Data is the fuel for training and inference as it enables stronger models and better inference results. As more data is generated and the value of data increases, the demand for storing data is also increasing quickly.  

There are a few ways that Western Digital can awaken an age-old industry to meet the demands of hyperscalers. The first is to increase areal density from 32TB to eventually 100TB as we end the decade. By packing more capacity into the same footprint, Western Digital delivers improved economics to alleviate surging capex. The company’s UltraSMR-enabled JBOD platforms offer TB per drive, lower cost per TB and lower power (and space) per TB, delivering not only increased capacity but also lower total cost of ownership.  

The company seeks to work with a larger customer base beyond hyperscalers by not just saying “go figure out SMR” on your own to enterprises. SMR stands for shingled magnetic recording (more on this below). There are barriers to adoption for SMR as it’s complex to integrate and can have unpredictable performance at times. Western Digital is planning for when AI broadens beyond hyperscalers by offering a validated JBOD platform that tests and tunes UltraSMR, offers predictability through controlled reference architecture, and that is also quick to deploy.  

When translating UltraSMR’s benefits in investor terms, management states it offers a 20% capacity lift over CMR (conventional magnetic recording) and a 10% capacity uplift over industry standard SMR. The UltraSMR solution is software-based, thus it’s “very accretive” from a margin standpoint. Last quarter, there was a 50% mix on UltraSMR with expectations this will increase as the company’s top three customers are onboard with UltraSMR drives today and another two to three are moving toward adopting UltraSMR. 

Looking beyond the recording format, HAMR is an important catalyst for Western Digital as it’s a new write technology that uses a tiny laser to briefly heat the disk surface to write onto higher-stability media at much higher densities. This means WDC can pack more data onto the same drive size to deliver higher capacity. The step-function upgrade to increase capacity is a key element to Western Digital’s future product road map. Overall, HAMR is a primary capacity lever that will lead to 100TB hard drives along with combining higher bits-per-platter and higher platter count.  

The analysis below is dense at times, yet a necessary step to discussing a stock that has seen returns of 591% over the past year.  

Brief Product Overview  

Multimodal datasets are among the largest drivers of incremental storage demand. As inference and physical AI scale, the low-cost and high-density of HDD economics are hard to beat. Video is a data hog that and even modest growth here from multimodal AI can create what’s called “data exhaust.”  

As you'll see below, HDD is the lowest cost per TB for bulk storage. As inference requires more exabytes to be stored, HDDs offer an advantage in that storage tier. In fact, Western Digital’s management team foresees a CAGR of 25%+ over the next 5 years with HDD representing “80% of the storage media that deployed within a hyperscale environment.” 

UltraSMR and ePMR   

To answer this incoming demand, Western Digital’s ePMR tech (energy-assisted Perpendicular MR) tech adds electrical currents to the write head to improve density and write smaller bits. This increase in areal density allows more data to be stored in smaller spaces, helping drive down costs per TB and improve TCO for customers. ePMR is a tried-and-true tech, with WDC noting that it has been the ‘workhorse of the industry’ for the last decade.  

WDC is currently shipping its ePMR-based drives in 26TB CMR (conventional magnetic recording) and 32TB UltraSMR (ultra shingled magnetic recording) configurations. It is also scaling to the world’s first 40TB UltraSMR later this year, a new product addition to its portfolio and a capacity that was previously thought to be impossible to reach with ePMR.  

UltraSMR also features technological and read channel optimizations that boost HDD capacity by up to 18% versus traditional CMR drives. A key enabler is Western Digital’s OptiNAND architecture, which integrates embedded NAND devices, enabling multiple active write zones and increasing track density per disk. WDC says its UltraSMR drives offer among the highest capacities per drive for data-intensive workloads, and consume as little as 5.5 watts of power when ideal, driving TCO lower. The UltraSMR drivers are also available in WDC’s JBOD hybrid storage platforms, integrating 60 to 102 drivers to offer up to 3.26PB of storage capacity. 

HAMR 

WDC is also moving into heat-assisted magnetic recording (HAMR) to scale to higher capacity drives, as ePMR tech is reaching its physical limits in areal density. This refers to how many bits can be packed onto each square inch of disk platter (where data is stored).  

Thus, future capacity gains must come from shrinking bit sizes further, which can be achieved via HAMR. HAMR uses a laser diode to heat a microscopic spot on the disk, enabling polarity of a single bit to be flipped to allow data to be written. This allows for substantial areal density gains, moving from <3 TB per platter under the current UltraSMR drives to up to  ~10TB per platter by the end of the decade.  

WDC acknowledges that its ePMR roadmap can extend up to 60TB, but after that, the shift to HAMR is all but inevitable in order to progress towards 100TB capacities and beyond.

Source: WDC 

WDC is harnessing its patented laser technology to not only reach 100TB drives over the next few years, but scale even further by adding more platters to drives:  

“So for the last 6 years, we've been working on our own patented laser technology. It solves for those 3 problems. By emitting more light, harnessing more of that light into the recording technology, we will increase the aerial density of the HAMR platters from 4 terabytes all the way to 10 terabytes by 2028 per platter. We have 11 platters. It's one of the reasons I'm confident about 100 terabyte HAMR drives by 2029. This technology is not theoretical. It's actually already in the labs. 

We've watched it do in the recording. The other part of it, as you can see from the micrograph, they're shorter. So it allows us to add yet more capacity per drive by packing up to 14 platters into the same 3.5-inch form factor. 10 terabytes, 14 platters, that sounds like 140 terabytes.” 

Accelerating ePMR and HAMR Roadmap 

WDC is accelerating its ePMR and HAMR roadmaps, noting that ePMR shipments are growing double-digits sequentially next quarter. HAMR qualification timelines are also accelerating by six months. 

Management explained in fiscal Q2’s call that ePMR shipments reached more than 3.5 million units, while starting qualification of both its upcoming HAMR and next-gen ePMR drives at two different hyperscaler customers. ePMR shipments were guided to reach closer to 4 million in fiscal Q3, or growth of more than 14% QoQ.  

On HAMR, WDC stated that they pulled forward qualification and started in February with one hyperscaler, with another expected to be initiated relatively soon. Management emphasized at its Investor Day in February that they are “so confident in our road map for HAMR. From last year, we said back in the '27 for the ramp, we pulled it in by 6 months. So it's ramping in the first half of 2027.”  

Inference as an HDD Driver 

We recently covered discussions over the role of SSDs in ‘warm’ storage and Nvidia’s upcoming Inference Context Memory Storage platform in our SanDisk analysis in detail. Simply put, Nvidia is essentially proposing SSDs to take a more central role in the ‘warm’ tier where HDDs sits – what Western Digital and competitor Seagate consider ‘nearline’, where data does not have to be accessed instantaneously but must remain readily available.  

We covered Seagate’s response to this proposal in our analysis, with executives believing there ultimately will not be much change to storage architectures with HDDs remaining critical from a TCO perspective to handle the massive volume of data generated by AI applications. Western Digital mirrored this view, explaining that Nvidia’s new initiative will likely at its core accelerate the growth of volume generated, which means HDDs will remain critical for AI storage requirements – management expects HDDs to still account for 80% of storage solutions deployed by hyperscalers over the next five years. 

However, management also pushed back on the economics of utilizing quad-level cell (QLC) SSDs for AI storage workloads, emphasizing that QLCs offer 10% of performance of HDDs for 10X the cost: 

“This performance has led some customers to think about using QLC flash to provide that performance in addition to hard drives. It's very attractive because — but QLC has a problem when the data is constantly moving as it does in the AI workloads and in the cloud workloads. QLC wears out. And that means you have to make a lot of changes in your software, so it doesn't wear out.  

Otherwise, you end up with silent data corruption. And that is just as scary as it sounds. Hard drives, on the other hand, just don't. They don't wear out. They'll operate for years without wear out and customers like that and it simplifies their code. The other reason to consider QLC flash is that the headline performance of a QLC drive is 6 gigabytes per second. That's way more than the 200 to 250 megabytes per second of a hard drive. But that's a headline number. It's only true when that drive, that QLC drive is attached directly to the GPU with a great big bus. In the real world, in object stores deployed in massive scale, that's not how it's done. Hard drives and QLC drives are connected to the network via a thing called the SAE interface.  

It's a thin pipe that takes data from the drive to the network. It can only support 530 megabytes per second. So customers would get less than 10% of the performance of QLC for 10x the cost of a hard drive. Do you think that's a good deal? I don't now or as a customer.” 

WDC also commented on more specific inference-based HDD demand drivers, such as multi-modal models requiring significantly large data sets to store queries and prompts, video generation, as well as autonomous vehicles and robotics needing extensive data sets to function in real-world situations. All summed up, WDC believes that inference and these upcoming AI applications will drive storage exabyte demand at a >25% CAGR over the next five years, providing a solid foundation for long-term revenue growth as HAMR unlocks a path to higher capacity drives.  

There is one risk with this, in that there will still likely be use cases and applications where customers use a higher mix of SSDs. HDDs offer the lowest-cost per terabyte, ideal for “big data” storage, backups and large AI datasets. However, solid state drives (SSDs), which store data on flash memory chips, are far faster and lower-latency but at a higher cost per terabyte. This means leveraging a mix of HDDs and SSDs is a popular choice, and some AI workloads prioritizing latency may take a higher mix of SSDs.  

High Bandwidth HDD Design and Power-Optimized HDDs 

At its recent Innovation Day, Western Digital shared more information on its product roadmap and technological innovations driving its path to 100TB capacity. WDC is not seeking just capacity gains but also performance gains with high-bandwidth HDD design. This is especially important as throughput (data transfer speeds) must continue to scale alongside capacity to prevent performance bottlenecks. 

This has not been the case over the last several years. WDC explains that since 2017, CMR HDD capacities have increased by 116%, from its 12TB Ultrastar to 26TB, yet maximum sequential throughput only increased 18%, from 255MB/s to 302MB/s. This is critical as a lack of throughput gains will make HDDs less suitable for bandwidth-intensive AI workloads despite strong capacity gains.  

WDC is aiming to boost performance and throughput via two innovations, High Bandwidth Drive (HBDT) and Dual Pivot design technologies. Put simply, WDC is working towards delivering NAND flash-similar performance and throughput but with HDD cost and TCO economics.  

WDC says that its HBDT will enable simultaneous read and write from multiple heads on multiple tracks, which up until now has been done on a single track at a time. Currently, HBDT is able to access two tracks simultaneously, though WDC believes it can ultimately scale to four and eight tracks simultaneously. Under two tracks, WDC says sequential throughput will double and will scale further as HBDT innovation progresses towards eight tracks at once. Importantly, HBDT is already in validation with customers. 

Dual Pivot tech (DPT) unlocks further performance gains by adding a second independent actuator on a separate pivot. Similar to how read and write were previously done on a single track at a time, HDDs have been limited by having one single actuator containing the read-write heads. With DPT, a second actuator is added on the opposite end of the drive, allowing for independent seeking between the two heads.  

This is the main difference between DPT and previous dual actuator drives. Previous drives had to remove on disk to make space for the second actuator to boost performance, sacrificing capacity, whereas with DPT and the placement of the second actuator, WDC can reduce spacing between disks, and boost capacity and performance at the same time. DPT remains in the lab for testing and is expected to be available in 2028. 

Combining both technologies is expected to drive significant performance and throughput gains while on the path to >100TB capacity. WDC states that “two-track HBDT plus dual pivot is projected to increase throughput from today’s 300MB/s to approximately 1.2GB/s, a 4x increase.” This would mean that a 100TB drive would have similar throughput and performance as the currently-available 26TB drives, preserving HDD performance and cost economics. WDC adds that eight-track HBDT and DPT could theoretically increase throughput to 4.8GB/s, another 4x increase from two-track and 16x versus today.   

Here’s how management explained this increase in performance, and this quote provides some perspective as to why demand may be high for drives integrating these technologies, as it can seamlessly integrate into existing infrastructure: 

The thing [customers] really love about this is that we can go to 4, 6 and 8x the performance. It is scalable. By the time we get to 100 terabytes, we could be 8x the performance of today's drives. We already have the technology to do it, and we're developing it, so we're ready for when customers are ready for it. We'll introduce this capability at the 50-terabyte mark to meet the customers' demand so that they are ready for us to consume and take advantage of all this performance. … 

This design will fit in an existing customer chassis with that change. It can be made on the same manufacturing lines. And they just see more performance. So customers are really excited by this. double the transactions smoothly for customers. … Dual-pivot technology helps customers focus their software effort on improving more performance for AI versus having to deal with how the hard drives are working. And we'll introduce this at the 60-terabyte mark. … 

My biggest problem is finding them enough material so they can start testing. Dual pivot technology will be in their hands in late '27 and '28. So all the performance that the customer's hardware can support their existing boxes, their existing software, their existing networks without having — can be delivered from these drives with the capacity that we are building without having to use QLC. We deliver performance 10x cheaper than QLC can.” 

Management also shed more light on software optimizations and how this will also accelerate deployment timelines for upcoming tech. WDC explained that the “shortcut is a simple, open API that allows customers to integrate that API to their existing file system, their existing object store,” that will be available on flash and extending to all HDDs scaling to 100TB. This will provide faster qualification and faster time to production, with this becoming available in 2027. 

WDC is also working on power-optimized HDDs, aiming to lower power consumption by up to 20% and boost capacity with minimal trade-offs on performance. The lower power consumption not only will offer a lower TCO, but also make these HDDs more attractive from a hyperscaler perspective by saving more power that can be allocated towards more GPUs.  

WDC says that by spinning the drive slower, “we can reduce the power by 20%, but we only trade 5% to 10% of the sequential I/O [input output operations], not something that the customers have seen before or even thought was possible.” This also will add ~10% more capacity, or 10TB for a 100TB drive, or increasing capacity inside the same 3.5 inch form factor without changing the drive’s power profile. WDC adds that this lower power consumption is optimal for cold data, or data that needs to be accessed within seconds for AI inference, helping enable AI data storage at scale. 

Multiple Margin Levers to Pull 

WDC outlined multiple different margin levers at its disposal, from strong yields with its ePMR products to increasing mix of UltraSMR drivers and soon the HAMR ramp. WDC has seen strong margin expansion, with Q2 gross margins up nearly 8 points YoY and operating margin following suit with a nearly 7 point YoY expansion. Perhaps most importantly, WDC expects to drive further gross margin expansion over the next couple of quarters and beyond, due to these levers.  

Management explained that yields for ePMR products are in the low-90% range, noting that “as we get yields up, cost continues to decline. As the UltraSMR mix goes up within those new products as well, that's also going to be a driver of cost down as well.” For context, UltraSMR drives now account for 50% mix in its nearline portfolio, with WDC’s top three customers onboarded with two to three other major customers likely moving to adopt the drives soon. This is expected to drive an increase in UltraSMR mix over the coming quarters and provide solid gross margin tailwinds. HAMR will be another margin lever in play once these drives begin to ramp, as WDC expects its HAMR products to be neutral or accretive to gross margins. 

Touching on the cost front, WDC explained that costs per terabyte were down around (10%) YoY in the quarter, which, combined with a 2-3% increase in ASP, provides room for solid margin expansion. This also pertains to higher capacity drives, which management explained have a cost benefit as well, which likely see lower unit costs, similar to Seagate.  

Analysts questioned about incremental gross margins considering the combined levers WDC has, with management explaining that they are currently running at a 75% incremental margin: 

“On the gross margin line, the guidance that you're giving for 47% to 48%, I guess the back of the envelope math would suggest that you're maintaining what looks to be like a 70%, maybe 75% incremental margin flow-through. So, I guess, my question is, how do you think about the durability of that incremental margin? 

EVP and CFO, Kris SennesaelEVP and CFO, Kris Sennesael 

We delivered 46.1% gross margin, up 220 basis points quarter-over-quarter, up 770 basis points year-over-year. And we are guiding to 47%, 48%, so 47.5% at the midpoint, which is up 740 basis points on a year-over-year basis. And, Aaron, I think your math is working. The incremental gross margin is on or about 75%, depending on how you look at it on a year-over-year basis or a quarter-over-quarter basis. So I've stated before, I'm very comfortable with an incremental gross margin higher than 50% and definitely 75% is higher than 50%. 

I mean in gross margins, there's two sides to the equation. On one hand, you have pricing environment. On the other hand, you have the cost environment. In pricing, I've talked about that before. We see a stable pricing environment with prices on a price per terabyte, kind of, flattish to slightly up. Actually, last quarter, it was up 2%, 3% on an ASP per terabyte basis. So that clearly demonstrate the value that we continue to deliver to our customers. 

And on the cost front, the teams continue to execute really well. We continue to upshift our customers to higher capacity drives, which gives us a cost benefit. And then there is great execution as well on driving down the cost in our manufacturing assets as well as throughout the supply chain. And when you look at it last quarter, the cost per terabyte was coming down on or about 10% on a year-over-year basis. And so when you put this all together, we continue to drive further gross margin expansion. And we believe in the next couple of quarters and beyond, we will continue to be able to do that.” 

What the incremental margin means is that for every dollar of revenue that WDC adds compared to the prior quarter, 75% of that flows through to gross margin – WDC delivered a $199 million QoQ increase in revenue this quarter, with $153 million of that flowing to gross profit. Looking ahead, if WDC can maintain this and deliver >$200 million QoQ growth throughout CY26 (as current estimates suggest), it could exit the year with margins above 50%. 

Visibility through 2027-2028 at Top Customers, Pricing is Stable 

WDC has already signed firm orders through calendar 2026 with its top seven customers, though it has visibility into demand extending out into 2028. Management explained that they have ‘robust’ agreements with three of its top five customers, with two of these covering calendar 2028 and one extending through calendar 2028, with these LTAs including both volume and price conditions.  

Analysts asked questions about WDC’s long-term agreements and what the economics of these new orders would look like. WDC revealed that they do contain conditions for volume and pricing, but added quite an important caveat at its Investor Day – hyperscalers want ‘predictable’ pricing, in sharp contrast to rapidly rising (and fluctuating) SSD prices. This means that upcoming contracts will likely have set price escalators so hyperscalers do not get exposed to rapidly changing memory cost structures: 

Irving, just given the tightness of the HDD market and kind of the significant inflation that NAND is going through right now, can you maybe just talk about maybe your patience in being able to sign purchase orders further into calendar '27 to extract better economics just relative to maybe how you were approaching signing POs last year? Is that making any difference in the economics you're able to extract?  

CEO Irving Tan 

As we highlighted, we're pretty much sold out for calendar year '26. We have firm [purchase orders] with our top 7 customers. And we've also established LTAs with two of them for calendar year '27 and one of them for calendar year '28. Obviously, these LTAs have a combination of volume of exabytes and price. And in relation to pricing, I think first, it's important to recognize [that] there's actually a structural shift in the value that we deliver to them, especially in the impact that we have to their total cost of ownership as the business moves more and more towards inference where monetization is happening.  

So, in this case, the pricing that we've provided there reflects the value that we're delivering to them. And so as Kris mentioned, we continue to see going forward a stable pricing environment that gives us an opportunity to continue to extract more value as we deliver both better TCO value to our customers and to better support their supply-demand needs as well through higher capacity drives. 

This ties in to comments from Investor Day, where management confirmed that they want to ensure there is a fair value exchange between capacity/performance and pricing, noting that the goal is to deliver “predictable pricing” as hyperscalers are concerned about “high volatility of some tiers of the storage space,” referring to the strong QoQ growth in enterprise SSD prices. 

Management also offered some more insights onto pricing trends through 2026, noting that FQ2 had seen stable prices with ASP per terabyte up 2-3%, while projecting mid-to-high single digit YoY ASP growth through the year and remaining stable into 2027: 

“If I look at calendar year 2026, 4 quarters of calendar year '26, I do expect ASP per terabyte to go up mid- to high single digits year-over-year for all 4 quarters, mid- to high single digits year-over-year for '26. And then beyond '26, I expect us to continue to operate in what I call a stable pricing environment, of course, from the higher level that we established in '26.” 

Battling Head to Head with Seagate on HAMR, but Expects to Lead 

It’s safe to say that WDC faces fierce competition with Seagate in the HDD space on both exabyte shipments and on the tech front. WDC exhibits a fair lead in exabytes, shipping 192 nearline exabytes in the quarter versus Seagate’s 165 exabytes. However, Seagate current is ahead when it comes to ramping HAMR drives. 

For an apple-to-apple comparison to Seagate, WDC’s first HAMR products are expected to launch with capacities from 40-44TB, which aligns with Seagate’s Mozaic4+ platform also offering up to 44TB, as both feature 4TB capacity per platter. The key difference is that Seagate’s Mozaic4+ is now shipping to two hyperscalers and ramping through the rest of the year, representing a three quarter head start over WDC in the first half of 2027. 

However, Western Digital expects to quickly take the lead in HAMR-drive capacity, with management confident in achieving 100TB+ products as early as 2029. This goes back to our discussion on the HAMr under the product overview, with WDC aiming to reach 10 TB per platter by 2028 to enable shipping 100TB HAMR drives by 2029.  

One reason that WDC is able to move so fast at scaling capacity is that it begins qualification processes at hyperscalers when introducing new hardware into the labs, cutting ramp timelines by months: “Together with our customers, we started to introduce the hardware into our labs and the qualification of the hyperscaler software so that we can start the qualification process while we're still developing the drive.  

That cuts out months from a qualification process. So by the time we're ready for volume manufacturing, the drive is ready to ramp. As Irving said earlier, we've ramped up our latest generation of drives very quickly. That's one of the reasons. The other part with rapid generation of more capacity points, customers will have a lot of qualifications. So instead of qualifying every single capacity point, they qualify one set of capacity point, let's say, 36 to 41 terabytes, and we will just ship them more capacity as we make it available. One qualification, many capacity points.  

And the next one is going to be at 42 to 56 and so on. So that innovation, not just in the drive design, but also in the processes we do gets us faster time to capacity in customers' hands in their fleets where they need it the most. So putting it all together, our HAMR capacity goes from 40 terabytes to 100 terabytes by 2029.” 

On the flip side, Seagate has that capacity penciled in for the early part of next decade, noting in Q2’s call that its Mozaic3+ and Mozaic4+ “developments align with our long-term areal density road map that extends to 10 terabytes per disk, which we expect to deliver early in the next decade.” This shift will be key to watch, as it suggest that Seagate could soon lag WDC’s capacity roadmap by several years.  

In plain terms, WDC could have a significant capacity and TCO advantage by 2029 if it can realize these density targets, making it a more attractive solution for AI data storage needs 

Financials 

Revenue Growth Accelerating to 40%, Potentially Peak Growth 

WDC delivered fiscal Q2 revenue of $3.02 billion, up 25% YoY and 7% QoQ, although this marked a deceleration from 27% YoY and 8% QoQ in Q1. Management said this was driven by strong demand for its higher capacity nearline drives.  

Exabyte shipments rose 22% YoY and 5% QoQ to 215 EB, including 103 EB from its ePMR product line on 3.5 million shipments. Revenues are closely correlated with EB shipments with pricing contributing only a 2-3 points of upside.  

Looking ahead to FQ3, WDC guided for revenue of $3.2 billion at midpoint, representing an acceleration to 40% YoY growth, up 15 points, while QoQ growth would tick slightly higher to 6.1%. Current estimates suggest WDC will close out the fiscal year with $3.44 billion in revenue in Q4, up 32% YoY and another 7.5% QoQ. At present, this would suggest that fiscal Q3’s YoY acceleration to 40% would be the company’s peak growth quarter moving through calendar 2026. 

For FY26 ending in June, revenue is expected to increase 31% to $12.47 billion, while an initial look at FY27 points to 25.6% growth to $15.66 billion in revenue. This is above WDC’s long-term revenue growth model for >20% growth CAGR over the next three to five years.  

Key Segments 

Similar to Seagate, WDC sees the large majority of its revenue go to Cloud customers, with minimal exposure to Client and Consumer end markets. 

Cloud revenue was $2.67 billion in Q2, up 27.5% YoY and 6.5% QoQ, decelerating from 31.5% YoY and 7.8% QoQ in Q1. Management noted that they are seeing strong demand from hyperscaler customers. Cloud accounted for 89% of revenue in the quarter.  

Assuming similar Cloud mix at 89% in fiscal Q3, though there is potential for slight mix gains on seasonality in its other two end markets, Cloud revenue would be implied at roughly ~$2.85 billion, up 6.5% QoQ and 41.9% YoY. 

WDC’s Client segment represented 6% of revenue at $176 million, up 26% YoY, while Consumer accounted for 5% of revenue at $168 million, declining (3%) YoY. 

Strong Margin Expansion 

As discussed above, WDC is seeing strong gross margin expansion with multiple levers available, and this margin expansion is flowing down the line.  

GAAP gross margin was 45.7% in Q2, up 8 points YoY and 2.2 points QOQ, while adjusted gross margin was 46.1%, up 7.7 points YoY and 2.2 points QoQ. For Q3, adjusted gross margin is expected to be 47.5% at midpoint, up 7.4 points YoY and 1.4 points QoQ.  

GAAP operating margin was 30.1%, up 6.9 points YoY and 2 points QoQ, while adjusted operating margin was 33.8%, up 9.3 points YoY and 3.4 points QoQ. Adjusted operating margin is implied to be 35.5% in Q3, up 9.5 points YoY and 1.7 points QoQ, showing a slight degree of operating leverage.  

GAAP net margin was 59.7% as WDC benefited from a more than $1 billion gain on its 7.5 million share stake in SanDisk, which it has now sold for nearly $3.2 billion to help reduce debt. Adjusted net margin was 26.7%, up 9.3 points YoY and 3.5 points QoQ. 

For a quick view on how current margins stack up to WDC’s long-term model, it expects adjusted gross and operating margins to surpass 50%/40% over the next three to five years, or roughly three to five points of expansion.  

EPS Growth Robust but Decelerating 

Driven by the margin expansion, WDC is seeing strong EPS growth, though growth is expected to largely decelerate moving through the year. 

GAAP EPS was $4.73, up 54% QoQ and 272% YoY, again driven by the gain on its SanDisk stake. Adjusted EPS was $2.13, up 78% YoY and 20% QoQ, beating estimates for $1.98. 

For Q3, adjusted EPS was guided to be $2.30, +/- $0.15, up 69% YoY and 8% QoQ at midpoint. Adjusted EPS growth is expected to decelerate further to 61% YoY in FQ4, and slow to 50% by the end of FY27. 

For FY26, WDC is expected to report adjusted EPS growth of nearly 80% YoY to $8.85, with another 52% to $13.46; despite the deceleration on the quarterly view, it should be noted that this EPS growth rate is still quite strong compared to the base it is growing from. Under the long-term model, management expects EPS to surpass $20. 

Cash and Balance Sheet 

Cash flow margins also showed strong expansion, and while debt does look inflated, WDC’s sale of its SanDisk stake is meaningfully improving its debt profile. Management explained at Innovation Day that “if you look at the revenue growth that we've delivered over the last 12 months, the margin appreciation, ultimately, what is done is to translate into very strong free cash flow. And in the last 2 quarters, we returned 100% of the free cash flow that we've generated. And we also were able to bring our net leverage well below the 1 to 1.5x that we laid out last year.” 

Operating cash flow was $745 million in Q2 for a 24.7% margin, up from 16.9% a year ago and 23.8% in Q1. Free cash flow was $653 million for a 21.6% margin, up from 13.9% a year ago and 21.3% in Q3. 

As of Q2, WDC reported cash of $1.98 billion and debt of $4.65 billion, though it already has redeemed $1 billion in its 2029 and 2032 senior notes following the stake sale. 

Inventories were $1.35 billion, down marginally from $1.39 billion in Q1. 

Conclusion 

Western Digital has emerged as one of the top AI winners over the past year with a 591% return, with the company getting added to the NASDAQ-100 index in December of 2025.  

Looking ahead to 2026, Western Digital is already sold out of capacity with set price and volume commitments, with visibility from key hyperscaler customers extending into 2027 and 2028. WDC also has been excelling at driving strong margin expansion with a handful of key levers at its disposal.  

Over the next few years, WDC is leveraging its technological expertise and several new innovations such as HBDT and DPT to drive significant performance gains on the path to 100TB capacity. WDC is also expecting to quickly take the lead in higher-capacity HAMR drives versus key competitor Seagate, potentially giving it a key advantage by the turn of the decade in meeting AI-driven data storage demand.

Damien Robbins, Equity Analyst at I/O Fund contributed to this analysis.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

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• Seagate: Slow QoQ Data Center Growth, 2027 Capacity Under Discussions
• Monolithic Power: Strong AI Tailwinds to Drive 50% Enterprise Data Segment Growth in FY26
• Teradyne Q4: Revenue Accelerates to 41% QoQ, Possibly Peak Growth Quarter

Ciena’s role is different than the many “inside-the-data-center" networking stocks the I/O Fund covers as instead of offering networking fabrics at the system level, Ciena offers optical transport across data centers and metro regions. While AI training is already pushing hyperscalers to connect clusters across data center sites, inference offers another leg up for metro/long-haul networking as workloads will be distributed across many data centers to scale significant application usage, especially as agents necessitate responsiveness and reducing latency. 

This quarter, Ciena proved it's a leader in data center interconnects with $1.43 billion in revenue and $1.35 in adjusted EPS – more than doubling year-over-year. Optical revenue grew 41% YoY and 10% QoQ with Waveserver and RLS up 80% YoY and backlog that grew by $2 billion to reach about $7 billion total. 

With 800G pluggables ramping, new platforms like RLS Hyper-Rail and Nubius products (Vesta Optical Engine and Nitro redriver) will help to expand Ciena’s footprint. Notably, Ciena benefits from two major customer pools: hyperscalers building and linking more AI data centers which drives demand for DCI/metro/long-haul optical networking, but also telecom carriers and service providers who are upgrading their networks in anticipation of increased AI traffic across the network.  

Below, we cover Ciena’s product positioning, its most recent earnings report and a few key catalysts to keep an eye on as we approach an inflection driven by the inference market. 

Product Overview: 

Ciena’s foundational business is to address connectivity needs in the wide area network (WAN), spanning long-haul, metro and data center interconnect (DCI). Ciena offers the optical backbone that connects AI data centers and regions and is poised to benefit as AI-driven traffic will lead to higher-capacity metro and long-haul upgrades. 

Below, we break down the main products that Ciena offers currently, such as RLS and Waveserver, and products that Ciena plans to expand into, such as Vesta higher-density optical engine and Nitro linear redriver to extend reach in active copper cabling. 

Optical Networking & DCI 

Ciena offers a range of optical networking solutions targeting scale across, campus and metro DCI (10-20km and 20-100km) to backbone and submarine (10,000+ km reach) optical systems.  

Ciena’s WaveLogic sends information over fiber using fewer lanes, which lowers power use and cost. Ciena uses WaveLogic inside its systems and offers compact pluggable modules that make it easier to add capacity without rebuilding a networking. Ciena’s Waveserver is the platform that connects data centers at scale by offering a packaged solution that can be deployed to expand bandwidth between sites quickly. The newer versions of Wavelogic detailed below allow Ciena to push higher speeds over the same fiber, which can reduce the number of components needed for a quicker and more simplified upgrade.  

• Ciena’s WaveLogic 5 Extreme supports 200G to 800G line rates to enable 400GbE transport across any distance, including ultra-long haul and subsea, while its WaveLogic 5 Nano 100G to 400G ZR/ZR+ pluggable coherent optics are optimized for DCI applications with low power consumption of 15W with reach up to 140km. WaveLogic pluggables also seamlessly integrate into its Waveserver stackable interconnect platforms, scaling up to 12.8Tb/s per 2RU unit for cost-effective DCI solutions. 
• Ciena’s WaveLogic 6 Extreme boosts speeds to an industry-leading 1.6Tb/s per wavelength, extending 800GbE transmission across the longest distances. Ciena says that WL6e delivers twice the capacity per wavelength in its existing 6500 and Waveserver platforms, helping reducing transceiver counts and lowering cost and complexity of systems. It also delivers double the capacity under the same power and space envelope versus WL5e. 
• WaveLogic 6 Nano offers fit-for-purpose 400-800G ZR/LR/ZR+ pluggables and 1.6T coherent-lite pluggable transceivers to meet high-bandwidth AI data center applications. Ciena says that WL6n combines it vertically integrated DSP, electro-optics, and high-speed packaging to support high-performance data center fabric, or 2km, and data center campus, up to 20km, applications. 800ZR pluggables were implied to be ramping later in the year, while Ciena is also developing future 1600ZR/1600ZR+ solutions built on 2nm silicon. 

Reconfigurable Line Systems (RLS) 

RLS offers the infrastructure that routes wavelengths over fiber for metro and long-haul networks. COLORZ pluggables are part of the optical stack and are the endpoints that generate and receive the optical signal for DCI/metro links. 

RLS plays an important role in ‘scale-across’ applications, the third pillar of scaling AI infrastructure. We have detailed the first two pillars, scale up and scale out, in detail, yet the challenge is that both cannot extend infinitely, which is where scale across fits in.   

While scale across is much less discussed, it refers to linking together multiple geographically distributed AI data centers to act as one cohesive compute facility, theoretically facilitating a path to >1GW-scale clusters as it bypasses site/land and power constraints.  This can either be in close proximity such as OpenAI’s Stargate cluster in Abilene spanning multiple buildings, Amazon’s Project Rainier or Microsoft’s Fairwater data centers linking together via ‘AI WAN’ (wide area network). Coherent ZR/ZR+ modules excel in scale across as they maintain the signal integrity and reliability across long distances at the highest data rates.  

According to the management team, Ciena’s upcoming RLS hyper-rail solution is expected to be in high demand: “We are addressing this demand for scale across solutions with our RLS platform, the de facto industry line system standard for cloud providers as well as our 800ZR pluggable optics. To underscore this, we realized a second consecutive record quarter for RLS shipments and revenue. We expect to expand our role in scale across applications with the introduction of our new RLS hyper-rail solution. Hyper-rail delivers an order of magnitude increase in fiber density within existing rack footprints, helping customers scale traffic while reducing and, in some cases, avoiding costs and complexity associated with adding substantial numbers of amplifier huts.” 

• Ciena offers reconfigurable line systems (RLS) in its 6500 RLS family, which addresses the highest-capacity bandwidth requirements in metro, long-haul and DCI applications. RLS can support 60Tb/s capacity on a single fiber pair, offering flexible configuration options while doubling fiber capacity without impacting existing C-band traffic. Ciena also says that its 6500 RLS can reduce physical footprint by as much as 70% versus traditional chassis-based systems from its modular form factor. 
• Ciena is expanding its RLS portfolio with hyper-rail photonics, which feature new amplifier configurations to deliver 32x density of current solutions, scaling to 128 fiber pairs in a single rack. This is achieved by scaling from one rail per module to four, reducing power consumption by up to 75% and space requirements by up to 85% while integrating into existing rack footprints. Ciena explained that the RLS Hyper-Rail was co-developed with its hyperscaler customers specifically for multi-region, large scale AI connectivity, and will begin standardization at the end of 2026 and ramp in 2027. Ciena expects to be first to market in hyper-rail, allowing them to extend current RLS momentum into 2027 driven by share gains. 

RLS is an important cornerstone for Ciena’s Optical Networking portfolio, with management explaining that FQ1 marked a “second consecutive record quarter for RLS shipments and revenue”, with growth of over 80% YoY. Ciena is seeing robust momentum for scale across stemming from its RLS solutions and ZR/ZR+ modules this year, with management explaining that they “are already experiencing extraordinary demand with 3 hyperscalers choosing to use our optical solutions for their training applications across distance.” All three hyperscalers were said to be “significantly ramping including additional orders for multiple additional clusters from the first hyperscaler we announced in Q3 2025.” 

Scale Up, Scale Out and CPO 

Ciena’s $270 million acquisition of Nubis in September 2025 expanded its presence inside the data center, as the aforementioned products primarily offer networking across the data center. With this new acquisition, Ciena is moving into scale-up and scale-out networking and co-packaged optics (CPO).  

As a brief recap, CPO places optical transceivers directly on the chip package, rather than using separate optical modules, resulting in faster data transmission, reduced latency and higher bandwidth. This may be the best of both worlds: the performance of optical yet with reduced power consumption for increasingly power-hungry AI racks. 

Ciena recently unveiled its Vesta 200 6.4T CPX, which it says is the industry's highest-density and lowest-power pluggable CPO solution. Ciena says that the retimer-free linear-drive operation saves up to 70% power versus other retimed options. According to management, samples of the Vesta 200 6.4T optical engine will be available in Q2 2026. 

For scale-up inside the rack, Ciena is advancing Nubis’ Nitro Linear Redriver tech, which extends the distance that signals can be transmitted over copper cables and also reduce power by up to 80% versus AECs. Ciena will also sample the redriver in calendar Q2. As stated on the call, this is especially important for XPUs (such as from Broadcom): “For scale-up opportunities inside the rack, where XPUs are getting faster and driving heat and power concerns, we are advancing the Nitro Linear Redriver technology also from our Nubis acquisition.” 

Data Center Out-of-Band Management  

Out-of-band management is critical yet underdiscussed, as it provides a separate, independent network to control and recover data center infrastructure – for example, it allows hyperscalers to have visibility over servers and other components, and provide a pathway remotely recover systems without physical intervention. However, traditional out-of-band management faces increasing challenges as AI clusters scale up and out. This is because the maximization of GPU density in racks leaves minimal space for OOB connectivity, such as for switches, routers and console servers. It also is copper-heavy (and power hungry) by relying on extensive Ethernet cabling.  

Ciena designed its DCOM solution with Meta to meet hyperscaler configuration requirements, noting that its DCOM solution, leveraging its routers, switches and its passive optical network (PON) ecosystem to reduce rack space by up to 99%, reduce power, and streamline remote access. Ciena says it is continuing to work with Meta on DCOM and had expanded last quarter, with two other hyperscalers in discussion. Management believes that DCOM will be a significant opportunity in the data center and a defensible space for them due to its speed, vertical integration and software.  

Managed-Over-Fiber Networks (MOFNs) 

Advanced networks called managed-over-fiber-network (MOFNs) are projects that connect multiple data centers in a metro area and upgrade capacity and resiliency on existing metro networks. This drives demand for Ciena’s optical transport and DCI solutions, especially across Waveserver, coherent optics and RLS amplifier and routing gear.  

MOFNs are starting to show up as a growth driver because AI is creating significant traffic that has to be distributed between data centers. The customer base includes hyperscalers, neoclouds and service providers with 10% to 15% coming from telecom. 

Ciena is seeing strong momentum in MOFN, noting that its orders in India were up 40% YoY, specifically for these solutions. According to management, there were three greater than 10% customers including two global cloud providers and one Tier 1 North America service provider with strong MOFN activity and “order intake has been incredibly strong over the past 90 days, leading to a new record by a significant margin.” 

There was an interesting quote from management about MOFN and the neoclouds, as Ciena hinted that this is a preferred method of connectivity from its speed to market and less capex requirements from a lack of maintenance on the neoclouds’ part:  

“We're seeing obviously an emerging ramp here around a bunch of the loosely called sort of neo-scalers, which encompasses a fair range of different players. It's, I would say, largely right now MOFN orientated, given the capital expenditures, time to market for them, et cetera. But what is clear from it all is that the network is now a real priority for them. And I think that plays through to the hyperscalers, too. There's been such a maniacal focus and continues to be, obviously, on things like power, GPU accessibility, et cetera, et cetera. 

Now it's really about the network. The traffic is beginning to come out of the network, both for inference and for training. And the neo-scalers are obviously seeing that, too. So they're leaning in on the network. Now we're also beginning to see some of them wish to have control of some of that network as well and do their own builds. We're cautious about that approachment given the financial structure of some of those neo-scalers, not all of them.” 

Backlog Rises 40% QoQ to $7 Billion, Orders Fulfilled in FY27 

Ciena revealed strong backlog growth in fiscal Q1 and robust order activity tied to strong demand from hyperscaler customers. The backlog growth sparked multiple important discussions around conversion and pricing power, suggesting Ciena has strong visibility into next year with pricing emerging later this year as a growth lever.  

Backlog rose 40% QoQ to $7 billion, with management noting that Q1 demand was ‘unprecedented’ with a very strong order intake. Roughly 80% of the backlog is for products and software, or ~$5.6 billion, up from $3.8 billion last quarter. Management would not put a concrete number on RPO, but said that it would be roughly 60% of the orders Ciena took in during Q1.  

Ciena expects its backlog to continue to grow throughout the year yet noted that “nearly all” of the new orders it is currently receiving will be fulfilled in fiscal 2027, suggesting that supply remains extremely tight relative to demand with this providing strong visibility for next year’s growth.  

CEO Gary Smith provided some color on the demand drivers and strength of demand, explaining that Ciena is “seeing growth in cloud, general cloud, you're seeing inference, you're seeing this new market of training now emerge. As I said in my comments, we've now got 3 hyperscalers deploying us for training, and we're at the very early stages of that. 

So you put all of that together, and that yields the incredible demand that we saw in Q1. And as Marc said, despite the fact that we're ramping our capacity for delivery as seen in our results, demand is going to continue, we believe, to outstrip our ability to supply. And that's going to continue for — we believe, this year. And so we're going to end up with a larger backlog than we have right now as we turn the year despite the fact that we're ramping our capacity strongly throughout the year and obviously through '27 and '28.”  

Smith also later clarified that it was purely demand that was driving this order growth and backlog increase, explaining that hyperscalers are ramping significantly in optical technologies both across clusters and within racks.  

Pluggables to Triple to >$500M 

Also intertwined with the scale across momentum is Ciena’s projections for hypergrowth to continue within its ZR/ZR+ pluggables business, where it is expecting its pluggable revenue to triple after doubling last year.  

For context, Ciena stated in Q4 that pluggables had reached more than $168 million in FY25, so management’s guidance implies a ramp to >$500 million this year. This would represent a ramp from ~5% of Optical Networking revenue to likely low-double digit share in FY26 for pluggables, making them a key contributor to the segment and overall topline growth.  

Management offered some commentary on pluggables and the drivers behind this growth, pointing to 800G ramping through FY27 and their expectation to lead the market with the new data rate:  

Amit Daryanani, Evercore 

“How do you see the pluggables market, especially with 800G ramping up through fiscal '26 and '27? And if you just maybe compare and contrast a bit about your position in 400 versus 800, that will be helpful as you go into the next cycle. 

Scott McFeely, Executive Advisor 

So we've seen pluggable revenue increase sort of period-over-period, and we've talked in the past about our interconnect business and when we went from 2024 to '25, that doubling. That's sort of in the rearview mirror. And then we talked about it as a major portion of our inside and around the data center with our aspirations to triple that this year, and we're well on track for that. 

So we do see significant growth from a competitive perspective, as we've talked about in the past, through choices that we made to focus early introduction of the technology in the last generation more on our systems business and our pluggable business because that was the bigger opportunity. We weren't necessarily first movers in that market. So that probably cost us some share and it probably cost us actually, frankly, some margin dollars. That's not the case in the 800G. We're first to market there and 800G is moving quite along.” 

800G is expected to ramp through the first part of 2026 and persist through 2027, and while the tripling of revenue is certainly welcomed, the upcoming cycle is expected to see strengthening margin tailwinds through the course of the year. Ciena explained last quarter that they are expecting to lower 800G unit costs over time, and as the ramp progresses through Q2 to Q4, they expect significantly lower costs versus the start of 2026. This suggests that 800G margin headwinds in the initial early ramp will quickly pass through and potentially shift to margin tailwinds by year-end on a much larger revenue base. 

The primary challenge with pluggables was touched upon by management, in that the market is competitive, any first-mover advantages may be fleeting and pricing power is not a given. For example, Marvell recently unveiled its 1.6T ZR/ZR+ module, the first to come to market, with the new product expected to be initially available in the second half of the year, meaning Ciena’s lead in 800G may be short lived.  

Not Aggressive on Pricing, but Tailwinds Emerging in 2H 

Given the demand environment and supply tightness, analysts were curious about pricing power, noting that other component suppliers are being much more aggressive in raising prices and repricing their backlogs higher, and if Ciena would do the same. 

Ciena has already been upfront about demand outstripping supply for at least the next several quarters and how supply constraints have impacted revenue growth, meaning a more aggressive stance on pricing could drive revenue growth at a much faster pace.  

However, management downplayed the need or desire to reprice the backlog and be aggressive with pricing, explaining that they are already seeing market share gains and tangible impacts to growth and margins. This is likely because Ciena has already raised prices and expecting these to begin landing in 2H: “As we disclosed in Q4, right, the pricing increases that we talked about were really on the new orders. And because we had such a big backlog at the time, most of that was going to be seen in the second half. So you should expect those price increases to show up in Q3 and Q4.” 

Management was also upfront about why they are opting to not be as aggressive as other suppliers when it comes to pricing, rather using it as a lever to get better contractual terms, better cash conversion and longer-term purchasing commitments to reduce the risk associated with converting its larger backlog.  

George Notter, Wolfe ResearchGeorge Notter, Wolfe Research 

“Obviously, you're raising pricing. I know it's going to come through later in the year as you eat down the backlog. But just stepping back and thinking about the space, you've got higher memory costs, you've got component suppliers that are being really aggressive on price. They're repricing their own backlogs. It just seems like it's an environment where you guys could be more aggressive on price and even perhaps reprice your own backlog. So I'm just curious like why not be more aggressive here given the supply-demand dynamics and what's going on in the supply chain? 

Gary Smith, Ciena CEOGary Smith, Ciena CEO 
We've talked a lot about the good things that we're doing to manage our margins and the rest of it, including the value rebalancing. But it is a balance to it all. And that's what we're trying to strike as we go through this. I mean you're seeing it translate into improved financial performance in all dimensions, market share gains, revenue, gross margin improvement and operating leverage. We're seeing that. And it's a confluence of things….  

Marc Graff, Ciena CFOMarc Graff, Ciena CFO 

No, I think Gary said it well. Pricing is a lever, George, but we're also looking at can we improve cash conversion? Can we get better terms and conditions? Can we get longer-term purchasing commits with maybe some more noncancelable, less risky terms as we satisfy this quite large backlog.” 

Ciena is already showing signs of healthier payment activity within its days sales outstanding (DSO), which declined to 72 days in Q1, down from 77 days in Q4 and 90 days in the prior year quarter. Additionally, inventory turns reached 3.2X in Q1, up from 3.1X in Q4 and 2.3X in the prior year quarter, suggesting that demand is strengthening and payment terms are improving. Aiming for longer-term contracts and less risky terms would provide a higher degree of visibility into revenue through 2027 and will prevent Ciena from falling back into an inventory overhang like it had faced in early 2024.  

Financials 

Revenue Accelerates to 33.1% YoY in Q1  

Ciena reported fiscal Q1 revenue of $1.43 billion, representing 33.1% YoY growth, while sequential growth came in at 5.6% QoQ. Revenue also beat consensus estimates by 2.1%, reflecting stronger-than-expected demand across optical networking and cloud connectivity deployments.  

The strong YoY growth marks a notable improvement compared to the muted growth environment seen through much of FY24 and early FY25 as telecom customers worked through inventory digestion and moderated capital spending. The current acceleration suggests spending patterns across service providers and cloud operators are normalizing, particularly as network upgrades tied to AI infrastructure and high-capacity data center interconnect (DCI) deployments expand. 

Looking ahead, Ciena guided for Q2 revenue of approximately $1.50 billion, which would represent 33.5% YoY growth and a modest 4.9% QoQ growth.  

For the full year, Ciena guided for fiscal 2026 revenue of $5.9 to $6.3 billion, raising its growth forecast from 24% YoY to 28% YoY at midpoint. While the raise is certainly welcomed and indicative of the strengthening demand Ciena is seeing in RLS and pluggables, it indicates a rather soft 2H, after 40% and 34% growth in 1H. This suggests that the order momentum and backlog building are not translating over to 2H growth as of yet, but more so for 2027.  

Margins Expanded, Ahead of Guidance 

Profitability improved across all levels during the quarter, with margins expanding sequentially and outperforming management’s guidance in several areas. 

GAAP gross margin came in at 43.8%, generating $625.5 million in gross profit. Gross margins benefited from improved product mix and stronger volumes across higher-capacity optical platforms.  

On an adjusted basis, margins were slightly stronger, with adjusted gross margin of 44.7% on adjusted gross profit of $638.2 million. This result exceeded management’s midpoint guidance of 43.5%, suggesting better pricing discipline and favorable mix within Ciena’s optical portfolio. The company’s WaveLogic coherent optical platforms typically command higher margins, particularly as customers transition toward higher-capacity wavelengths such as 800G and beyond. Looking ahead, Ciena expects that its upcoming products such as RLS hyper-rail and more focused cost optimizations will help deliver improvement in gross margins. On the call, management explained that ” moving forward, you'll see even more aggressive cost reductions. And then the price increases that we talked about at the end of last year, those really haven't started to fully kick in until the second half of the year. So I think that creates additional tailwinds for us. So all in all, again, I think we're making really good progress towards that 45% way point, and you should see that throughout the year.” 

Operating leverage became more visible in Q2 as operating margins improved meaningfully in the quarter, reflecting the benefits of stronger revenue growth flowing through the cost structure. GAAP operating margin was 13.3%, improving 5.8 points YoY and 12.5 points QoQ, and marking Ciena’s first return to above a double-digit margin since the end of 2021. 

Adjusted operating margin was 17.9%, coming in well ahead of management’s 16% guidance. Because Ciena operates with a large fixed-cost R&D base tied to its optical platform development, revenue expansions typically translate into disproportionately stronger operating profit growth once demand improves. Operating leverage will remain a key driver of earnings growth if revenue continues expanding at a high double-digit pace over the coming quarters. 

This improving operating profitability flowed through to net income as well, with GAAP net margin of 10.5%, up 6.3 points YoY and 9.1 points QoQ. Adjusted net margin was 13.8%, with the difference reflecting stock-based compensation and other non-cash adjustments.  

EPS 

Ciena reported a strong 15.6% beat to adjusted EPS estimates in Q1, earning $1.35 in the quarter, up 110.9% YoY. GAAP EPS was thinner at $1.03, up 232.3% YoY on a softer comp. 

Looking ahead, Ciena is expected to see EPS growth accelerate in Q2 on a softer YoY comp, with growth decelerating through the back half of the year but remaining strong. Adjusted EPS is projected to rise 247% to $1.46 in Q2 before decelerating to 134.6% YoY to $1.57 in Q3. Growth is expected to reach 94.1% by Q4 to $1.77. 

For the full year, Ciena is currently projected to report 132.4% growth to $6.14, before decelerating to 34% growth in FY27 to $8.22. 

Cash Flow Generation Remains Healthy 

Cash flow generation remained solid in the quarter and improved alongside stronger profitability. Ciena’s balance sheet remains solid with a manageable leverage profile and ample liquidity. 

Operating cash flow was $227.7 million for a 16.0% margin, improving from a 9.7% margin a year ago. Free cash flow was also positive at $153.8 million, representing a 10.8% margin, up from 7.2% a year ago.  

These cash flow margins remain healthy for a hardware-driven networking company, particularly one with significant R&D investments in optical technologies and silicon photonics. Over time, improving operating leverage and scale could push free cash flow margins higher, particularly if higher-capacity optical products continue gaining share within the product mix. 

Cash and short-term investments totaled $1.30 billion, while total debt was $1.54 billion. 

Notably, capex was $74 million in Q1, which is 2X to 3X more than the company’s average capex over the past three years. The trend toward higher capex is likely to continue given a mix of strong visibility from customers and the need to secure critical components ahead of demand. Here is what was stated on the earnings call: “Second, we are deeply engaged with component vendors, which is where more of the industry challenges exist to secure and expand supply, including through responsible long-term purchase commitments. As shown by our Q1 results, we are navigating the supply environment well and are investing to expand capacity. However, we expect demand will continue to outstrip supply at least for the next several quarters.” 

Conclusion 

Ciena’s quarter reinforced the company is a direct beneficiary of AI-driven connectivity spend – not just inside the data center, but across metro and long-haul networks that connect AI clusters and regions. Ciena was also recently included in the S&P 500 – and for good reason as the $50B+ market cap company is set to report over $6 billion this year in revenue with a bottom-line that is doubling. 

Record revenue and expanding profitability, plus a backlog that pushes into fiscal 2027 all point to demand that is both strong and increasingly visible. The company’s 800G pluggables are ramping, and new platforms like RLS hyper-rail and Nubis products are set to expand Ciena’s footprint ahead of more long-haul/metro demand from distributed inference and multi-site training. 

Although our portfolio is loaded with market-leading AI networking winners, with some up as much as 100% YTD, Ciena holds its own by offering a differentiated way of participating in the next phase of AI infrastructure, where the focus shifts to scaling the bandwidth that connects data centers and regions.

Damien Robbins, Equity Analyst at I/O Fund contributed to this analysis.

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Recommended Reading:

• Seagate: Slow QoQ Data Center Growth, 2027 Capacity Under Discussions
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• Teradyne Q4: Revenue Accelerates to 41% QoQ, Possibly Peak Growth Quarter
• Talen Q4: Reveals 2028 Timeline for Data Center Power Delivery

Seagate has been a rather under-the-radar AI beneficiary with shares up more than 262% over the past year, keeping pace with heavyweight Micron and other strong memory sector performers. The company is working with cloud service providers (CSPs) to supply hard disk drives, stating they are qualified with 6 out of 8 CSPs on their new HAMR-based Mozaic products. As it pertains to data centers and AI, it’s expected that HDDs will handle the high-volume data storage requirements for agentic AI, which relies on persistent access to large volumes of historic data for planning, reasoning and decision-making. 

With that said, Seagate’s data center revenue growth is quite slow at just 5% QoQ in Q4, as the company is not exposed to the same swift price surges rippling across DRAM and SSD markets due to locked-in pricing for 2026.  

Looking ahead to 2027, Seagate could potentially raise prices with management stating that pricing is not locked-in yet (but notably, management was a bit evasive on the details when asked many times in the Q&A session): “But I would say we have — the vast, vast majority of the volume is already allocated. Calendar '27, we will start working on that fairly soon. Of course, we have very good indication and agreement on volumes, but we have not — we have not fixed the price yet.” 

Regardless of exact timing on when pricing can be renegotiated, Seagate’s fundamentals show exceptional margin growth as HAMR products offer stronger profitability and improved cash flows, leading to net leverage of 1.1x. It spells good things to come as HAMR products are only beginning to ramp now yet are making an impact on margins. 

Brief Product Overview: HDDs and HAMR Technology 

Hard disk drives (HDDs) offer the lowest-cost per terabyte, which makes HDDs ideal for “big data” storage, backups and large AI datasets. Compare this to solid state drives (SSDs) which store data on flash memory chips and are far faster and lower-latency. SSDs cost more per terabyte, thus leveraging a mix of HDDs and SDDs is a popular choice.  

As it stands today, SDDs have illustrated significant pricing power compared to HDDs. Therefore, because HDDs are considered more commoditized in the current market dynamics compared to SDDs, I’m quoting the management team in full as to why HDDs are likely to increase in importance as the AI economy plays out – as this is the predominant question Seagate must answer (when comparing to other memory sector stocks): 

“So if the concept is that drives aren't working hard, they're in the background, just storing data, that's not the way — a good way to think about it. That's not the way hard drives are being used right now. They're working 24/7. A lot of times, they're optimized for performance themselves, largely streaming performance, not random small block workloads. That's more of a memory thing. And so if you had an application that's random small block, it's probably memory. If you have big data, it's probably a little bit of memory on the front end and a lot of hard drive on the back end. And we think that — there are applications across the entire spectrum, of course, but we think that in the future when we start to talk about the concepts in their enormity, about checkpoints and physical AI and video and things like that, it's large, large data. So the architectural tier that stores the data will probably remain constant for the next decade.” 

Heat-assisted Magnetic Recording (HAMR) 

Seagate has developed heat-assisted magnetic recording (HAMR) tech for substantial areal density gains, which refers to how many bits can be packed onto each square inch of disk platter (where data is stored). HAMR uses a laser diode to heat a small spot on the disk, enabling polarity of a single bit to be flipped to allow data to be written.  

Other HDD tech such as energy-assisted magnetic recording (EAMR), like Western Digital’s ePMR (energy-assisted Perpendicular MR) tech, adds electrical currents to the write head to improve density and write smaller bits. While EAMR is simpler and builds on familiar PMR tech, offering faster time to market, it does not scale to the same capacity as HAMR. WDC acknowledges that EAMR is expanding to 30-40TB drive capacity with roadmaps to 60TB, while HAMR enables capacity to expand to >100TB by 2032. 

Seagate says HAMR allows data bits to become even smaller and more densely packed, while remaining thermally stable, and its HAMR-based drives can offer more exabytes of storage while taking up less space in the rack, offering substantial increases in TCO. To put this in number form, Seagate says a 1 exabyte deployment with HAMR would consume ~2 million kWh per year in 204 sq ft of space, versus 3.2 million kWh per year and 400 sq ft of space for a similar PMR deployment. 

Management believes that HDDs and higher-capacity storage systems will play a key role in meeting the storage needs for agentic AI, which need constant access to substantial volumes of data for reasoning and decision-making. Seagate projects AI workloads will drive “7.2 zettabytes of nearline storage demand over the next four years, exceeding the entire industry's consumption over the last decade.” 

Seagate’s Mozaic3+ HAMR, offering >3TB per disk, is qualified with all major US CSPs and the company says it remains on track to qualify with all global CSPs within the first half of CY26: “We ended the year shipping 3 terabyte per disk Mozaic-based HAMR products to our first CSP customer. And by year's end, quarterly HAMR shipments exceeded 1.5 million units and have continued to ramp. Mozaic 3 HAMR drives are now qualified with all of the major U.S. CSP customers and qualifications for our second-generation Mozaic 4 terabyte per disk products are tracking well to plan.” 

In terms of future catalysts, Mozaic4+ HAMR is currently qualifying, with the ramp expected to begin later this quarter and multiple CSPs expected to be qualified over the coming months. Mozaic is powering Seagate’s Exos family of products, which scale to multi-petabyte block storage systems, offering up to 2.5 PB (2,500 TB) in storage.  

In terms of volume, Seagate says that quarterly HAMR shipments have exceeded 1.5 million units and are continuing to ramp, or roughly 20% of its estimated ~7.2 million nearline unit shipments in Q2. To note, Seagate is ahead of Western Digital when it comes to HAMR, as WDC is not expecting to ramp its HAMR products until the start of CY27. 

HDD Role in ‘Warm-Storage’ 

We recently covered discussions over the role of SSDs in ‘warm’ storage and Nvidia’s upcoming Inference Context Memory Storage platform in our SanDisk analysis. We had stated: 

“Nvidia believes that “AI factories need a complementary, purposebuilt context layer that treats KV cache as its own AInative data class rather than forcing it into either scarce HBM or generalpurpose enterprise storage.” For example, the current inference context hierarchy begins with HBM (G1), providing near-instant access to latency-critical context in active generation, down to SSDs (G3) in the third tier to handle ‘warm’ data, or data that is used regularly but less frequently and still requiring efficient, cost-effective storage. Enterprise or shared storage sits at the bottom of the hierarchy (G4), handling ‘cold’ data, or data stored for long-term retention but much less frequently accessed.” 

The connection here to Seagate is that Nvidia is proposing SSDs to take a more central role in the ‘warm’ tier where HDDs sits – this is what Seagate and WDC consider ‘nearline’, where data does not have to be accessed instantaneously but must remain readily available.  

Analysts questioned about this possible shift to SSDs in warm storage: 

“Dave, while we have you, a little bit of a technical one, are you — what kind of activity are you seeing at sort of the so-called warm tier of storage? It's a question that comes up a bunch in our conversations. We've heard that it's obviously growing, it's growing both hard drive and flash storage is participating nicely, but would love to get your input on it. Because I think there's still — first of all, we love to know if what we're hearing is accurate. 

But secondarily, I think there's a lot of people that are assuming that that's really like it's becoming a NAND tier, largely a NAND tier in the GenAI world. And anyway, just love to get any context there that you have. 

CEO and Chairman William MosleyCEO and Chairman William Mosley 

“When you start talking about big data storage, if you will, in data centers, the tiering architecture is fairly well set and probably won't change based on economics and also architectures that are well known. People know how to play. So if the concept is that drives aren't working hard, they're in the background, just storing data, that's not a good way to think about it. That's not the way hard drives are being used right now. They're working 24/7.  

A lot of times, they're optimized for performance themselves, largely streaming performance, not random small block workloads. That's more of a memory thing. And so if you had an application that's random small block, it's probably memory. If you have big data, it's probably a little bit of memory on the front end and a lot of hard drive on the back end. … So the architectural tier that stores the data will probably remain constant for the next decade.” 

While there has been some chatter about this newfound role for SSDs to command a leading position in meeting inference-driven storage demand, Seagate does not believe that there will ultimately be much change to storage architectures, with HDDs remaining critical to handle the massive volumes of data generated by AI applications such as agents, video generation, world models and more.  

2026 Capacity Sold Out, Beginning to Contract for 2027 

One of the reasons for this shift to SSDs is that HDD capacity is already sold out through 2026, with Seagate already turning to signing long-term agreements (LTA) for calendar 2027. Seagate said its nearline capacity is already fully allocated through CY2026, and management expects to “begin accepting orders for the first half of calendar year 2027 in the coming months,” supported by strong demand visibility from some of its major cloud customers seeking supply assurance through 2027 and into 2028. 

Considering the supply tightness and elevated level of demand in the market for HDDs, analysts prodded about how pricing would look under new LTAs, and if new agreements would be closed at higher prices. Management noted that 2027 prices are still in discussion and have not been locked in, and implied that higher prices are possible due to demand: 

Q, Christopher Muse, Cantor FitzgeraldQ, Christopher Muse, Cantor Fitzgerald 

“And then, I guess, maybe bigger picture, as you think about overall average pricing per exabyte, we've gone from kind of down double digits to high single digits. And I think we just exited the quarter down 4% year-on-year. Do you see a world where pricing could flat or even move positive year-over-year?” 

CEO William MosleyCEO William Mosley 
“Pricing will be dictated by the demand. Right now, the demand is really strong. So I think as we roll through into '27 and '28, we look at how much capacity we're having. We're bringing online by virtue of the fact that we're making all these aggressive product transitions. We'll bring more exabytes to bear and then people go out there and renegotiate for those. I think flat to slightly up is certainly possible. And that's the way we're really managing it as we talk to our customers.” 

This ties into a later response where Seagate revealed that pricing has not been locked in for 2027, while 2026 volumes and prices are well defined – meaning any potential upside in 2026 would only come from excess capacity being sold in the open market.  

CFO Gianluca Romano explained that Seagate has “very good indication and agreement on volumes, but we have not fixed the price yet,” so if prices begin to move higher as higher-capacity next-gen HAMR devices ramp, considering how tight supply remains relative to demand, Seagate has tailwinds to both revenue growth and profitability.  

It should also be noted that in clear contrast to SSDs, HDD prices are not surging – analysts had implied HDD prices exited Q4 down (4%) YoY, while other reports placed prices up ~4% QoQ, a far cry from SSDs rising 40% to 100% QoQ – this is why Seagate’s QoQ Data Center revenue growth pales in comparison to competitors such as SanDisk. 

If Seagate can only realize a small low to mid-single digit price increase with 2027 contracts, this suggests growth will likely follow its projections for mid-20% exabyte growth with a few points' upside, rather than sharply accelerating on a YoY or QoQ basis. 

Financials:  

Revenue Growth

Seagate reported fiscal Q2 revenue of $2.83 billion, up 21.5% YoY and 7.5% QoQ, with sequential revenue growth across nearly all end markets. Growth was relatively steady on both a YoY and QoQ basis compared to fiscal Q1. 

Looking ahead, Seagate guided for FQ3 revenue to be $2.90 billion, +/- $100 million, pointing to YoY growth of 34.3%, accelerating nearly 13 points, though QoQ growth would be just 2.7% at midpoint. This softer QoQ read is due to typical March quarter seasonality from edge IoT markets, though management expects Data Center to more than offset that impact.  

Seagate also did not provide guidance for the full-year, but did state that its current outlook expects “sequential improvement to both the top and bottom line throughout calendar 2026,” meaning QoQ growth in each quarter through fiscal Q2 2027.  

Assuming low double-digit QoQ growth in FQ4 from the midpoint of Q3’s guide, FY26 revenue would roughly project to ~$11.64 billion, up 27.9% YoY, slightly above current estimates for $11.50 billion for 26.4% growth. 

Looking out to the first half of FY27, considering management’s commentary and similar QoQ growth rates as the past two years at ~7-8% QoQ, Seagate could exit calendar 2026 (FQ2 27) at ~$3.75 billion, or about 4% above current estimates for $3.61 billion. 

Key Segments – Data Center Growth Decelerates to 5% QoQ 

Seagate reports under two segments – Data Center and Edge IoT, with Data Center being the company’s primary revenue stream, accounting for 87% of its shipment volume in the quarter but only 79% of revenue. 

Data Center revenue increased 28% YoY and 5% QoQ to $2.22 billion in FQ2, decelerating from 34% YoY and 13% QoQ in Q1. Driving this was a deceleration in shipments – Data Center shipments were 165 exabytes in the quarter, up 4% QoQ and 31% YoY, slowing from 17% QoQ and 39% YoY in Q1.  

Seagate said it is seeing “sustained demand growth for our high capacity nearline drives across global cloud data centers as well as continued improvement from the enterprise edge,” expecting strong demand trends to continue for some time. In the enterprise OEM specifically, Seagate said it is “benefiting from slight improvement in traditional server units, along with increasing demand for storage servers, driven in large part by the adoption of AI applications and need to store data at the enterprise edge.” 

Outside of Data Center, Edge IoT revenue rose 2% YoY and 17% QoQ to $601 million, though it should be this sequential growth followed a soft FQ1 which saw an (11%) QoQ decline. Management said this was driven by anticipated seasonal improvement for consumer products.  

Looking ahead to FQ3, management expects Data Center to more than offset typical March quarter seasonality in edge IoT – assuming a similar (7%) QoQ decline in Edge IoT, this would project Data Center revenue to be up just over 5% QoQ, matching Q2’s pace.  

Gross and Operating Margin Reach Records 

Seagate is witnessing solid margin expansion, driven by pricing and operating leverage, with management pointing to high-capacity drives as a gross margin tailwind while opex continues to decline. Both gross and operating margin reached company records in Q2.  

Q2 GAAP gross margin was 41.6%, up 6.3 points YoY and 2.2 points QoQ, while adjusted gross margin was 42.2%, up 6.7 points YoY and 2.1 point QoQ. Management said this was driven by its pricing strategy and improving mix of high-capacity drives as HAMR shipments ramp. Seagate noted that the upcoming Mozaic4+ adds more content per unit, helping reduce costs and improve profitability. 

Q2 GAAP operating margin was 29.8%, up 8.8 points YoY and 3.4 points QoQ, while adjusted operating margin was 31.9%, up 8.8 points YoY and 2.9 points QoQ. Seagate continues to see a greater degree of operating leverage, as adjusted opex as a percent of revenue declined to 10.3%, from 12.4% in the year ago quarter and 11.1% in Q1. 

Q2 GAAP net margin was 21%, up 6.5 points YoY and just 0.1 points QoQ. Adjusted net margin was 24.8%, up 6.2 points YoY and 2.6 points QoQ. 

Looking ahead to FQ3, Seagate projected a notable uptick in both gross and operating margins. Adjusted operating margin was projected to be in the mid-30% range, up around 3 points QoQ assuming this would correspond to roughly 35%. Based on adjusted opex guidance to be ~10% of revenue, this would place adjusted gross margin at ~45% under this framework.  

Evercore’s Amit Daryanani questioned about the QoQ strength in margins, more specifically the gross margin – management would not offer much aside from pricing and mix, with a HAMR ramp at a recently qualified customer aiding this expansion: 

“Gianluca, I'm hoping you can talk a little bit about the March quarter guide because there seems to be a really sizable uptick in gross margins. I think it's up like 250 basis points or 100% plus incrementals. Could you just — is there anything you would call out in March quarter that's unique that's helping drive that kind of margin expansion? And is this really all coming from the core HDD business? Or is there a potential benefit from the old systems business helping you as well?” 

EVP and CFO Gianluca Romano 

“Amit, well, I would say, we expect to be a very good quarter. I don't think it's different than what we have done before. It's always based on the pricing strategy and the mix, as you know. We qualified another customer on HAMR, so we will ramp a little bit more volume on HAMR. This is helping us to get better margin. But fundamentally, is not really different in how we think we are going to execute the quarter and is good. I think the incremental margin looks very good.” 

Romano had also clarified that Seagate had previously presented a model with a 50% incremental margin above $2.6 billion of revenue, noting that this model covers the next two to three years, with the HAMR ramp helping drive further margin expansion.   

EPS 

Driven by the margin expansion, Seagate delivered strong sequential EPS growth, with adjusted EPS up 19% QoQ to $3.11, beating estimates by 9.6%. YoY growth for adjusted EPS was 53.2%, decelerating from 65.1% in Q1. GAAP EPS in Q2 was $2.60, up 67.7% YoY, decelerating from 72.3% in Q1.  

Looking ahead to Q3, Seagate guided for adjusted EPS to be $3.40, +/- $0.20, representing a more than 25 point acceleration to 78.9% YoY at midpoint. Growth is expected to decelerate back towards ~50% YoY in FQ4 to $3.87.    

For FY26, current adjusted EPS estimates sit at $13.02, up 60.8% YoY, while GAAP EPS is projected to be $11.71, up 73% YoY. 

Cash Flows and Balance Sheet 

Seagate noted that its free cash flow generation reached the highest level in the last eight years, while they also retired $500 million in debt to strengthen its balance sheet.  

Operating cash flow in Q2 was $723 million for a 25.6% margin, up 17.1 points YoY and 5.4 points QoQ.  

Free cash flow was $607 million for a 21.5% margin, up 15 points YoY and 5.3 points QoQ. Management guided for free cash flow to expand further in Q3, supported by strong demand trends and operational efficiency. 

Cash and equivalents totaled $1.05 billion with management noting that total liquidity was $2.3 billion including its undrawn revolving credit facility.  

Inventories remained flat QoQ at $1.5 billion.  

Debt was $4.5 billion exiting Q2, down from $5 billion at the end of Q1. Seagate said its net leverage ratio was 1.1x, improving 16% QoQ and 63% YoY, with the expectation that net leverage will continue to trend lower as profitability and cash flows increase.  

Valuation 

Seagate is trading close to peak multiples, a tougher pill to swallow considering the slow sequential growth the company is seeing in the Data Center. Seagate trades at 7.8x forward PS, well above its 5-year average of 3.0x, and just below its recent peak of 8.5x. Shares had traded as low as 1.5x in April. 

Looking at the bottom line, Seagate trades at 31.5x forward PE, below its 39.9x average, though it should be noted this is skewed higher due to margins falling negative in 2023. Over the past year, shares are trading nearly double its average of 17x. 

Conclusion 

Seagate’s data center growth is much slower than other memory peers at just 5% QoQ as the HDD space is witnessing soft pricing power relative to SSDs or DRAM. Data center growth is also unlikely to meaningfully inflect moving through CY26 as price and volume agreements have already been locked in. Seagate does see potential for some pricing upside in 2027 as contracts are open for discussions, yet for now, pricing tailwinds are muted compared to what is seen in enterprise SSDs and DRAM.

Damien Robbins, Equity Analyst at I/O Fund contributed to this analysis.

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