Western Digital Corporation (WDC) Q1 2026 Earnings Call Transcript

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Overview

The earnings call presents a positive outlook with strong revenue growth, solid gross margin projections, and robust demand driven by AI tailwinds. The Q&A highlights promising AI productivity gains and consistent demand from hyperscale customers. Despite some uncertainties, such as the lack of specific details on UltraSMR capacities and AI CapEx allocation, the overall sentiment is positive. The company's strategic plans, including monetizing SanDisk shares and maintaining a high free cash flow margin, further support a positive stock price movement prediction within the 2% to 8% range.

Key Financial Performance

Revenue $2.8 billion, up 27% year-over-year, driven by strong demand for nearline drives.

Earnings per Share (EPS) $1.78, above the high end of the guidance range.

Exabytes Delivered 204 exabytes, up 23% year-over-year, including 2.2 million drives of latest generation ePMR with capacity points up to 26 terabytes CMR and 32 terabyte UltraSMR.

Cloud Revenue $2.5 billion, representing 89% of total revenue, up 31% year-over-year, driven by strong demand for higher capacity nearline product portfolio.

Client Revenue $146 million, representing 5% of total revenue, up 5% year-over-year.

Consumer Revenue $162 million, representing 6% of total revenue, down 1% year-over-year.

Gross Margin 43.9%, improved 660 basis points year-over-year and 260 basis points sequentially, reflecting mix shift towards higher capacity drives and tight cost control.

Operating Expenses $381 million, slightly exceeding guidance range due to higher variable compensation on stronger-than-expected results.

Operating Income $856 million, translating into an operating margin of 30.4%.

Cash and Cash Equivalents $2 billion at the end of the fiscal first quarter.

Total Liquidity $3.3 billion, including undrawn revolver capacity.

Debt Outstanding $4.7 billion, translating into a net debt position of $2.7 billion and a net leverage EBITDA ratio of just below 1 turn.

Operating Cash Flow $672 million for the fiscal first quarter.

Capital Expenditures $73 million, resulting in free cash flow generation of $599 million for the quarter.

Share Repurchases 6.4 million shares of common stock for a total of $553 million during the quarter.

Dividend Payments $39 million during the quarter, with a 25% increase in quarterly cash dividend to $0.125 per share.

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Operating Highlights

ePMR and UltraSMR Drives: Shipments of ePMR products offering up to 26 terabytes CMR and 32-terabyte UltraSMR capacities surpassed 2.2 million units in the September quarter. The company is also progressing on HAMR technology, with plans to start qualification for one hyperscale customer in the first half of 2026.

HAMR Technology: Rapid progress is being made, with qualification for hyperscale customers planned for 2026 and volume production expected in 2027.

AI-driven Data Storage Demand: AI adoption is driving robust demand for data storage solutions, particularly higher capacity drives. The company has secured long-term purchase orders from major customers, including agreements extending to 2027.

Cloud and On-Prem Storage: Growth in cloud and on-prem storage, including AI and social media applications, is driving demand for the company's platforms business.

AI in Operations: AI is being used internally to enhance productivity, improve yield, detect defect patterns, and optimize test processes, leading to up to 10% productivity gains in select use cases.

Manufacturing Enhancements: Investments in automation, AI tools, and a new test lab in Rochester, Minnesota, are increasing manufacturing throughput and accelerating product qualification cycles.

Customer Agreements: Top customers have provided purchase orders extending through 2026, with one major customer committing through 2027, reflecting confidence in the company's product roadmap.

Capital Allocation: The company increased its dividend by 25% and repurchased $553 million in shares, reflecting strong free cash flow and confidence in long-term business strength.

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Risk or Challenges

Macroeconomic Uncertainties: The company acknowledges navigating macroeconomic uncertainties, which could impact revenue growth and profitability.

Manufacturing Complexity and Lead Times: The increasing demand for higher capacity drives comes with greater manufacturing complexity and longer production lead times, potentially affecting delivery schedules and customer satisfaction.

Regulatory and Tariff Impacts: The outlook includes anticipated or known tariff-related impacts, which could affect the company's financial performance.

Technological Transition Risks: The transition to HAMR technology requires rigorous qualification processes to ensure reliability and scalability, posing risks of delays or technical challenges.

Supply Chain and Cost Control: Tight cost control in manufacturing and supply chain is critical, and any disruptions could impact gross margins and operational efficiency.

Customer Dependency: A significant portion of revenue is driven by a few major customers, making the company vulnerable to changes in their purchasing decisions or financial health.

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Guidance & Outlook

AI-driven growth in data storage: The rapid adoption of AI and data-driven workloads at hyperscalers is driving robust demand for Western Digital's products and solutions. Customers are transitioning to higher capacity drives, with shipments of ePMR products offering up to 26 terabytes CMR and 32-terabyte UltraSMR capacities surpassing 2.2 million units in the September quarter.

Customer commitments: Top 7 customers have provided purchase orders extending throughout the first half of calendar year 2026, with 5 of them covering all of calendar year 2026. One major hyperscale customer has signed an agreement covering all of calendar year 2027.

HAMR technology development: Western Digital is on track to start HAMR qualification for one hyperscale customer in the first half of calendar year 2026 and expand to up to three hyperscale customers through calendar year 2026. Volume production ramp-up is expected in the first half of calendar year 2027.

Next-generation ePMR drives: Qualification of next-generation ePMR drives will begin in the first quarter of calendar year 2026, building on the existing ePMR technology.

Fiscal second quarter 2026 outlook: Revenue is anticipated to be $2.9 billion, plus/minus $100 million, reflecting approximately 20% year-over-year growth. Gross margin is expected to be between 44% and 45%. Operating expenses are projected to decrease to a range of $365 million to $375 million. Diluted earnings per share are expected to be $1.88, plus/minus $0.15.

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Shareholder Return Plan

Dividend Increase: Western Digital announced a 25% increase in its dividend per share, raising it to $0.125 per share. This increase reflects the company's long-term confidence in its business.

Dividend Payment Schedule: The quarterly cash dividend of $0.125 per share will be payable on December 18, 2025, to shareholders of record as of December 4, 2025.

Share Repurchase Program: Western Digital significantly increased its share repurchases during the quarter, buying back approximately 6.4 million shares of common stock for a total of $553 million.

Capital Return Program: Since the launch of the capital return program in Q4 fiscal 2025, the company has returned a total of $785 million to shareholders through share repurchases and dividend payments.

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Key Q&A

Q:How does the company plan to meet rising customer demand while keeping supply/demand in balance?

A:The company focuses on delivering higher capacity drives, such as the PMR product, which shipped over 2.2 million units last quarter (70 exabytes) and is expected to ship over 3 million units this quarter. They are also leveraging UltraSMR technology, which provides a 20% capacity uplift over CMR and a 10% uplift over standard SMR. The next-generation ePMR drive will start qualification in Q1 of 2026 and ramp in the second half of 2026. Additionally, they are increasing manufacturing throughput using automation and AI tools, enhancing test capabilities, and investing in areal density technology improvements.

Q:How should we think about incremental gross margins from here?

A:The company delivered a 43.9% gross margin in Q1, up 660 basis points year-over-year and 260 basis points sequentially. Incremental gross margin in the quarter was approximately 75%. For Q2 fiscal '26, they guided for gross margin improvement in the range of 44% to 45%, with incremental gross margins of approximately 50% on a sequential basis.

Q:Is there further potential upward expansion on average capacities for UltraSMR beyond 36 terabytes?

A:The current roadmap includes 28 terabytes CMR and 36 terabytes UltraSMR. The company is working to push capacity points further and has pulled forward the qualification process for HAMR to the first half of 2026, with plans to expand to up to 3 customers by the end of the year.

Q:How should we think about seasonality in the business?

A:The business has structurally changed, with 89% of revenue coming from data centers, which are not seasonal. Seasonality may apply to the 10%-15% of the business in the channel and client/consumer portfolio, but overall, there is no material seasonality.

Q:What are the updated thoughts on exabyte growth and price per terabyte deflation?

A:The company sees exabyte growth trending towards a 23% CAGR, especially with long-term agreements extending into 2027 and beyond. The mid- to high single-digit cost down per terabyte is still a safe assumption.

Q:How short is supply relative to demand today, and when will supply expand?

A:Supply is expected to remain constrained through 2026. The ramp-up of new capabilities in ePMR and HAMR will bring more exabytes on stream in the second half of 2027.

Q:How long does it take for a product to go from qualification to deployment, and will HAMR follow this timeline?

A:It typically takes 2-3 quarters for a product to go from qualification to deployment. HAMR is expected to follow this timeline, with ramping planned for the first half of 2027.

Q:What productivity savings can be realized from AI implementation internally?

A:AI initiatives have resulted in a 10% productivity gain in manufacturing operations and a 20% productivity gain in firmware rewriting. These initiatives are still in early stages but show promising results.

Q:How should we think about the mix of ePMR drives shipped in the quarter?

A:The company shipped 2.2 million ePMR drives (70 exabytes) last quarter and plans to ship over 3 million units this quarter. The mix is expected to remain consistent.

Q:What is the breadth and stickiness of the announced price increase?

A:The price increase primarily affects channel customers, representing 10%-15% of the business. Hyperscale customers on long-term agreements or firm POs are not affected.

Q:What are the plans for monetizing the remaining stake in SanDisk?

A:The company intends to monetize the remaining 7.5 million shares of SanDisk before February 21, potentially through a debt-for-equity exchange.

Q:How are long-term agreements structured to ensure value?

A:For 5 hyperscale customers, the company has firm POs, not LTAs. For one large customer, there is an agreement for all of 2027 with significant commercial terms to protect against forecast adjustments.

Q:What percentage of AI CapEx is allocated to HDDs?

A:The percentage of AI CapEx allocated to HDDs has increased from low single digits to 4%-5%.

Q:Does the forward exabyte demand profile suggest normalization to a 23% CAGR or higher?

A:The demand profile is trending towards a 23% CAGR, with potential for higher growth in the 2027-2028 timeframe. The company is working closely with customers to support this growth.

Q:What is the mix trend for UltraSMR into 2026, and does it impact gross margins?

A:The mix of UltraSMR is expected to increase as more customers adopt it. The transition to higher capacity drives, including UltraSMR, typically improves gross margins.

Q:What drove the upside in Q1 results?

A:Upside was driven by strong manufacturing execution, modest low single-digit ASP increases, a shift to higher capacity drives, and operational efficiencies.

Q:How should we think about cost declines in the outer quarters?

A:Cost declines are expected to continue in the mid- to high single-digit range, driven by higher capacity drives, productivity improvements, and operational efficiencies.

Q:How should we think about free cash flow relative to net income going forward?

A:Free cash flow margin is expected to remain above 20%, though incremental benefits from working capital reductions seen in Q1 may not be repeated.

Q:How does the company balance capacity discipline with the risk of pushing customers towards SSDs?

A:The company believes HDDs will continue to account for 80% of data center storage due to TCO benefits and reliability challenges with SSDs. They do not anticipate a major shift in storage tiering.

Q:Has the company mitigated risks related to Intevac's acquisition by a competitor?

A:Yes, the company has fully mitigated risks by using Canon's ANELVA system for HAMR development.

Q:Review of Unclear Management Responses

A:Management avoided providing specific details on the potential upward expansion of UltraSMR capacities beyond 36 terabytes, stating only that engineers are working to push capacity points further. Additionally, they did not provide a clear framework for how AI CapEx allocation to HDDs might evolve beyond the current 4%-5% range. Lastly, while they mentioned significant commercial terms in long-term agreements, they did not elaborate on the specific mechanisms ensuring adherence to these agreements.

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Earnings Word Cloud

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