Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Yes. And so again, the name of the game here for us is to move to higher capacity drives, right? And we have been executing really well going from 24 terabytes to 26 terabytes all the way up to 32 terabytes. We are now at the cusp of introducing the 40s and the 44 terabyte drives. And then we do actually have a road map to get to 50 plus, eventually 100-plus terabytes per drive. And again, that adds a lot of value to our customers, right? Lower real estate cost through better rack density, better power consumption and the ability to manage vast amounts of data in a very predictable, scalable, reliable way. And at the same time, as I said before, we're also adding more performance to the hard disk drives. And the combination of all of that creates a vast amount of value creation for our customers that they need, right? Because let's be clear, there is no AI without HDDs, right? HDDs might only be 4% or 5% of the total CapEx spending of the big hyperscalers, but it is a critical component, right? And without HDDs, there is no data centers, there is no AI. Again -- and that's why 80% of the data is being stored on HDDs. It's the most economical, scalable, reliable way of storing data.

Okay. As we talk about HAMR, you guys have laid out you're doing quals, you expect to ramp here. What are the most important customer qualification milestones that investors should look out for as you're continuing -- you're going into HAMR as well?

Yes. We're doing really well with our HAMR technology and product road map. We've been working on for almost 10 years by now. And we're getting to the point where soon we will start shipping our first-generation HAMR. We're currently in qualification with 4 large hyperscale customers, and the qualifications are going really well. We are getting great feedback from our customers. They like the product. They like how it behaves inside their production environments. They like the areal density, the reliability and the quality of the product. And so we are ready to go. We've said before, we intend to start shipping in the first half of calendar year '27, probably a little bit in Q1, a little bit more in Q2 and then continue to ramp that in Q3 and Q4 of calendar year '27 and beyond that as well. And so things are well on track. And so I can't wait to start shipping the first HAMR drives.

And just again, from those who, kind of, follow the HDD qualifications, like could you like double-click a little bit what exactly needs to happen right now? Just because one of your competitors is already up there on HAMR, but the fact that these hyperscalers have already tested HAMR before, would that speed it up a little bit? There's obviously demand for more capacity. And could that speed it up? Like what are some things that have to happen for those qualifications to be met before you do volume production?

Yes. It definitely helps a little bit that we are not the first one introducing HAMR. So our customers are familiar with HAMR drives as well. Having said that, our customers are, I think, rightfully so, very conservative as it comes to qualifying new products. They don't want to lose my data or your data or anybody's data here in the room, right? And so they have a very rigorous process. They're not cutting corners or anything like that. They just follow the process. And so we are going through it right now. Again, we're executing well, great feedback and all of that. In the meantime, we are at the cusp of ramping the 40-terabyte ePMR, right? And so customers love that product. They have more than 10 years of experience with that product. But there as well, we went through the same lengthy qualification cycles as well. It's just a little bit earlier in terms of the time line. And as I said, we shipped a little bit last quarter. It will start ramping this quarter and then progressively more over the next couple of quarters as well.

Okay. All right. And then just from a competitive opportunities, you guys did talk about high bandwidth drives at your Innovation Day. You talked about dual pivot architecture. You talked about opportunity within AI data lakes. Just help investors understand where -- has there been adoption on some of those innovations that you've talked about? Are they part of some qualifications? And when do you see that ramp for some of the additional technologies?

Yes. So our high bandwidth drives was very well received by most of our customers. We are shipping, I believe, 5 of our customers. We're shipping engineering samples as well. And again, so far, the feedback is really great. They like the characteristics and the features of the product. We will continue to further enhance, right? We are now targeting a 2x improvement on the performance, but we have a 4 and an 8x that's in the works. And as I said, like so far, customers really like the product. The introduction of the high bandwidth drives will be in the plus 50 terabyte range. We're not introducing that in the 40s or the 44 terabyte. But once we move to the higher terabytes, there it becomes even more important to have those features of high performance.

Okay. All right. So yes, so you're saying it will be timed with when you do the 50 terabyte, right? Okay. That's great. Maybe I'll just turn it around to the questions. If there is any in the audience, please do raise your hand. We have one here in the front.

You talked a lot about maybe some of the differences today versus maybe prior cycles in HDDs. It's clearly more structural demand for exabytes, higher capacity drives. It seems like the industry is a little bit more focused on no new supply. And so it would be interesting to hear from your perspective, 3, 4, 5 years down the road past this huge surge in capital spending, what does the industry look like? Is there sort of more of a predictable algorithm of volume and pricing growth over time? Or do you expect there to continue to be cycles as there have been in the past?

Yes. Again, the cycles in the past were totally different, right? It was consumer PC cycles and other things. Here, this is a lot more structural, right? This is a planned economy. Our customers, they plan their data center builds more than 5 years in advance because they need to go and secure the land, they need to go and secure the permits. They need to go and secure all the XPUs. They need to secure the memory and they need to secure, of course, the storage side on the SSD and the HDD side. And so they really need to plan many, many years ahead. And they are doing that. And they -- and again, we have -- with our deep customer engagements, we have earned our seat at the table. We do get insights and we are able to challenge them and ask them to explain. And that's why they want to secure the supply for up to 5 years out, right? Because they have this all planned out. As I said before, data is still somewhat different than compute because data keeps compounding, right? When you have compute power installed, every time you use your compute for 3 or 5 or 10 seconds, you can recycle it and reuse it. But every time you use it, you spit out data that needs to be stored and that typically gets stored forever.

Maybe you can switch a little bit to talking about margins, Kris. I mean, incremental margins, 70% plus, I think you guys have talked about. And on top of that, you have operating leverage as well. So just help investors understand, like, margin expansion, sort of what you're thinking about over the next several years? Is there some theoretical limit there that investors should keep in mind, clearly, as supply continues to undership demand here?

Yes. No, we've done a great job at improving the profitability. Again, the name of the game is move to higher capacity drives. As you move to higher capacity drives, you add more value to your customers that's reflected in a better price per terabyte. At the same time, higher capacity drives also lower your cost per terabyte. And so the result of that, the gross margins have continued to increase, and we are now in the mid-50s with operating margins now in the mid-40s. And so this is a very highly profitable business. And is there -- I get the question a lot, is there a ceiling to the gross margin? Is it like a magical number where gross margins could not get over? I don't see it, right? Again, we need to continue to execute and continue to drive the technology and the product, move to higher capacity drives and continue to add more value, which will also continue to lower the cost. So I think we're very well positioned. We are obviously very thoughtful in terms of supply. We want to make sure that we fulfill the needs of our customers, right, with the strong exabyte demand growth. But again, as we execute on our technology and product road maps and introduce the 40s and the 44s and the 50 and the 50-plus and eventually down the road, the 70s and eventually the 100-plus terabyte drives, we will be able to continue to grow the exabyte supply somewhat in line with the exabyte demand growth that we see as well.

Okay. And then, as you're talking about transitions towards these higher capacity drives, 40, 44, 15 (sic) [ 50 ] , how should we think about these cost per terabyte reductions? I think it historically was around 10% or so roughly in terms of cost per terabyte. As you're transitioning towards these higher capacity drives, you have SMR, UltraSMR as well on that. How should we think about the cost per terabyte reductions?

Yes. So in the long term, we do believe that we will be able to reduce cost per terabyte on or about 10% year-over-year, right? That's very clear. And we've demonstrated that in the past as well. Now you need to be careful, right? That doesn't mean each and every year or each and every quarter, it will be down 10% year-over-year, right? Again, the biggest driver for cost per terabyte to be down is move to higher capacity drives. As we explained before, currently, we are somewhat in between 2 product transitions. And so when you're in between 2 product transitions, that slows down temporarily a little bit the cost per terabyte reductions that you see. In addition to that, I mean, we do see input cost increases, right? As you probably know, inside the hard disk drive, we use a little bit of DRAM and we use a little bit of NAND, and that has become a lot more expensive. And across the board, the supply chain, you do see a little bit of input cost increases. And so that's, again, not each and every quarter, you will see the 10% cost down per terabyte. And currently, we are facing a little bit of headwinds. But then again, in the long term, mid- to long term, as we move to those higher capacity drives, as we continue to execute on our value engineering initiatives, taking out cost on the drive as well. I have strong conviction that over time, cost will be down on or about 10% year-over-year on a cost per terabyte. And even in the near term, given where the pricing dynamics are and where the cost dynamics are, gross margin will continue to increase at a pretty good pace.

Okay. All right. Great. And then, just you do have -- even though your CapEx is very small as a percentage of your revenues, you are still investing. What are some of the areas that you need to invest in, especially as you're going towards the 40 -- the higher capacity drives, maybe they have more heads or platters in there as well? Like just help us understand the investments that you're making right now. What are they -- how are they in line with the technology road maps that you have?

Yes. So our long-term CapEx forecast is in the range of 4% to 6% to revenue, right? Now again, that doesn't mean each and every year, it's going to be within that range. Actually, the last couple of years, we've been below that range. I believe the next couple of years, we might be actually slightly above that range. But when you look at it over 5-year periods, it should be in or about that 4% to 6% CapEx to revenue. And so where do we spend the CapEx? Well, most of the CapEx spending goes to head and media as well as automation, right? And why do we have to continue to invest in head and media? Well, as we execute on our technology and product road map, right, we -- and as we move to those higher capacity drives, we -- how do we get to higher capacity drives, there's 2 factors. The most important one is areal density, right? Get to 3 terabyte or 4 terabyte or 5 terabyte, eventually way down the road, 10 terabyte per platter, right? In order to do that, you need better head and media, right? And so we need to continue to invest in the head and media. Now secondly, we also -- the way we get to higher capacity drives is to add more platters in the box without changing the form factor of the box. And so as you add more platters in the box, you also have to make sure you have more capacity for media and heads as well. Media, by the way, for us is 2 sides. We do our own substrate and then turning substrate into media, into the magnetic platters as well, right? And so there's no hesitation there. We will make the necessary investments in there. And then, of course, we also focus on automation, right? We are big believers in AI. We use a lot of AI inside our factories as well, but that also requires a lot of automation. All of that translates into better yield, better productivity, more uptime of the equipment that actually enables us to produce a little bit more units each and every quarter without actually having to spend major CapEx in expanding the unit capacity, we are able to produce a little bit more units just by investing in automation and productivity inside our manufacturing sites, which, again, all helps us to further drive down the cost per terabyte over time as well.

Okay. And then, just all of that comes back down to great free cash flow generation, and you guys have been great at that. There's a net cash balance sheet right now. You've been talking about an optimal -- you've been generating a lot of free cash flow, returning that to shareholders. Just help us understand what is that optimal capital structure for Western Dig?

Yes. First of all, I mean, the free cash flow is very strong. Our target free cash flow margin is plus 30%. We've already a couple of quarters operating at that level. Now there again, each and every quarter might be a little bit up and down depending on how much CapEx and what's going on in the business as well. But we have a business model that throws off a lot of cash. That's one. Second, the balance sheet is in really good shape right now. We've completed the monetization of the SanDisk shares. We've cleaned up most of the debt on the balance sheet. As you've seen from some of the filings that we've done, we're still working on the convertible debt and cleaning that further up. But we are already in a positive net cash position right now. And so there is no hesitation. All the remaining accessible free cash flow is being used to return back to the shareholder. And we do that through a combination of our dividend program and share buyback program. The vast majority of the cash goes to the share buyback program, but we are, of course, fully committed to our dividend program. We've already increased the dividend a couple of times, and we'll continue to do so. And so when you put that all together, I think we have a very shareholder-friendly capital return policy in place that on top of the strong revenue growth for many years based on long-term demand visibility, the strong gross and operating margins improvements that all translate to very strong free cash flow as well as strong earnings per share growth that's being further accelerated with our shareholder-friendly capital return policy. I think that's a great setup.

That's a great reason to own Western Dig. Thank you very much. That wraps up the call.