right? We're not going to give it away. We want to continue to increase the price on the price per terabyte. And while we do that, provide more value to our customers, potentially lower their total cost of ownership. It's a win-win for them. It's a win-win for us and it's a win for our shareholders. So that's how we approach it.

Great. I'll wrap it up there, but thank you to the audience, and thank you as well for coming to the conference.

Thanks for having us.