Western Digital Corporation (WDC.US) Q1 Earnings Call: HAMR to Enter Mass Production in the First Half of Next Year, Demand Visibility from Seven Major Customers Extends to 2030

Western Digital Corporation (WDC.US) reported first-quarter results for fiscal year 2027 and held an earnings conference call. Management noted a strong start to fiscal year 2027, with first-quarter revenue of $4.4 billion, up 55% year-over-year, and shipments of 248EB, up 22% year-over-year and 8% quarter-over-quarter; Non-GAAP gross margin of 58.1%, up 1,420 basis points year-over-year, operating margin of 49.1%, earnings per share of $4.64, up 161% year-over-year, free cash flow of $1.4 billion, and $1.1 billion returned to shareholders during the quarter through buybacks and dividends. By segment, cloud revenue was $3.9 billion, representing 88% of total revenue and up 54% year-over-year; client was $320 million (7% of revenue, up 119% year-over-year); and consumer was $193 million (5% of revenue, up 19% year-over-year). Blended average price per TB rose 28% year-over-year, further accelerating from the high-teens growth of the prior quarter. Second-quarter guidance is revenue of $5.1 billion $100 million (midpoint up 69% year-over-year), gross margin of 60%61%, and earnings per share of $5.80 $0.20. The board approved a 17% increase in the quarterly dividend to $0.175 per share, payable December 17. Capital expenditure guidance averages 4%6% of revenue over five years, with the next two years slightly above that range, and explicitly directed only to heads, media, and factory automation, not to increasing unit capacity. Key Q&A content: Management spent considerable time addressing three topics. First, the HAMR cadencetwo hyperscale customers will complete qualification in the first quarter of calendar 2027 and begin mass production shipments in the first half, with qualification for two additional customers starting in the same period, and qualification for second-generation HAMR (5TB per platter, 11-platter platform) starting in the second half of calendar 2027; the company said customer feedback centers on failure rates superior to peers, with no signs of anything requiring a pause. Second, costs and gross marginthe company acknowledged rising input costs for DRAM, NAND, and other components, and that near-term cost-per-TB reduction will be below the long-term target of 10%, but it is offsetting this through value engineering, incremental gross margins remain above 80%, and it attributed gross margin expansion to three legs: pricing, product mix shift upward, and fixed-cost dilution from areal density. Third, capacity disciplineasked about possible industry capacity expansion, management repeatedly emphasized meeting demand through areal density rather than unit capacity, citing vertically integrated head and media capabilities; for neo-cloud customers, it emphasized selecting only those with stronger balance sheets and higher-quality end customers, and said that even if that subsegment slows, the three drivers of cloud, model training, inference, and agentic AI are sufficient to absorb it. Market focus: The core question of this call was "how long can the storage strength last," and management's answer rested on visibility and pricing structuredemand visibility from the top seven customers extends to 2030 and 2031, long-term agreements are expiring and being re-signed, spot pricing for non-contracted volumes is equally strong, and average price per TB still has room to rise over the next three to four quarters. Corresponding to this are three unresolved points: this quarter's 22% EB growth was notably below peers' 30%-plus level, which the company explained as being between two product generations and reiterated long-term growth "above 25%"; the cost-per-TB reduction temporarily fell short of 10%, meaning continued gross margin expansion relies more on price than cost; and HAMR's transition from qualification to mass production, along with the rollout of second-generation HAMR and the 14-platter roadmap, are key to whether supply can be delivered in 20272028. Management also shifted the narrative from "compute" to "data," saying that AI is fundamentally a data systemthe most important qualitative statement of this call. Prepared Remarks Host Good afternoon, and thank you for standing by. Welcome to Western Digital Corporation's fiscal year 2027 first-quarter earnings conference call. [Host instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Mr. Ambrish Srivastava, Vice President of Investor Relations. Please go ahead. Ambrish Srivastava - Vice President, Investor Relations Thank you, and good afternoon, everyone. Joining me today are Irving Tan, Chief Executive Officer of Western Digital Corporation, and Kris Sennesael, Chief Financial Officer. Before we begin, please note that today's discussion will include forward-looking statements based on management's current assumptions and expectations, which are subject to various risks and uncertainties. Forward-looking statements include our expectations regarding product mix, business plans and performance, ongoing market trends, and future financial results. We undertake no obligation to update these statements. For more information on the risks and uncertainties that could cause actual results to differ materially, please refer to our most recent Annual Report on Form 10-K and other filings with the U.S. Securities and Exchange Commission. Unless otherwise noted, today's remarks reflect Non-GAAP results, and reconciliations to GAAP results are available in our press release and at investor.wdc.com. I will now turn the call over to Irving. Irving Tan - Chief Executive Officer and Director Thank you, Ambrish. Good afternoon, everyone, and thank you for joining us. The first quarter marked a strong start to fiscal year 2027, reflecting solid execution across the business and results that exceeded our expectations. Revenue grew 55% year-over-year, with gross margin and operating margin expanding significantly to 58% and 49%, respectively. Earnings per share grew 161% year-over-year, and we generated $1.4 billion in free cash flow. These results reflect continued strong customer demand, operational discipline, and successful execution of our product and technology roadmap. Demand is strong broadly across our customer base and end markets. Our visibility is extending further, and with it our confidence in the durability of HDD data storage demand. We are increasingly seeing storage demand expand from core cloud and hyperscale customers to enterprise environments and newer end markets such as neo-cloud and AI frontier labs, creating a larger and more diversified customer base. Customers are making long-term infrastructure investments and continuing to extend their planning horizons into the next decade. As the value of data rises, customers are investing with confidence to support their growing storage needs, and the vast majority of that data is stored on HDDs. We see this directly in our customer conversations and in broader industry research. A recent IDC survey of more than 750 companies across multiple countries found that organizations are storing more data, retaining it longer, and increasingly putting archived data back to work. At the core of these trends is continued data growth, driven by the ongoing expansion of cloud environments and the growing storage requirements of AI. Much of the discussion around AI focuses on compute, but we believe the more durable opportunity is in data. AI is fundamentally a data system. Every workload generates more data, and that data must be stored, managed, and accessed in a scalable, economical way. As AI continues to proliferate across industries, data creation and storage requirements expand with it. Inference and agentic AI systems are generating large volumes of logs, model outputs, and system performance data that must be stored and retained. Physical AI applications such as Siasun Robot&Automation, factory automation, and autonomous driving are further accelerating this trendAI-generated content and video workloads are creating and retaining data at scale. Turning to our industry-leading technology and innovative products. We are executing well on our technology roadmap and maintaining our cadence in migrating customers to higher-capacity drives. As the next-generation ePMR and HAMR platforms ramp, we expect EB shipments to continue growing in fiscal year 2027 and beyond. Our latest ePMR platform offers up to 40TB of capacity and is off to a strong ramp. Customer adoption is faster than any prior generation, and we expect the platform to account for nearly 30% of nearline shipments by the second quarter of fiscal year 2027 and 50% by the third quarter. On our first-generation HAMR product, we remain on track to complete qualification with two hyperscale customers in the first quarter of calendar 2027 and to begin mass production shipments in the first half of calendar 2027 as planned. We also expect to begin qualification with two additional customers in the first half of calendar 2027, further broadening customer validation and supporting broader HAMR adoption. As AI workloads expand, customers need not only greater capacity but also higher performance from their storage infrastructure. We are expanding the role of HDDs in cloud and AI infrastructure through innovations such as high-bandwidth drives and dual-pivot technology. By combining the economics of HDDs with significantly higher performance, we believe this technology can address a broader range of existing and emerging workloads. We are currently sampling high-bandwidth drives with multiple customers, with positive feedback and clearly identified use cases and value creation points. In summary, Western Digital Corporation is executing with momentum: we are deepening customer relationships, extending visibility, and broadening our customer base, while our product and technology roadmap delivers exactly what customers need. As the scale and value of data continue to grow across cloud, AI, and emerging workloads, we have high confidence in the durability of long-term storage demand. I will now turn the call over to Kris. Kris Sennesael - Executive Vice President and Chief Financial Officer Thank you, Irving. Our first-quarter results demonstrate the continued strength of the business and excellent execution across all fronts. Customer demand remains healthy, and our visibility is extending further. Product transitions are progressing well, bringing higher-capacity products, solid year-over-year EB shipment growth, and improved pricing, together driving another strong financial quarter. In the first quarter of fiscal year 2027, revenue was $4.4 billion, up 55% year-over-year, driven by strong EB growth and a favorable pricing environment. We shipped 248EB during the quarter, up 22% year-over-year and 8% quarter-over-quarter. Nearline products continue to drive growth, and we are advancing product transitionsfirst ramping our latest-generation ePMR drives with capacities up to 40TB, followed by the introduction of HAMR technology in the first half of calendar 2027, which lays the foundation for stronger year-over-year EB shipment growth. Cloud revenue was $3.9 billion, representing 88% of total revenue and up 54% year-over-year, driven by durable demand for high-capacity nearline drives, including the initial ramp of our latest ePMR platform. In addition, continued pricing strength reflects the value and total cost of ownership (TCO) advantages we deliver to customers. Client represented 7% of total revenue at $320 million, up 119% year-over-year. Consumer represented 5% of revenue at $193 million, up 19% year-over-year. Gross margin expanded to 58.1%, up 1,420 basis points year-over-year, with year-over-year incremental gross margin above 80%. Gross margin reflects the structural shift to higher-capacity drives, disciplined operational execution, and a favorable pricing environment across the portfolio as we continue to deliver greater value to customers. Average price per TB rose further to 28% year-over-year, above the high-teens growth reported last quarter. Operating expenses were $391 million, or about 9% of revenue, improving 130 basis points quarter-over-quarter, demonstrating continued operating leverage in the model. Operating income was $2.2 billion, up 152% year-over-year, driven by strong revenue growth, gross margin expansion, and operating leverage. Operating margin expanded to 49.1% in the quarter, demonstrating our ability to continue moving the profitability of the business higher. Interest and other expense was $10 million, and the effective tax rate was 17%. With 383 million diluted shares, earnings per share were $4.64, up 161% year-over-year. We generated $1.4 billion in free cash flow during the quarter and returned $1.1 billion to shareholders through share repurchases and dividends, reflecting our confidence in the durability of free cash flow generation and our ability to drive long-term shareholder value. Supported by strong free cash flow and consistent with our capital allocation framework, the board has approved a 17% increase in the quarterly cash dividend from $0.15 to $0.175 per share, payable on December 17, 2026, to shareholders of record on December 4. Turning to the balance sheet. During the quarter, we took further steps to simplify our capital structure, substantially reducing the remaining 2028 convertible notes. Our balance sheet remains strong, with net cash of $500 million at quarter end. Turning to our outlook for the second quarter of fiscal year 2027. We continue to operate in an environment of strong demand across all end markets and favorable pricing. For the second quarter of fiscal year 2027, we expect revenue of $5.1 billion, plus or minus $100 million; the midpoint represents 69% year-over-year growth. Gross margin is expected to be in the 60%61% range, as we continue to benefit from the shift to higher-capacity drives and a strong pricing environment. Operating expenses are expected to be $400 million$410 million, up quarter-over-quarter due to program expenses from increased product qualification activity. Interest and other expense is expected to be $15 million. The tax rate is expected to be 17%. Accordingly, we expect diluted earnings per share of $5.80, plus or minus $0.20, based on 380 million Non-GAAP diluted shares. Looking ahead, demand remains strong. Customer engagements continue to deepen and broaden, and our visibility continues to improve. As technology and product transitions progress, we expect EB supply growth to accelerate through fiscal years 2027 and 2028. Our strong balance sheet and free cash flow generation capability position us to make targeted investments that strengthen technology leadership and support customers' growing storage needs. While we expect capital expenditures to average 4%6% of revenue over the five-year period, we expect capital expenditures as a percentage of revenue to be slightly above that range over the next two years as we continue to invest in head and media technology and factory automation to support our industry-leading areal density and higher-capacity drives without adding unit capacity through capital expenditures. In summary, accelerating EB growth, technology leadership, gross margin expansion, and disciplined capital allocation provide a solid foundation for sustainable earnings, free cash flow growth, and long-term shareholder value creation. We will now move to the Q&A session. Ambrish? Ambrish Srivastava - Vice President, Investor Relations Thank you, Kris. Operator, we are ready to open the line for questions. [Host instructions] Operator? Q&A Session Host [Host instructions] Our first question today comes from Amit Daryanani of Evercore. Amit Daryanani - Evercore ISI Institutional Equities I want to start with HAMR. The market has been focused on this, and you mentioned completing qualification with two hyperscale customers in March and mass production shipments in mid-2027. Can you talk about what milestones remain between those two steps in your view? And after that, what determines the ramp speedmore the customer deployment cadence or your manufacturing readiness? Irving Tan - Chief Executive Officer and Director Okay, Amit, thanks for the question. First, I have to say I am very pleased with the HAMR progress. As we have emphasized, customer feedback has been very positive, especially on our drives' failure rate performance relative to what they see from other vendors in the market. As such, we are very confident in completing qualification with two customers for our first-generation HAMR product in the first quarter. We will also begin qualification with two additional customers in the first half of calendar 2027. We have not received any feedback that would give us reason to pause converting qualification completion into mass production shipments beginning in the first half of 2027. Our customer technical support teams are working closely with customers to complete qualification plans and move products into production. On the global operations side, we are working closely with our internal manufacturing assets and suppliers to prepare the supply chain for ramp. After that, beginning in the second half of calendar 2027, we will also begin qualification of our second-generation HAMR drive on a 5TB-per-platter, 11-platter platform. Overall, I am very pleased with the progress. I think the engineering and operations teams across the company have done an excellent job helping us accelerate product development and reliability validation, and we are now very focused on scaling and getting products into customers' hands. Ambrish Srivastava - Vice President, Investor Relations Amit, do you have a follow-up? Amit Daryanani - Evercore ISI Institutional Equities Yes. I want to follow up on cost per TB. I know you have talked about some headwinds from rising input costs. But my impression is that cost per TB declined about 4%5% in the September quarter, the lowest decline we have seen in some time. Can you talk about what happened there and how we should think about it longer termbecause I note your December quarter gross margin guidance is very strong. Kris Sennesael - Executive Vice President and Chief Financial Officer Okay. As Irving just said, we continue to execute well on our technology roadmap and product transitions, essentially moving to higher-capacity drives through better, higher areal density. So over the long term, we are well positioned to reduce cost per TB by about 10% per year. In the near term, as I mentioned before, this is not a surprisewe are facing some input cost increases. As most of you know, we use some DRAM and NAND in our drives, and the supply chain is indeed operating in a very tight environment. So we are seeing some input cost increases. We are addressing this through value engineering measures and have seen some good progress. These solutions take some time to implement and validate. So in the near term, our year-over-year cost-per-TB reduction will be below 10%. Taking all this together, as you also mentioned, we delivered very strong gross margins in the September quarter and have strong guidance for the December quarter. Our incremental gross margins remain very strong, well above 80%. So I think we are well positioned for continued gross margin improvement. Host Our next question comes from Wamsi Mohan of Bank of America Corp. Wamsi Mohan - Bank of America Corp Securities Research Irving, I would like you to address market anxiety about the smallest player in the market adding incremental capacity, and there has also been some recent talk about potential industry consolidation. I would like to hear how you see the implications at the industry level? And does this affect your price negotiations with hyperscale customers in future years? Irving Tan - Chief Executive Officer and Director Okay, Wamsi, thanks for the question. At a high level, we do not see any change in the long-term fundamentals of the industry or our own business. We continue to see very strong demand and, as we have consistently emphasized, 25%-plus compound annual growth in a very tight supply environment. We are sticking to our established strategy and focus of meeting supply and demand growth by delivering areal density, and areal density comes from technologyparticularly head and media technologybecause that is the best way to provide customers with the best TCO while also delivering the best profitability for our business. You can see this in our focus on R&D and capital investment in our head and media businesses. I think our unique differentiation in in-house head and media development, along with our drive integration capability, gives us confidence that we can meet this growth trajectory through areal density, and therefore we are committed to not investing in any incremental unit capacity. There may be other participants in the market that do not have the unique ability to build their own media, build their own heads, and drive areal density improvement, and they have to compensate by potentially adding unit volume to maintain market share and position. Ambrish Srivastava - Vice President, Investor Relations Wamsi, do you have a follow-up? Wamsi Mohan - Bank of America Corp Securities Research Yes, Ambrish. On EB shipments, you grew 22%. Listening to you talk about the trajectory for the rest of the year, it looks like you expect that growth rate to improve as product transitions progress and HAMR enters the portfolio. Can you give a high-level senseis it fair to think of fiscal year 2027 as roughly in line with your long-term range? Also, if you consider unconstrained demand, how much higher is it than your current supply? Because demand is so strong, will that gap widen in the coming years? Irving Tan - Chief Executive Officer and Director Okay, thanks for the question, Wamsi. We roughly view the current quarter as the low point for EB growth and expect acceleration through the rest of the fiscal year. Obviously, as Kris mentioned in the prepared remarks, the same applies to 2028 and beyond. This really comes from our confidence in the new platforms coming to market. Obviously, HAMR will launch in the first half of fiscal year 2027. And as I mentioned, second-generation HAMR drives will also begin qualification in the second half. So we are moving quickly from 32TB drives to 44TB and then to 55TB and above at the high end. For our customers and for ourselves, this is the best and most economical way to meet their product needs. On the demand question, as I said, we see it continuing to grow and it is very durable. There is no weakening in demand, and we do not believe the current supply-demand gap will disappear in the near term. So we continue to focus on supporting customers as best as possible with existing technology. Host Our next question comes from Erik Woodring of Morgan Stanley. Erik Woodring - Morgan Stanley Research Congratulations on the quarter and guidance. Irving, can you give more detail on the visibility you mentionedspecifically, how far out you see and how many customers are involved? For those customers planning that far out, how does their current or future EB demand compare with three or six months ago? Are you seeing demand expanding relative to three or six months ago? Irving Tan - Chief Executive Officer and Director Okay, Erik, thanks for the question. In terms of visibility, take our top seven customerswe have good visibility with each of them through 2030 and 2031, which we have always valued highly because it allows us to ensure we deliver both technology and supply to meet future demand growth. So we have good visibility there. In fact, we see demand signals actually strengthening over time, quarter after quarter. As we move into the 2028, 2029, and 2030 timeframe, we see demand continuing to be very durable. Ambrish Srivastava - Vice President, Investor Relations Erik, do you have a follow-up? Erik Woodring - Morgan Stanley Research Yes. As a follow-up, you grew revenue 55% year-over-year, with December quarter midpoint guidance of 69% year-over-year growth, very strong. Obviously you mentioned EB growth is accelerating, but that also implies pricing is accelerating in the December quarter. Can you help us understand the sources of pricing acceleration? Is it from non-nearline or nearline? I guess probably both. But can you give more detail on why pricing is accelerating in the December quarter and how sustainable that acceleration is? Kris Sennesael - Executive Vice President and Chief Financial Officer Okay, Erik, we continue to operate in a very strong, favorable pricing environment. You can see our blended average selling price per TB rose 28% year-over-year. We are seeing this strength in nearline and non-nearline, as well as in some consumer and client businesses. The pricing environment is strong because we are truly executing our technology and product roadmap, continuously delivering higher-capacity drives to customers and helping them reduce total cost of ownershipbetter rack density, lower power consumption, and many benefits for customers. As we continue to execute this strategy and continue to deliver higher-capacity drives, there is an opportunity for price per TB to rise further over time. As you may know, some of this business is under long-term agreements. Some long-term agreements are expiring and new ones are being signed. In addition, of course, we have some EB that is not contracted, and for that uncontracted EB we are also seeing a very strong pricing environment. Host Our next question comes from C.J. Muse of Cantor Fitzgerald. C.J. Muse (Christopher Muse) - Cantor Fitzgerald Research Irving, you said at the outset that results exceeded expectations. Following up on the prior question about gross margin: you initially guided incremental gross margin around 62%, delivered 80%, and now guide 75%. I would like to understand in more depth what is driving this incremental strengthmore uncontracted bits? Contracts expiring and repricing? And looking ahead, how should we think about sustainability in 2027 and beyond? Irving Tan - Chief Executive Officer and Director Okay. C.J., first at a high level, we believe the sustainability of gross margin expansion is absolutely there. There are three drivers. First is pricing. As Kris said, we have a set of long-term agreements with contractual price escalation clauses, and as we move through different periods, reach anniversary price adjustment points, and deliver higher-capacity platforms with better TCO value, we are able to share in that value and drive higher pricing for customers under long-term agreements. In a tight supply environment, we have also secured better spot pricing for nearline customers not under long-term agreements. As Kris also mentioned, in client and consumer businesses we are likewise seeing a better overall pricing environment. So pricing is a key element. Second, we are also driving customers to upgrade to higher-capacity drives. As we migrate them to higher-capacity drives, these products are clearly more profitable for us because the average selling price per drive is also much higher. So that is the second driver of gross margin expansion, and we expect it to persist over a longer period as well. Third, obviously we will ship more EB through higher areal density. When we can deliver more EB through areal density, we avoid the fixed costs of producing more units, which is another driver of gross margin expansion. Combining these three factors, we are very optimistic about continued gross margin expansion. Ambrish Srivastava - Vice President, Investor Relations C.J., do you have a follow-up? C.J. Muse (Christopher Muse) - Cantor Fitzgerald Research Yes, Ambrish. You talked about broadening the customer base, including enterprise and MCP customers. I am curious whether this is changing the term, pricing, and deposits of long-term agreements? I would like to hear how your customer base is evolving and how this might affect your contracts? Irving Tan - Chief Executive Officer and Director Okay. We are indeed seeing the customer base diversify. This is something we have communicated before: the three-tier architecture and the critical role HDDs play in itwhether scalability, reliability, or the economic value delivered to customersis really coming to fruition. We are indeed seeing demand from frontier AI labs, neo-cloud participants, and hybrid cloud solution OEMs. So we factor these demand signals into our outlook, and this translates into the expanding demand signals I mentioned in answering earlier questions. Again, we are delivering technology and investing in heads and media to provide areal density and capacity to support all customers in this more diversified customer environment. Host Our next question comes from Asiya Merchant of Citigroup. Asiya Merchant - Citigroup Research Okay. Irving, you talked about high-bandwidth drives and the growth opportunity there. Can you elaborate on how big this opportunity is today? How much are you shipping? If you can, please expand on how big you think this opportunity can be? Irving Tan - Chief Executive Officer and Director Okay, thanks for the question, Asiya. I think this opportunity is still relatively early. Our primary focus today is obviously getting capacity into customers' hands. But as we move into the second half of calendar 2027, 2028, and beyond, this will become a major differentiator in our view, because products like high-bandwidth drives give customers the opportunity to use HDDs for workloads that previously required more expensive alternative storage media. For example, KV cache workloads in AI inference, and video streaming. We have been sampling this product with many customers so they can test different use cases. As I said, feedback has been very positive. We are working through the commercial structure for how to price high-bandwidth capability. But from a technical capability standpoint, it is very positive. We are designing the future commercial architecture and pricing approach. Ambrish Srivastava - Vice President, Investor Relations Asiya, do you have a follow-up? Yes, please go ahead. Asiya Merchant - Citigroup Research Okay. Can you also talk about physical AI? You mentioned it in the prepared remarks as well. How much early indication is there of this opportunity today? Are you shipping for it? It may still be early now, but how do you see it developing in calendar 2027 and into 2028? Irving Tan - Chief Executive Officer and Director Okay. We are indeed seeing very promising signs from the physical AI segment. For example, some of our customers in Asia working on autonomous driving are indeed asking us to increase supply to support their physical AI initiatives. A good data point is that NVIDIA Corporation itself recently highlighted its revenue opportunity from physical AI in the order of $10 billion. So if you see this on the compute side, then the storage demand to support that compute clearly follows. So we are very bullish. Autonomous driving will be one. Siasun Robot&Automation is also becoming a key area for us. Much of this is actually happening in Asia, but I expect it will also emerge in other parts of the world over the next two to three years. Host Our next question comes from Ben Reitzes of Melius Research. Benjamin Reitzes - Melius Research I want to go back to the earlier question about competitive capacity expansion. Some basic questions would help: can a certain company increase its capacity share from 10% to 30%? Is there enough material to make media and heads? Can you address it from that angle? Do you think anyone can do it? What would the bottlenecks be? Irving Tan - Chief Executive Officer and Director Okay, Ben, thanks for the question. I cannot comment on what others do, but I can share what we have done to have this capability. First and foremost, it all starts with technology. Our R&D team has done an excellent job on head design and media formulation, truly achieving high-areal-density products. Obviously, we combine this with firmware capability and drive servo-mechanical capability. So it is not just a single component issue; it is when you integrate all of this that you get the optimal areal density per drive. This is truly at the engineering level, and it is a major differentiation for us relative to the other participant in the market that relies on third-party suppliersthey are not vertically integrated. Second, as you mentioned, a key element is not so much the unit capacity you have, but whether you can scale production of the media and heads needed to support higher areal density in drives. This is also something we have been doing and will continue to invest in at Western Digital Corporation, both in R&D capability and in manufacturing assets, specifically to enable higher areal density in our head and media assets. So this is what we are doing, and we are seeing results. Other organizations without this degree of vertical integration, I think, will find it more difficult to achieve the same level of growth we are seeing. Benjamin Reitzes - Melius Research Obviously, there was a lot of concern in the market coming into this call. Can you talk more about how big neo-cloud is for you today and how much it represents in your forecast? If there is a demand hiccup there due to funding timing, how would we see it, and how much of a concern would it be for you? Irving Tan - Chief Executive Officer and Director First, we need to step back. There are actually four growth drivers in storage. One is the long-term structural growth of cloud. Cloud itself has existed for nearly two decades and is still growing at a very healthy rate, in fact accelerating, driven by more storage from video content. A large amount of stored content is video, and many cloud services are becoming AI-enabled, which brings greater storage demand. So this is a key growth driver that will persist for the foreseeable future. The second growth driver is model training and development. We see this continuing to grow as new models are created and reinforcement learning takes placereinforcement learning supporting existing models requires storing more data, and neo-cloud does play a role here. But even if the neo-cloud subsegment slows, we do not see that as any major hiccup. Third is inference and agentic AI, where we see a lot of opportunity and are beginning to see tremendous growth in this area, because customers need to store logs, checkpoints, more inference outputs, and decision points of agent systems to support reinforcement learning. Finally is physical AI, which we just mentioned. So adding these four together, demand remains very durable. Even if one of the four subsegments weakens slightly, demand can easily be absorbed by any of the other three. Overall, we are very optimistic about the outlook for demand remaining strong and durable. As for how we view the neo-cloud segment, we are clearly very selective in choosing the strategic neo-clouds we want to work with, choosing those we believe have very strong balance sheets and are supported by high-quality end-customer bases. So we prioritize them over other participants in the market. Host Our next question comes from Tom O'Malley of Barclays. Thomas O'Malley - Barclays PLC Sponsored ADR Research If you look at the compound annual growth rate of total HDD EB shipments over the past few quarters, it has gone from roughly low-20s to mid-30s. Plugging that into your guidance, it looks like implied year-over-year pricing in the December quarter is above 30%. You have historically said high-teens is a sustainable growth rate, and now the past few quarters have been well above that. Can you update us on how we should think about the sustainability of this pricing increase going forward? Kris Sennesael - Executive Vice President and Chief Financial Officer Okay, Tom. I think the 10% or whatever number you mentioned, we are now running well above it. Just one quarter ago, we had achieved an 18% increase in average price per TB. Last quarter we did 28%. As I said before, given the strong demand environment we are in, given our continued shift to higher-capacity drives and continued value addition for customers, there is indeed room for further increases in average price per TB over the next three to four quarters. I envision it will eventually moderate. But over the next three to four quarters, there is indeed room for further expansion in the year-over-year increase in average price per TB. Host Tom, do you have a follow-up? Thomas O'Malley - Barclays PLC Sponsored ADR Research Following up on the earlier comment, capital expenditures average 4%6% of revenue over the five-year period, but slightly above that over the next two years. I guess the market's first reaction is to confirm this is only investment in heads, not expanding capacity, or feeling the need to seize opportunity as the market approaches a potential peakI am not saying that, just listing possible interpretations. Can you take a moment to talk about why heads need this investment? Is it diversification due to recent news in the media, or a desire to bring internal capability to a better position? Kris Sennesael - Executive Vice President and Chief Financial Officer Tom, to clarify, in the prepared remarks we explicitly said capital expenditures will go to heads, media, and factory automation, not to expanding unit capacity. Irving Tan - Chief Executive Officer and Director I think Kris summarized it well. Obviously, as we transition to HAMR, the production steps for the required head wafers and media products involve longer cycle times. So we are making appropriate investments to support both technical capability and the slightly more steps and slightly longer cycles involved in producing the head and media components required for HAMR. Host Our next question comes from Timothy Arcuri of UBS Group AG. Timothy Arcuri - UBS Group AG Investment Banking Research You talked about accelerating EB growth. You have consistently been about 10 percentage points below peers in shipmentsyou are in the mid-20s, they are in the mid-30s. Kris, when you mentioned this, what is the target? Should we think that after several quarters you might reach the mid-30s to close that gap? Kris Sennesael - Executive Vice President and Chief Financial Officer Yes, we did 22% last quarter, and we talked about it. We are between two product generations. Over the past few quarters, we executed well on the ePMR transition up to 32TB. Now we have begun executing the ePMR transition up to 44TB. Then we have the first- and second-generation HAMR transitions, which will bring significant increases in areal density and higher-capacity drives, and will certainly accelerate our year-over-year EB supply growth over the next six to eight quarters. Host Tim, do you have a follow-up? Timothy Arcuri - UBS Group AG Investment Banking Research Yes. To drill down on that: Kris, should we think that six quarters from now you will be shipping about 35% growth? Is that the message you are conveying? Kris Sennesael - Executive Vice President and Chief Financial Officer We guide one quarter at a time, but your thinking is in the right direction. Host Our next question comes from Krish Sankar of TD Cowen. Krish Sankar (Sreekrishnan Sankarnarayanan) - TD Cowen Research I have two questions. Thanks for the pricing commentary. I am curious whether, as your first HAMR customers ramp in the first half, this has any impact on average price growthmainly because you are helping early customers ramp HAMR, or should there be no impact? Irving Tan - Chief Executive Officer and Director No, we have absolutely not given any discount on HAMR products relative to ePMR products. We price in dollars per TB, and we have long-term agreements with periodic appropriate price reviews as mentioned. So whether we ship HAMR bits or ePMR bits, the price is the price. Krish Sankar (Sreekrishnan Sankarnarayanan)