Western Digital Corporation ($WDC)

All right. Good morning, everyone. Really delighted to have with us Kris Sennesael, CFO of Western Dig. I guess before I get into questions, Kris, you have fair disclosures you've got to read.

Yes. So today, I will be making some forward-looking statements based on my current assumptions and expectations, about our product portfolio, the business plans and performance and the future financial results. These forward-looking statements are subject to risks and uncertainties. So please refer to our Form 10-K and other SEC filings, so because risks and uncertainties could cause actual results to differ materially from expectations. We will also be talking about some non-GAAP financials, and the reconciliation is available on our website in the Investor Relations section.

Perfect. Thank you for that. All right. So we have about 20 minutes on this. It's a fairly short fireside chat. I'm going to kick it off with some questions, but anyone in the group here has questions, feel free to raise your hand. Happy to integrate you into that as we go forward. Kris, thanks a lot for being here. I appreciate your time. There's a lot going on. The drive names have done extremely well. Western Digital has been extremely well in the last couple of years. Maybe just talk about at a very high level, right, what are the messages from you folks have been the underlying data need for data storage is getting -- growing faster, and it used to be low 20%, maybe it's over 25% CAGR right now. Just talk about what are you seeing from a data storage requirement perspective? And to the extent you've sounded a little bit more positive on the data growth in the last couple of quarters, what is driving that upside to data growth?

Yes. Yes, it's a great time to be at Western Digital and be part of this AI data-driven economy. And so let's try to unpack that. So currently, based on all the discussions that we have and frequent discussions that we have with all our customers, we are getting more and more comfortable that the exabyte growth over the next 3 to 5 years will be greater than 25%. So very strong growth in exabyte. And so what is driving that? Well, first of all, there is still -- we sometimes we forget about that, that is still the cloud, right? And there is 8 billion people on the planet that continue to take pictures and video and upload that to the cloud through their phones and other devices and then, in many cases, multiply that through their social media, right? In addition to that, I think every company on the planet by now has understood what the value of data is and is storing all the data that's being generated inside the company. We at WD do that. And so there is definitely still a lot of growth just by data being pushed into the cloud. In addition to that, yes, there is a lot of growth as a result of AI. And AI, there are several factors in it. First of all, and that's what it started was big data lakes that were created to support the training of the multi-model large language models, right? It's a multi-model because it was not just on the tax base but also pictures and more and more video based. And that is still ongoing, but there's still a lot of relearning, retraining of the models, and they are training the next generation models. Some of them are very broad. Some of them are more specific. And that all still requires a lot of data, the vast majority of that being stored on heart disk drives. In addition to that, we've now moved into inferencing, right? And inferencing can have multiple forms from a simple chat box inferencing all the way to agentic AI, right, where one agent or multiple agents go through some very complex inferencing and all of that. And so what we have seen is that the output of all that inferencing is being stored, right? And it's being permanently stored. They want to remain the history of every question you've ever asked to do with chat box, but they also want to use the output and some of the logic, how they came to the output to retrain the language models as well. And then last but not least, and that's just beginning, you have physical AI, right? Physical AI from autonomous cars, robotics in the future, humanoid, right? A lot of those devices, they have multiple cameras they shoot video footage 24 hours and that video focus is then being used to retrain and learn the algorithms. There is actually not enough video footage available today. So that's now all the hyperscalers and people involved in physical AI, they use AI to generate synthetic data to complement the real data to further train their models. And so when you combine all of that, we have, again, high conviction that exabyte growth is greater than 25% for the next 3 to 5 years.

Perfect. Data grow another 25% to your point for the next several years. Talk about where do we end up storing all this data? Because I think one of the dynamics has been, you have this number better than I do, but 80% of the data gets stored on hard disk drives, I think, traditionally, how much capacity does the industry have? How much capacity is Western Dig have? And how much of this data growth can you really support from a supply basis?

Yes. Yes, if you look at hyperscalers, roughly 80% of all the data is being stored on HDD and roughly 20% or so is stored on SSD. By the way, both segments are growing very strong, right? It's not that one segment is growing faster or slower than the other. Both segments are growing very fast. And to the other part of your question, right, how do we support greater than 25% exabyte growth over the next 3 to 5 years? What is very simple. We don't have to add unit capacity to support that, but we can support this very strong growth of greater than 25% through technology and product transitions, right, as we move to higher capacity drives, right? And we have a great track record there. Just to put it in perspective, right? The average terabyte per drive that we shipped last quarter was on or about 23 terabytes, right? Despite the fact that we have a 32-terabyte available, and we're actually shipping it in really high volume. And in addition to that, we are working on qualification of our next-generation ePMR solution that will go up to 40 terabytes. And in parallel, we're working on the qualification of our first-generation HAMR drives that will go up to 44 terabytes. In addition to that, we have a road map that goes out multiple years, where we have a path to 50 or 60 or 70 or 100 or plus 100 terabyte drives. And when you take that into account, there is sufficient exabytes there to support the strong demand growth that we see from our customers.

Got it. One of the things that's really changed. I think this industry is historically price per terabyte revenue sold to your customers would be down 10%, maybe more in a bad down cycle. That's fundamentally shifted. And a little bit of this is what you said, supply is good -- demand is good, you don't want to add that much supply. How do we think about price per terabyte as we go forward? And maybe if you can contrast that a bit with what we're seeing on the NAND side, for example, where the price increases are very dramatic.

Yes. Well, first of all, our industry and the hard disk drive industry has changed drastically compared to 3 or 5 or 10 years ago, where a lot of the business was consumer or client, some of that was cloud, but it was done through OEMs. Fast forward to today, 90% of my business is cloud, still 5% consumer and 5% client. And we -- within the cloud, we're now dealing directly with the large hyperscalers, all of them, right, on -- in the U.S. and outside of the U.S. And so that has changed drastically. And our relationship with our customers is really -- and our pricing strategy is really value based as we provide more value to our customers we want to get paid for the value that we deliver to them. And moving to higher capacity drives is adding more value to our customers because that is good for them in terms of rack density, lower real estate cost, better power efficiency and less power consumption. And so as we move to higher capacity drives, we provide more value, and you will see the price per terabyte goes up last quarter. Our average ASP per terabyte was up 9% on a year-over-year basis. We do it slightly different than on the memory side. The memory side is more of a supply-demand driven pricing. It goes up in some cases, very drastically, but in some cases, it comes down as well as the demand supply dynamics change over time.

Got it. Maybe just on the pricing side, if I stick for it right for a minute. One of the enablers has been these long-term agreements, LTAs and build-to-order processes that drive Western Dig driving [indiscernible] implemented. Just talk about a little bit of what does the LTA provide to you folks. And as you look at that over the next several years, what sort of pricing visibility do you end up having?

Yes. For me, the LTAs -- first of all, we're not asking for it. It's our customers who are asking for it because they see the very strong demand and need for storage multiple years out, and they want to secure the supply from the suppliers and from Western Digital. And so some of our customers, they want to have LTAs all the way till 2032, 5 years LTAs. For us, the LTAs are important to create more visibility in both ways. We want to better understand what the long-term demand trends are from our customers multiple years out. We also want to provide visibility to our customers on how much supply we have, and how we grow the supply over time, again, as we move to those higher capacity drives. And so in addition to that, I mean keep in mind that it takes on or about 52 weeks to produce a hard disk drive, 9 months to produce the wafers that goes into the heads and then 3 months to produce the hot disk drive itself. And so as a result of that, we've educated our customers and most of our customers, they place purchase orders now 52 weeks in advance. So we have pretty good visibility, at least one year out. But even beyond that, right, in part because of those LTA discussions. Those LTA discussions, they have a volume component and a price component in there with some flexibility, right? And so it's not all really set hard there is some flexibility around that. But again, most important thing is better visibility both ways.

Got it. Perfect. You touched a little bit on like the EPM road map and then you obviously have a hammer road map as well. Maybe just -- and you touched on [indiscernible] araldensity improvements you focusing go after. Talk a little bit on cost per bit. What does that mean for the company as you go forward? And what's the right way to think about cost per bit decline maybe on ePMR and then also as you go to HAMR eventually?

Yes. So again, if you look at moving to higher capacity drives. Forget what the recording technology is that's not the most important thing. The most important thing is moving to higher capacity drives that does a lot of good for everybody. I call it win-win situation, right, moving to higher capacity drives. It provides more exabytes, right, for storage at a higher value for our customers. Of course, you get better rack density and lower real estate costs and better power efficiency. Also for us, it has a benefit because we can -- as we provide more value, get a better price per terabyte. But at the same time, moving to higher capacity drives also results in a cost per terabyte that comes down because -- it doesn't cost that much more to produce a 40 terabyte drive versus a 32 terabyte drive, right? And so it's a win-win situation all over the place. Our cost we think, over the longer term, costs will come down on or about 10% year-over-year on a cost per terabyte basis, right? It's not necessarily going to be like that each and every quarter. But in the mid- to longer term, we see a cost down of on or about 10%.

Got it. If I take a couple of these things together, right, you said win-win, I imagine this. There's a win on your revenue side because pricing goes up, there's a win on your COGS side because cost per bid comes down as well. What does that mean for incremental margins and gross margins for the company as we think about this on a multiyear basis?

Yes. So at the Innovation Day in February 2026, I indicated that gross margins the next 3 to 5 years will be greater than 50%. We actually the March quarter, we entered the new ZIP code, and we got into the 50% already. So we are now operating in this greater than 50% environment. Incremental gross margins, depending on how you look at it quarter-over-quarter or year-over-year, I tend to focus more on year-over-year because it's more meaningful. It's in the 70%, 75% range. So very strong, and it's driven by price per terabyte that goes up and cost per terabyte that comes down. And so I think -- yes, we're in a, I think, in a very strong position to continue to see further gross margin improvements for many, many quarters to go.

Got it. And you have good top line growth. You have 70%, 75% incremental gross margins. OpEx, I assume it's going to be fairly limited as well. What does that mean from an EPS and free cash flow basis eventually for investors?

Yes. I mean, if you look at the story, right, we have very, very strong top line growth the gross margins and operating margins continue to increase. We have a really strong capital return policy as well. leveraging our very strong free cash flow. I mean the free cash flow margin is approaching 30%, and so that generates just last quarter, close to $1 billion in free cash flow. What do we do with the free cash flow? Well, we return it all back to the shareholder, right, through a combination of our dividend program and the share buyback program. On the dividend program. We fully committed to that dividend program. We've already increased it twice. And there is a lot more opportunity there in the future. But the vast majority of of the free cash flow is being returned through the share buyback program in for me, there is no hesitation, right? I do intrinsic value calculation. I look at my forecast, my strong revenue growth, my gross operating margin improved is my free cash flow. There's no hesitation. We are we're buying back almost every day.

All right. Perfect. You folks bought back some of the convert today, [indiscernible], or is the 8-K leasing a bit of a redemption. Maybe just touch on that and kind of how does that play into your capital allocation process?

Yes. So in addition to the free cash flow, we also have a very strong balance sheet. At the end of last quarter, the only thing what was left was $1.6 billion of debt. We wiped out all the other debt. And we had $2 billion of cash. So we were in a positive net cash position at the end of March. At the end of March, we also still had 1.7 million of [indiscernible] shares. Subsequent to March, we already monetized on or about 600,000 [indiscernible] shares in an equity-for-equity exchange. And we have the intention to further monetize the remaining slightly more than 1 million [indiscernible] shares that we have. But we also have the $1.6 billion convert out there, that has a maturity in November 28, but we can call it in November 26, but the convert is so far in the money, the converters can actually put it to us as well. And so we are having discussions with some of the note holders. And as we've announced this morning, we did a private exchange with a good chunk of that $1.6 billion of the note holders and will pay the principal in cash and pay the premium in shares.

Perfect. One of the questions I get a fair amount when we talk about Western Dig investors has been what makes them add more capacity, what makes them add more units to the ecosystem over time. Just touching your CapEx philosophy and maybe ask the question like what would it take for Western Dig to actually add more units to the ecosystem?

Yes. So again, we -- let's start with the demand, right? So we see strong demand greater than 25%. And so I'll leave it up to you to pick what that means, what -- but it's greater than 25%. And so -- but we believe that as the demand is even greater than 25%, we can fulfill that demand without having to spend CapEx for adding unit capacity, right? We will have to spend CapEx on or about in the long term, 4% to 6%, right? In some years, it might be less than that, some years it might be more than that. But in the long term, 4% to 6% of CapEx to revenue, we will have to spend that in head and media, right? Because we need better hats and in some cases, we need more hats and we need better media and in some cases, we need more media, right? And we are -- there's no hesitation there. We are making the necessary investments to make sure we can, again, support the growth of more than 25% exabytes.

Perfect. One of the challenges, I think, for folks always have the drug space has been like you're dealing with 5 or 6, maybe a bigger number, but a constant number of very large buyers and how much leverage do you really have in these negotiations with them over time versus not. I think Kris, it's your prior job you dealt with Apple as your big buyer, if I'm not mistaken, which probably is the toughest one on supplier sometimes. Just talk about how does that engagement work? Is it just they come into [indiscernible] agreed to it? Or is it more if we collaborate than Western Dig?

It is. I mean we have changed the engagement model as well, right? We have a very strong collaborative engagement model with our large hyperscalers. They share their multiyear data center road maps and technology and product programs, we do the same from our side. And I think we have earned our seat at the table. They fully realize to build out this AI data center infrastructure. They need a lot of elements. They need a lot of GPUs and TPUs and CPUs. They need a lot of HBM and memory, but they also fully realize they need a lot of HDD, and that is a very critical component in the overall buildout of the AI data center. And that's why we have this very strong mutual respectful relationships. We're working hard to provide as much value to our customers. We obviously want to get paid for that. And I think that's a win-win.

The thing is going right on me, but I'll ask you a quick question, if you don't mind. How do you know all the stuff you're shipping to these hyperscalers actually getting deployed in the data center versus sitting in shelf somewhere?

Oh, yes. No, no, no. We -- I mean, we have, again, a strong relationship with our customers customers are pounding the table. They want how this drives as fast as they can. And through the collaboration we have with them, we have great visibility that all the hard disk drives we are shipped are being deployed as fast as they practically can do it.

Perfect. We're up on our time. So maybe I'll stop there. Kris, turning back to you. Any closing comments, anything we did not touch on that you want to flock to investors tell us how great greater than 20 really means.

No, again, I leave that up to the to the investors to figure that out. But it's still improving. It's still improving. Again, like I've been with the company for 12 months now. I talk to the customers as well. Many of our employees talk to the customers every time they come back. It's with a forecast that continues to go up. And so again, we are -- I think we are well positioned. We're a technology leader. We have a great technology that our customers love and appreciate, and we're well positioned to be one of the winners in this AI data-driven economy.

Perfect. We'll stop with that. Thank you very much for your time, Kris. Thank you.

Thank you.