Good morning, everyone. I am, my name is Erik Woodring. I lead U.S. IT hardware research based out of New York for Morgan Stanley. Delighted to kick off day one here at the Morgan Stanley Conference with Western Digital. Before we get into things, first, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures for important disclosures. If you have questions, please reach out to your Morgan Stanley representative. So I'm pleased to be joined today by Irving Tan, CEO of Western Digital, Kris Sennesael, CFO of Western Digital. Before we start, Kris has a safe harbor statement, and then we'll get into things.
Yeah, thanks, Erik, for hosting us here. S o before we start, just a couple of remarks. Today, we will be making some forward-looking statements in our discussions 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 risk and uncertainties, so please refer to our most recent financial reports 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 expectations. We will also be making references to non-GAAP financials, and a reconciliation to GAAP and non-GAAP results can be found on our website as well.
Perfect. Awesome. Thank you, guys, for joining today. I figured we'll start at the very top. Irving, you know, demand for HDDs is very strong right now. You've kind of conveyed a lot of messages around demand strength and visibility. I'd love to understand at a more granular level why demand is so strong, meaning, are these some of these new AI video platforms supporting incremental strength in HDDs? Is it companies projecting out kind of token growth? What is it exactly that it feels like over the last three months demand has really kind of ticked up? Why is that?
Yeah, thanks for the question, Erik. Actually, we've seen demand probably tick up for the last three, four quarters. Now, at the highest level, there are two primary drivers, right? The first is just the ongoing transition of more and more on-prem storage to the cloud. So it's sometimes forgotten, right, that just basic cloud storage services continue to grow at a reasonable pace, somewhere in the mid-teens, exabyte growth figure is what we're seeing. Then, obviously, that's been turbocharged more recently by AI. And within the AI, we see two, again, two key drivers. One is the value of data is increasing because of AI. So more data is actually getting stored, even as more data is getting generated. So we traditionally are looking at data generation rates that are gonna increase over the next three years by 3x.
Historically, the percentage of data that gets stored is roughly in the 2%-3% range. We're seeing that more move up to the mid-single digit range. So just the value of data to train models, to drive inference, is increasing. Second, I would say it's video, right? And the big driver of storage has always been in video. That's whether it's in the basic cloud or in AI, as well. And obviously, there's been a lot of talk around AI-enabled videos for consumers or for marketing purposes like Sora and the likes. But people tend to forget also there are major industrial applications that are driving a lot of video. Take autonomous vehicles. For a while, we just came from Arizona where you have tons of Waymos driving around, right? All those vehicles are storing the telemetry of the vehicle. They're recording all the videos of their journeys, both for regulatory reasons, and they're storing the videos to actually train the models, right, to enable the vehicles.
What's interesting, these autonomous vehicle companies are running out of roads to train their models because they keep plowing down the same routes, and so they don't learn anything new. They're using that video and AI to generate synthetic video t o further train the model. And so there's this self-fulfilling prophecy, of more video getting used, more video getting generated as well to train these models. And we see these are the primary drivers of growth.
Okay. And then when we talk about AI as an incremental HDD demand driver, we don't necessarily hear or see a number of, like, what I would call AI-native vendors or NeoClouds or AI labs coming to market necessarily with huge HDD orders. Just what do you hear from them in terms of their storage architecture? Because seemingly that is a large kind of new market, clearly AI-centric. What's the message you'd send on demand c oming from those players?
Yeah. You're right in a sense that the bulk of the demand is coming from what I would say the more established players, like the top four, five hyperscalers that have really dominated the market, and if you take the NeoClouds, the CoreWeaves of the world, the xAIs of the world. I mean, their primary focus has to be has been putting their investments in GPUs, and in memory. And that makes sense because that's the business model. They're trying to drive inference. They're trying to drive compute resources. But what they do is they connect back into the typical hyperscale storage environment, right? So as an example, CoreWeave is a big user of Amazon Web Services S3 a s an example. And so, we're still seeing the benefit of that.
Just not necessarily with the NeoClouds, but they're leveraging the hyperscalers who have really perfected the infrastructure management and the economics of storage. W e are seeing we are having conversations with them of late because I think what they're also figuring out as they evolve their business model purely from compute to memory, storage has to become a key component of that just in terms of the service they provide and the economics of their business.
Okay. So, maybe Kris will bring you into the conversation as well with you, Irving. And what does that ultimately mean? My question is, what does that mean if we think about exabyte growth in kind of the timeframe that you laid out at your analyst day earlier this year? You kind of outlined it in exabyte growth CAGR of between 15% and 23%, 15% with your CSPs, kind of eight points of AI potential upside. You know, is there an upward bias to this metric? Just how do we think about it? Again, just given what we hear about HDD demand being so strong.
Yeah. Maybe I can start off and Kris can jump in. So at our investor day back in February, we laid out a base exabyte growth case of 15% CAGR. And it was a very conservative case, to be very frank, really just driven by the ongoing organic growth of the cloud. And then we laid out an upside case, what we called the AI uplift case, which was a 23% exabyte growth case, right? So a t eight-point delta between the two. And that was driven by what we thought would be the AI use cases at that time, right? I would say we've been pleasantly surprised. We're seeing the trending probably more in the mid-20 range. Last quarter, our growth rate was 30% exabyte growth. And we're getting better and better visibility in terms of the growth rates going forward. As we've shared in our last earnings call, we now have firm purchase orders from our top five hyperscaler customers that extend throughout the entire calendar year 2026. One of those five have given us orders for all of calendar year 2027, as well. So we definitely see the trajectory continuing.
Okay. And I wanna also make sure we touch on supply, a hotly debated topic in the market. You guys, the industry alongside yourselves, have been very disciplined with supply. Maybe for the benefit of the audience, I know you get the question of, you know, would you expand supply? Would you expand unit supply? Maybe the way I wanna ask it is, is there something that could convince you to expand unit supply above and beyond where the run rate is? And what would that be if there was anything?
Yeah. I mean, we, we've been quite clear and explicit to say, as things stand, we are not adding any unit capacity. Our focus is really on improving areal density, maybe for the benefit of the, the folks in the room who may not be that technical. Areal density is about increasing the amount of Exabytes we can store on a single platter within the drive. And so if, as we increase areal density, we can go from our current flagship drive is 32 TB. We can go to 40 TB, 50 TB, 60 TB, eventually up to 100 TB per drive. So our focus is really on supporting our customers' needs by driving areal density. The reason, Erik, is those contracts and POs that I've just shared with you. They are giving us orders based on the amount of Exabytes we can support them with. T hey're not u nit-based. What customers really want is, can you supply me the amount of Exabytes? And the higher density we can provide in terms of Exabytes per drive is good for our customers because it's better TCO for them. They have better rack density. They have less power consumption. There's less real estate that's required. So there's, you know, less need to build out new facilities, as well.
Okay, w hich makes a ton of sense, and we'll kind of get into areal density t echnology innovation. I'd love to better understand. We've kind of talked high-level demand. We just addressed supply, at least unit supply. When it comes to the totality of the interaction of those two sides of the market, how do we think about supply growth into calendar 2026 and into calendar 2027? Because you are coming out with new technology. You're moving up the areal density curve. Seemingly, you know, you should be able to meet the shortages better as you move along through this technology innovation curve. Just before we get into the specifics of the actual technology, just how do we think about the ramp in supply from your perspective from this year into the next two years?
Yeah. I would say that obviously we are in a very tight supply-demand environment. That'll probably persist a bit into the calendar year 2026. As you rightly pointed out, as we deliver higher capacity drives through areal density improvements, we'll catch up over time. So we are making investments in our head and media facilities t o support the next generation of technology that we're bringing out to support the increase in head and media capability, and those are the big drivers of areal density that will feed into the units.
And maybe just to add there, Erik, last quarter, our average terabyte per drive that we shipped was approximately 22 TB. Despite the fact that we are shipping in high volume, 32 TB. In addition to that, the 22 TB was up 21% on a year-over-year basis. This is for our nearline drives. This clearly illustrates that we can increase our average capacity per terabyte on or about in the mid-20s i n line with the expected demand growth.
Okay. So, I was going to ask you a question on that, but I'll stay on track w hich is going back to maybe the comment you made earlier, Irving, about visibility. So you generally have nearline bits accounted for from your top five customers. You have one customer through calendar 2027. You know, can you maybe just elaborate? One, is that kind of the totality of the visibility that you have today? And really the second part of that is, how do you protect yourselves from the risk of kind of over or double ordering f rom those customers? Because clearly, if they want bits, they'll try to get the bits from you, but you don't wanna create an industry glut. So, how do you protect yourself?
Yeah. I think it's a really good question. I mean, the industry has been quite notorious for not doing a good job. So we're very mindful of that. As I mentioned, the orders that we have for the five customers in 2026 and 2027 are pretty much firm, t here are specific commercial terms in them, with financial teeth associated with them. We are in discussion in 2027 for not only the remaining four, but extends probably to the top 10 customers that we have, to look at longer-term contracts that extend all the way up to calendar 2028, sorry. One of them is talking to us about extending a contract to calendar year 2029, as well. So that gives us a lot more visibility. Now, is there a risk that maybe double ordering? I mean, that's always on people's mind.
Right now, we are quite confident there isn't because we have a good sense of the inventory that they have. And pretty much everything we're shipping to them is being racked and stacked and shipped into data centers almost immediately. It's sort of a just-in-time model. That's how tight things are. But if you extrapolate forward, obviously there's always a risk in that. But the way we look at it is we use our customers' demand signal, what they're asking us to supply to them in terms of Exabytes. There's just one data point in how we run the business and how we make supply investments. So we do use our own internal analysis. We look at how many data centers are being built over the next four to five years. When are they gonna come on stream? We have some internal proxies in terms of, you know, the gigawatts of a data center, how much that would translate into HDD capabilities and various other metrics that we use as well. So we form our own opinions a nd that's basically what forms the investment decisions that we make.
The other side of that is it's just even fascinating to me that your customers are giving you that level of visibility. Historically, you could argue the CSPs weren't always the most accurate forecasters of their own demand. What do you hear from them? Why are they giving you this level? Is it purely a supply-driven dynamic, or is it more to that?
I would say they're getting a bit better in terms of forecasting. They still have a ways to go, just like we do, as well. I didn't want us to fundamentally change, both for us and for them. I mean, if you take us as an example, first of all, today, 90% of our business is in the data center, s o we are a data center company. I mean, if you go back five, six years ago, only 50% of what we did was in the data center, and it was primarily through OEMs, right? Today, it's 90%. The vast majority of that with large hyperscalers, both in the U.S. and in Asia. So it's a very different company today. We basically are aligned fully to the hyperscaler data center environment.
W e've sort of restructured our organization as well to specifically cater to the hyperscale environment. So for our top five customers, as an example, we have dedicated resources across sales, product management, engineering, customer technical support, firmware to specifically support the architectures that they're building for today and to tomorrow. If you take the customer viewpoint also, you know, with AI in particular, they've realized that actually storage is a critical piece of the AI infrastructure stack, right? If you don't have enough storage, you're not gonna be able to continue to train models. You're not gonna be able to deliver inference. You're not gonna ultimately be able to monetize AI.
So the relationship between us and the hyperscalers have really changed a lot w here it used to be very transactional or it used to be predominantly through the OEMs, it's a much more direct relationship. They're giving us greater visibility around the use cases they're gonna bring out over time, how that's gonna translate into storage requirements, and giving us a lot more conviction in terms of the exabyte demands that they're projecting. It's really underpinned by a degree of fact.
Okay. No, that's helpful, so let's move to the technology innovation side of things. It's a kind of exciting time. For the entirety of my coverage, we've kind of time covering this space. We've heard about HAMR coming, and now, you know, it's here or on the cusp, and so I believe, you know, at Western Digital, you are qualifying up to a 36 TB Ultra SMR in the first quarter of next year, launching that in the second half of next calendar year, and then qualifying HAMR next year to launch in volume in the first half of calendar 2027. Have any of those targets shifted? Any change in how to think about the qualification process? Lastly, when you say in volume, I think there's a specific, you know, focus when you say in volume because you wanna ship at least a million units per quarter at least. So just unpack all of that for us, please.
Yeah. So we've taken a slightly different tack in terms of how we're introducing technology, into the market, especially given how critical our technology is to the business of our key customers, the hyperscalers. And, again, without overcomplicating things, there are two primary recording technologies in the HDD industry. One is called PMR, perpendicular magnetic recording, and the other one is called HAMR. The acronym's heat-assisted magnetic recording. And, while some of our peers have gone head-on into one particular approach, i.e., HAMR, we've taken a slightly different track by de-risking the transition. We are committed to HAMR, as you pointed out. We've accelerated our HAMR qualification and pulled it forward by six months, and HAMR is critical to enable the industry to get to 50 TB, 60 TB, 70 TB.
We have been able to see that it will deliver a 100 TB drive in the not-too-distant future. But in parallel, we continue to deliver the highest volume, highest capacity drives to our PMR portfolio as well. And again, we pull forward the qualification of our next-generation PMR drive to Q1 of calendar year 2026. As you pointed out, the current roadmap is for it to be a 36 TB drive. We have brilliant engineers within the team. I think there's an opportunity we can eke out a bit more, so we'll share a bit more at the Innovation Day that we're hosting in New York on February the 3rd. So if you have an opportunity, do join us live or watch the webcast as well. But the whole approach is to really de-risk the transition of any technology to our customers. And secondly, it goes back to the point I made that they want as much Exabytes as they can get. Therefore, our view is how do we deliver the most amount of Exabytes to them at scale?
And we feel that for the time being and for a period of time, that's true doing using our PMR portfolio. And the data point on that is that our current generation of PMR drives, which is now three quarters into production. The first quarter after qualification, we shipped 800,000 units. The second quarter, we shipped 1.7 million units. Last quarter, we shipped 2.2 million units and delivered 70 EB. So if you do the math, it's north of 30 TB per drive. As we shared in our investor call this quarter, we will be shipping north of 3 million units, probably somewhere in the 3.4 million - 3.6 million range. So it shows you the scalability, the confidence in that customers have in the reliability of the products and its ability to deliver Exabytes at scale. And we'll continue to do that. And eventually, we'll transition to have both PMR and HAMR in the market. And then over time, as we get to higher and higher capacities, we'll transition fully to HAMR.
Right. Okay, and maybe as a follow-up, you know, this is a question I get fairly often. You might have just answered it, but I wanna give you the standard answer to this specifically, which is that there's an investor debate whether your competitors coming to market with HAMR before you guys put you at a competitive disadvantage because you couldn't technically deliver the same TCO. What would be your rebuttal or help us better understand why not being first to market in HAMR doesn't put you at a competitive disadvantage?
Yeah. I would think that first thing I would say is, you know, if I go back to those contracts that we mentioned, customers have given us for 2026 and 2027, they are exabyte-based. They are technology agnostic. C ustomers don't care whether you're shipping them. I mean, none of them wake up in the morning and say, "I need to get a HAMR drive or a PMR drive. Just give me Exabytes." That's the focus right now. But what they do want is a partner that is able to deliver to them Exabytes at scale that's reliable, that's not gonna have any issues one year down the road, two years down the road, three years down the road in their hard drive fleets where they have millions and millions of units.
So we actually don't feel we're at a disadvantage. Obviously, we get the benefit of that any fast follower gets because we avoid some of the pitfalls, and therefore, we've been able to compress the qualification cycle. But for us, it's really, really a function of how do we support our customer TCO value and the economics of our business. And we actually think that, for the near to a medium -term, our ability to do that through PMR and then eventually through a combination of two before we transition fully to HAMR is the most optimal for our customers and for us.
Okay. Okay. So, let's kind of bring demand, supply, technology, innovation all together. At least, you know, pricing in the same model that you introduced back in February, you had talked about price per exabyte being kind of down 7%-ish in your model. Recently, it's been flattish. And so, maybe talk about the difference between the forecast and what's actually happening in your model today. And if we then look out over a few years , you know, 7% annual price deflation per exabyte, is that too aggressive? Just how should we think about that as you've kind of learned more about the market in the last eight months?
I think it's a great question to bring Kris to the discussion.
Yeah. So the 7% was basically the average over the last five or six or seven years, and that was for us the starting point, but given the tightness in the market in terms of demand and supply, you look at the current pricing environment. I describe it as being stable, which means kind of flat to slightly up, low single digits on a year-over-year basis, and we do have some great visibility multiple years out there as we do have purchase orders for multiple years, and we're having discussions on longer-term LTAs with our customers. That does have a price component inside as well. We are comfortable that the pricing environment for at least the next couple of years will remain stable, meaning flat to slightly up on a year-over-year basis, o n a price per terabyte basis.
Right. Exactly. And maybe a follow-up to that is just, like, how are your customers responding to all of this, right? It's a big change in the market where there's a lot of demand, supply shortages, pricing is increasing as opposed to going through cycles of deflation. Is there frustration, or what are they communicating to you guys on the other end when you talk about longer lead times, pricing increases? How do you make sure that they stay happy?
Do you wanna take that?
I think for our customers, the most important part is high volume of Exabytes, scalable, reliable. That are the priorities. And of course, if they can pay a lower price, they always wanna pay a lower price. But that's not in their top. By the way, as we move to higher capacity drives, we are giving them a TCO benefit. So their TCO, their total cost of ownership, is improving despite the fact that they have to pay slightly more on a price per terabyte basis.
Okay. Now, let's touch on maybe another risk, which is kind of long-term disruption from eSSD. There's concerns in the market about supply shortages causing re-architecting. I'd love if you could address that. And then we've heard from some of the large NAND players that, you know, we'll be able to have, you know, multiple versions of technology innovation from now, a point at which eSSD is price competitive with HDD. Not calling for the death of HDD, but you see where this question is going. I'd love if you can maybe address the re-architecting risk and then maybe the longer-term risk of disruption.
I guess at a macro level, the good news is for all storage media providers, whether it's tape, whether it's HDDs or ESSDs, you know, both the ongoing growth trajectory of the cloud and AI is actually creating a tide that all boats are rising. So that's good news for everybody, s o that's positive. You know, if you think about substitution of ESSDs to HDDs, we don't think that's anyway likely to happen. HDDs today are about 80% of all data stored in a data center, and that's likely to continue at least for the next four years, from what we see because actually we have visibility of what the customer architectures are, right? We have a system integration lab in Minnesota where we have separate facilities that replicate the production data center environment of our customers. We have the latest versions, the current and latest and future generations of the chassis, of the storage racks they're delivering. So we have a really good sense of what they're gonna look like. And they're not gonna change the architecture overnight. S o these are, you know, sort of generations of design that they have put in place. It's out three, four years out there.
And secondly, you know, one thing is, as I mentioned, the shift has happened. As we become a HDD-centric company, we're very focused on making sure there's a strategic partnership with the hyperscalers because we, you know, we are a data center company. They're in the data center business. It makes sense for us to be aligned. One of the things that they've shared with us also that's a concern with eSSDs is the volatility of pricing. At least with HDDs, it's very consistent. As Kris mentioned, it's very stable. Whereas if you understand enterprise SSDs, the underlying technology is NAND, and that's fungible. You could use that to build an enterprise SSD. You could put it into your mobile phones. You can put it into your consumer devices like your laptops or your PCs or your iPads, and history has shown they will move bits around, to what drives the highest economic return for them w hereas with HDDs, we are fully committed to the data center stack.
We're laser-focused on the TCO value that we bring. You know, in at our investor day, we shared that acquisition cost of just the devices, HDDs have a 6x advantage over enterprise SSDs. If you add total cost of ownership, real estate, power, the likes, we still have a 3.6x advantage over enterprise SSDs. That advantage in both acquisition cost and TCO has probably gone up, because even as Kris mentioned, the HDD pricing environment is stable, so flat to slightly up. You've seen quite marked increases in the enterprise SSD pricing as well. So it's increased the gap, and that strengthens the TCO advantage that we have.
So, last two. Quickly, Kris, for you, last quarter in September, price per exabyte grew 1% sequentially. Cost per exabyte was down about 4% sequentially. You know, is there a path where we can be looking at 50%+ gross margins in the not-too-distant future, in the foreseeable future, as you continue to kind of hold pricing steady but mix down or mix up into these higher-capacity drives to help that cost per terabyte keep moving lower?
Yeah. Yeah. First of all, I'm really happy with the gross margin trend that we have seen over the last couple of quarters. We have now gross margins in the mid-40s. And at the last earnings call, I was indicating that I'm comfortable with incremental gross margin on incremental revenue in the plus 50% range. So, that's another way of expressing my confidence that gross margins will continue to improve. I'm not gonna put a ceiling on it, but good progress being made and further gross margins expansions in front of us.
Okay, and an asset that I think investors don't maybe fully appreciate that you guys have is 7.5 million shares of SanDisk. Over the last few months, that ownership or that stake has increased materially. You've expressed a clear indication that you wanna sell that tax-free by, I think it's February 21st, the year anniversary of the spin. Does all of that go to delevering? Can you buy out some of the convert? Just how are you going to use that? Because obviously, you know, more than $1.5 billion is much larger than the $300 million that it was, you know, three or four months ago.
Yeah. Yeah. A couple of things. So yes, we still have 7.5 million of SanDisk shares, and it's our intention to monetize that. 7.5 million shares at today's share price is well over $1.5 billion. I t's our intent to do a similar transaction that we did in June, a debt for equity transaction, and so reducing the debt on the balance sheet. Just to add and maybe summarize our discussion here, right? We are experiencing very strong demand in Exabyte. We have long-term visibility. The pricing environment is stable to slightly up. We are indeed driving down the cost and expanding gross margins, operating margins, free cash flow margins. We generate a ton of cash, and we return all that cash back to the shareholder. The balance sheet is in really good shape. We still have the 7.5 million of SanDisk shares. So feel pretty good about the business. And so we return all the excess cash back to the shareholder through a combination of our dividend program and share buyback program.
Maybe the last thing before we depart, Irving, you know, just anything that you can share with us about maybe what you think is most underappreciated about the Western Digital story.
Yeah. I think, you know, our, as Kris mentioned, our ability to, first of all, play in the most exciting space t oday, which is AI, and that's gonna be a big driver of growth for us. Second, the fundamental change in the business to become a data center-centric company. So to be able to partake of that growth, to be able to generate the higher margins, the strong financials, and the cash flow that Kris mentioned. And third, we continue to invest back into the business as well, right? We're not only continuing to invest in our core business of HDDs, but also to look at what's next for storage, beyond HDDs as well to continue to power the company's innovation going forward.
Right. And I'll give you the quick plug of the February 3rd Investor Innovation Day, but we are out of time. So with that, Irving, Kris, thank you very much. Thank you guys for attending.
Thanks for having us.
Thank you.