Earnings Call Transcript - SNDK Q1 2026

Operator, Operator

Good day, and welcome to the Sandisk First Quarter Fiscal 2026 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Ivan Donaldson, Vice President of Investor Relations. Please go ahead.

Ivan Donaldson, Vice President of Investor Relations

Before we begin, please note that today's discussion will contain forward-looking statements based on management's current assumptions and expectations, which are subject to various risks and uncertainties. These forward-looking statements include expectations for our technology and product portfolio, our business plans and performance, market trends and opportunities, and our future financial results. We assume no obligation to update these statements. Please refer to our annual report on Form 10-K and our other filings with the SEC for more information on the risks and uncertainties that could cause actual results to differ materially from expectations. We will also make reference to non-GAAP financial measures today. Reconciliations between the non-GAAP and comparable GAAP financial measures are included in written materials posted in the Investor Relations section of our website. With that, I'll turn the call over to David.

David V. Goeckeler, CEO

Thanks, Ivan. Good afternoon and thank you for joining Sandisk's First Quarter Fiscal year 2026 Earnings Call. Sandisk delivered a strong quarter with revenue of $2.3 billion, up sequentially 21% and non-GAAP earnings per share of $1.22. We generated $448 million in adjusted free cash flow and closed the quarter in a net cash position of $91 million. As discussed in February during our Analyst Day, we are focused on growing revenue, expanding margins and generating sustainable free cash flow to create shareholder value, and we are executing that plan. Our results reflect the strong execution by the Sandisk team in an environment marked by strengthening demand across our end markets. In the first quarter, demand for our NAND products continued to outpace our supply, a dynamic we expect to persist through the end of calendar year '26 and beyond. In response, we are making strategic allocation decisions to maximize long-term value creation. We are focused on advancing our technology road map and strengthening customer partnerships to deliver the right products to the right applications and customers. Customers are proactively seeking long-term commitments given the critical nature of our technology and to secure continued access to our products. These priorities are expected to deliver durable and attractive financial results while unlocking the strength of our broad product portfolio. With investments in data centers and AI infrastructure expected to surpass $1 trillion by 2030, the demand for NAND storage products capable of processing large volumes of data quickly and efficiently is increasing dramatically, creating a strong tailwind for our high-capacity power-efficient SSDs enabled by our BiCS8 technology. BiCS8, which delivers industry-leading capacity, I/O performance and energy efficiency, accounted for 15% of total bits shipped and is expected to reach the majority of bit production exiting fiscal year '26. Our BiCS8 products are expected to enable us to grow our data center business while further strengthening our positioning in the edge and consumer markets. Let's dive into the first quarter results by business. Our data center business gained momentum with revenue up 26% sequentially as global hyperscaler, neocloud and OEM customers are seeking to deepen their partnership with Sandisk. Our storage-focused SSD product line, codenamed Stargate, is growing in demand with 2 hyperscaler qualifications underway and a third hyperscaler along with a major storage OEM planned for calendar year '26. Across the data center portfolio, we are working with 5 major hyperscale customers through active sales and strategic engagements. In edge, we are seeing positive momentum from a PC refresh cycle, aided by Windows 11 adoption and Windows 10 end of life. PC unit shipments are expected to grow low single digits with mid-single-digit growth in capacity per device in calendar years '25 and '26. Beyond PC, premium smartphones are delivering modest unit growth, supported by new model launches featuring enhanced generative AI capabilities. Average smartphone capacity per device is expected to grow high single digits in calendar years '25 and '26. Looking ahead, we expect continued momentum in edge as device upgrades accelerate, driving increasing NAND content. Ongoing supply and demand dynamics are expected to extend the need to strategically place bits as mentioned above. As customers across data center and edge seek higher performance AI inference capabilities, demand for innovative solutions to address AI inference storage has increased interest in our high-bandwidth flash or HBF technology will deliver. Building on the technical advisory board and ecosystem partnership with SK hynix we announced last quarter, we are actively engaging potential customers for inference applications in both data center and edge. As we enter the holiday period, we are also well positioned to capture strong seasonal demand with our refreshed consumer portfolio and significant presence across key retail and online channels. We are engaging with the gaming and creator communities to sustain our momentum. Our recently launched Memory Man campaign is creating lots of interest and excitement, strengthening brand relevance ahead of the holiday season. Also in consumer, our partnerships with leading companies like Nintendo remain strong with solid adoption of our co-branded Switch 2 microSD Express Card, which eclipsed 900,000 units sold in fiscal Q1. We are also expanding our presence in the handheld gaming sector with the new Sandisk microSD for ROG Xbox Ally, reinforcing our position in gaming storage. Our consumer business remains a major focus for the company, driving revenue growth and attractive margin through the cycle. In summary, this is a new era for Sandisk. We have a strong balance sheet, an industry-leading product portfolio and a clear technology road map that drives organic strategic customer engagements. As we help power one of the most transformative technology megatrends of our time driven by accelerated AI proliferation, we are confident in our ability to create significant and sustainable value for our customers and shareholders. With that, I'll turn the call over to Luis to dive deeper into our financial performance and guidance.

Luis Visoso, CFO

Thank you, David. Let's dive deeper into the quarter results. Revenue for the first quarter was $2,308 million, up 21% quarter-over-quarter and up 23% year-over-year. This compares favorably to our guidance of $2.1 billion to $2.2 billion. Bits were up mid-teens sequentially with pricing up mid-single digits. Pricing strengthened during the quarter. Higher-than-expected bit growth enabled the revenue over delivery. Before reviewing the details by market, I will share that we will be aligning the names for our end markets to match the nomenclature commonly used in the industry. Going forward, we will use data center to refer to the business that's comprised primarily of our products for public and private cloud environments. We used to refer to this business as cloud. We'll use edge to refer to the business that serves our original equipment manufacturer and channel customers with a broad array of high-performance flash solutions across computer, mobile, gaming, automotive, virtual reality headsets and other edge devices. We used to refer to this business as clients. We will continue to use consumer to refer to the business that contains our broad range of retail and other end-user products, which capitalize on the strength of our product brand recognition and vast point of presence around the world. In the first quarter, we saw strong sequential demand across all end markets. Edge revenue came in at $1,387 million, up 26% sequentially. Consumer revenue came in at $652 million, up 11% quarter-over-quarter and data center came in at $269 million, up 26% sequentially. Non-GAAP gross margin for the first quarter was 29.9%, up 350 basis points quarter-over-quarter. This compares favorably to our guidance of 28.5% to 29.5%. The incremental revenue drove the higher-than-expected gross margins. In the first quarter, we incurred $61 million in start-up costs and $11 million in underutilization charges. Excluding this cost, non-GAAP gross margin would have been 33.1%. Non-GAAP operating expenses for the first quarter were $446 million, which is higher than our guidance of $415 million to $430 million. Operating expenses were above guidance, mostly driven by higher variable compensation from the revenue over delivery versus plan. As a result, non-GAAP operating margins at 10.6% were up 530 basis points quarter-over-quarter. Non-GAAP EPS for the first quarter were $1.22, up from $0.29 in the prior quarter. This compares favorably to our guidance of $0.70 to $0.90. The non-GAAP EPS beat reflects a higher-than-expected revenue and gross margins and a more favorable tax rate. Key GAAP to non-GAAP reconciliation items include $47 million in stock-based compensation, net of taxes, which represents 2% of revenue, $9 million in separation charges and $17 million in one-time costs related to the SSDs transaction and separation from Western Digital. Moving on to the balance sheet. We closed the quarter with $1,442 million in cash and cash equivalents and $1,351 million in gross debt. We achieved a net cash position approximately 6 months faster than the target shared during Investor Day in February, driven by strong cash focus in a robust market. During the quarter, we paid an additional $500 million of our TLB and reduced our inventory days from 135 to 115 as demand exceeded supply. Moving on to free cash flow. During the quarter, we generated $448 million in adjusted free cash flow, which represents 19.4% free cash flow margin. This included $488 million cash from operations and $10 million cash received from our activities related to Flash Ventures, partially offset by $50 million invested in our back-end operation and offices. The $10 million received from our operations related to Flash Ventures includes $337 million in gross CapEx with $107 million funded through depreciation as part of our cost of goods sold and $240 million funded from external sources, mainly subsidies and equipment leasing. Altogether, our gross capital expenditures totaled $387 million and represents 16.8% of revenue. Moving on to guidance. For the second quarter, we expect revenue between $2,550 million and $2,650 million due to double-digit price increases and mid-single-digit bit growth. Consistent with our expectations, we anticipate demand for our products to exceed supply throughout the end of the calendar 2026. Based on current supply and demand dynamics, we believe demand for our products will exceed supply beyond that period. Our products are currently on allocation across all end markets. Recall, the third quarter is a seasonally lower volume period for our consumer business following the holidays. Our forecast for non-GAAP gross margin for the second quarter is between 41% and 43% from higher pricing and cost tailwinds. This estimate includes an expected $30 million in start-up costs. For the second quarter, we expect non-GAAP operating expenses between $450 million and $475 million. The incremental operating expenses are to support our data center business expansion and our HBF innovation. We expect non-GAAP interest and other expense between $40 million and $45 million and non-GAAP tax expenses between $80 million and $90 million. We forecast non-GAAP EPS for the second quarter between $3 and $3.40, assuming 155 million fully diluted shares. The higher diluted share count in the second quarter is driven by the increase in the stock price following the treasury model. We expect to generate positive free cash flow in the second quarter despite capital investments to enable the BiCS8 transition, which is expected to be our most significant node by the end of the fiscal year. Our fiscal 2026 CapEx plans remain unchanged along with the long-term strategy to grow supply in line with the market, assuming bit demand compound annual growth rate in the mid- to high teens. Our capital allocation priorities are consistent with what we shared during Investor Day in February. Our first priority was to achieve a net cash position, which we have now accomplished through strong cash generation. Going forward, our capital allocation is unchanged, and we expect to continue to invest in the business and return cash to shareholders. We're executing the strategies and plans that we shared with you in February, and the results are coming in as anticipated with revenue growth, margin expansion, and more efficient use of assets. We remain focused on creating sustainable value for customers and shareholders with continued prudent management of the business. With that, let me turn the call back to David.

David V. Goeckeler, CEO

Thank you, Luis. In summary, Sandisk delivered a strong start to the fiscal year, underscoring the success of our strategy to drive profitable growth, expand margins, and generate sustainable free cash flow. Our solid execution amidst robust demand positions us well for continued momentum across the data center, edge, and consumer markets. Our ongoing qualifications and strategic engagements with key hyperscale customers underscore the growing adoption of our high-capacity power-efficient enterprise SSDs. As we move through the remainder of fiscal 2026, our focus remains on disciplined capital allocation, operational excellence, and delivering differentiated technology that meets evolving customer needs. We are well positioned with industry-leading technology and products, healthy long-term market fundamentals, a strong balance sheet, and an efficient operating model to create substantial value for our shareholders. Our technology is arriving at exactly the right time. When the market is ready, the demand is real, and the opportunity to drive meaningful earnings power is just starting. With that, we will open the call for questions.

Operator, Operator

Our first question comes from C.J. Muse with Cantor Fitzgerald.

Christopher Muse, Analyst

I guess, Dave, you spoke to customer engagement evolving now that we're on allocation. And you know very well how that's transpired in the HDD world moving from build to order, followed by long-term agreements. So curious, are you seeing similar trends emerge here in NAND? How does your visibility extend? And how are you allocating the bits that you can produce?

David V. Goeckeler, CEO

Yes, I'll let Luis discuss the allocation. It's great to hear from you, C.J., and thank you for joining the call. We are seeing two phases in how customers are engaging with us. The first phase involves securing multi-quarter deals, particularly through the first half of next year, where customers are seeking volume and price certainty. This marks a shift from the previous norm of quarterly agreements. As data center growth accelerates, customers are proactively reaching out to share their demand forecasts extending through 2027, and they want to discuss how we can align our supply to meet that demand, especially with our emerging product lines undergoing qualification across various players. This is an evolving situation, particularly in that second phase, and we will continue these discussions in the coming months and keep you informed on our progress. This development is certainly positive for the market. As you know, we make long-term capital expenditure decisions, and short-term demand doesn't significantly impact those decisions. We are focused on understanding demand over the coming years. Engaging with what are becoming our largest customers is a very encouraging development. Luis, would you like to address allocation?

Luis Visoso, CFO

Yes. C.J., we're working very closely with our customers. We talk to them all the time. And what we're doing is we're prioritizing our most strategic customers, those customers that have been very close to us, those customers where we see growth, those customers where we can create value for them and value for us, right? And that's how we're evolving our portfolio. We're going from a mobile-centric company to really serve our customers, and we're seeing very strong growth in our data center business. So we're very excited about the opportunity that this presents to us, but working very closely with our customers, particularly those more strategic to us.

Christopher Muse, Analyst

As a quick follow-up, how are you thinking about your bit shipment growth opportunities here in calendar '25, '26? Your days inventory down to only 107 days and BiCS8 is just kind of ramping. How are you thinking about what kind of bits you can ship this year and next?

Luis Visoso, CFO

Yes, our aim is to maintain our market share. We're not looking to disrupt the market, but we are very optimistic about the direction things are going. Our client portfolio is performing well, and we're seeing strong results in our consumer business. We're confident in our potential to grow our presence in the data center sector, where we currently have less representation, a topic we've addressed in earlier discussions. The key to this growth is through innovation. With BiCS8 coming in and our products gaining qualifications, we feel positive about our market share in bits overall.

David V. Goeckeler, CEO

So, as Luis mentioned, we are focused on growing alongside the market and have the capital plans to support that growth. We are investing with the expectation of mid- to high-teens demand levels in the long term. As demand surpasses that, we will address the allocation phases we previously discussed. I'm optimistic that our customers are beginning to consider their future demand, which is beneficial for our strategy. We are certainly growing with the market, and our capital plans remain unchanged.

Operator, Operator

Our next question comes from Jim Schneider with Goldman Sachs.

James Schneider, Analyst

Just structurally, obviously, we're in a supply-constrained scenario, and I think a lot of customers are clearly asking for supply as you kind of talked about. So maybe you just kind of give us your view on over the next couple of years, the supply situation you expect to deliver, whether that's just through upgrades at this point? And what would make you decide to add wafer capacity over the next coming years?

David V. Goeckeler, CEO

Yes. First, regarding the overall environment, we have been discussing for at least a year that we anticipate an undersupplied market until the end of 2026. This perspective is based on long-term demand trends and the capital invested in this business over recent years, considering the changes in all market players. As mentioned earlier, we are now seeing this situation extending beyond 2026, especially since customers are approaching us about supply for 2027. We have prepared for this market. Although it's challenging to predict on a quarterly basis, we have recognized this setup for quite a while. Concerning our capacity decisions, we are currently not considering additional capital for this business. As Luis pointed out, we are investing significantly to transition to BiCS8. We have a strong technology roadmap that allows us to enhance productivity and bit supply without increasing wafer production. At this stage, we’re not discussing capacity expansion; we need to see sustained demand over a long period to consider that. We have focused on the mid to high teens demand level, which we are currently exceeding, but that figure is part of our long-term investment strategy.

James Schneider, Analyst

Regarding your position in enterprise SSDs, you previously shared some targets at the time of separation about your goals in that market. Could you provide an update on the qualifications? As we look toward the end of 2026 or 2027, what market share percentage do you hope to achieve, and how significant will that be for your overall business?

David V. Goeckeler, CEO

We are very pleased with the current state of the business, particularly with our product portfolio. We previously discussed our Stargate program, which focuses on storage-based enterprise SSDs, and those products are now being tested by customers. The 128T drives are part of this, and we expect to expand from there. Customers are already discussing supply needs with us for several years ahead, indicating confidence in our products. We believe in our offerings as well. Our compute-focused enterprise SSD continues to perform strongly, and we are seeing a growing number of customers adopting it. Everything is aligning to improve our product portfolio and shipping volumes. We anticipate increasing sales in this segment throughout fiscal year '26 and believe we will finish the fiscal year with a strong exit rate. However, discussing market share right now is challenging due to the rapidly changing market dynamics. Just a few months ago, we projected a mid-20% growth in data center exabytes for '26, but we have since revised that upward to mid-40%. The market is evolving quickly, and our objective is to secure our fair share. We believe our product portfolio is well-positioned, and the BiCS8 node will significantly enhance our performance and density. You will see this narrative reflected in our figures as we progress through calendar year '26.

Operator, Operator

Our next question comes from Aaron Rakers with Wells Fargo.

Aaron Rakers, Analyst

Building on the last question, David, there's been a lot of discussion about hard disk drives facing supply constraints and a growing interest in enterprise SSDs related to AI. How do you view the enterprise SSD market opportunity compared to hard disk drives? Has your perspective changed at all? Have the recent shortages in hard drives affected your approach to these opportunities?

David V. Goeckeler, CEO

Yes, my main perspective on this, Aaron, as we have discussed extensively over the years, is that these technologies in the cloud are largely complementary. We are seeing a general improvement benefiting all areas. With AI, there is an increasing amount of warmer data moving to enterprise SSDs. I've always believed that both technologies will grow, with enterprise SSDs experiencing faster growth. While there may be dynamics of substitution based on market shortages or tightness, I believe the long-term prospects for enterprise SSDs in the data center are very strong. We are consistently seeing more data being stored, the value of data is increasing as it is used for training models, and the sophistication of video creation models is leading to even faster data generation. Therefore, we have a positive long-term outlook on the data center market. The NAND market is currently undergoing a significant transition. In calendar year '26, the data center market will become the largest segment in NAND, moving ahead of the mobile market. This represents a major change. The growth rate is increasing, and the customer base is becoming more diverse, which alters customer interactions, purchasing decisions, and pricing visibility. All these factors are evolving as the data center market becomes the dominant force in NAND. Additionally, the demand numbers we are discussing, such as the 27 exabyte figures, are substantial. Overall, this indicates a robust market and increased visibility for enterprise SSDs. While the situation with HDDs may play a role, I do not believe it is the main driver influencing the developments we will see in the coming years.

Aaron Rakers, Analyst

Yes, that's very helpful. And then Luis, if I can, real quick. I mean, in your prepared comments, you alluded to seasonality or just be aware of seasonality into the March quarter. Can you kind of unpack that? What should we be thinking about? Are we down sequentially in the March quarter? It seems like pricing could continue to trend higher. And how do we think about kind of feathering out the start-up costs as we move forward?

Luis Visoso, CFO

Yes. So let me start with the last part of your question. Start-up costs, consistent with what we said in the last call, we went from $60 million last quarter to call it, $30 million this quarter to pretty much 0 going forward. So that's easy to put into your forecast. Now I don't want to guide into Q3, but I did want you to be careful as you build your models in Q3. If you look at historically, right? Our bits are down in Q3 somewhere around 12% to 14% sequentially. Now the dynamics in the market may be a little bit different because data center is stronger, and therefore, the mix of our portfolio is slightly different. But I want you to be careful and just assume that there is some seasonality, which is particularly important for us given that we have a stronger consumer business.

Operator, Operator

Our next question comes from Joe Moore with Morgan Stanley.

Joseph Moore, Analyst

I wonder if you could characterize some of this data center demand that you're seeing. Is there demand for QLC on the enterprise side? How much of it is QLC? And can you talk a little bit about how BiCS8 enables you to kind of increase your presence in that market?

David V. Goeckeler, CEO

Yes, Joe, while I don't have a specific breakdown for you between QLC and TLC, there are two main use cases to highlight. One is the compute enterprise SSD, which utilizes a faster TLC interface, and we are seeing strong demand for this from our customer base, with many clients looking for increased capabilities. The second is the storage class product, with the 128T currently undergoing qualification as a QLC product. BiCS8 QLC is highly energy-efficient and offers high performance, putting us in a great position. For FY '26, I have some projections indicating that QLC could grow from 20% to 40% of the market by the end of that fiscal year. We are definitely observing significant growth in this storage category as the product gains traction in the market.

Joseph Moore, Analyst

Great. And then as you describe the market, I would have to think that the fabs are all running full in NAND at this point, but you didn't mention underutilization expense. Do you think there's any incremental supply coming from the fact that people had underutilized the fabs earlier in the year? And just how does that affect your view of '26?

Luis Visoso, CFO

Yes. We've moved to 100% utilization, Joe. So fabs are running at full capacity, and we keep on pushing them to produce as much as we can because as you've seen, inventories are down very meaningfully. So yes, we're running full capacity, Joe.

David V. Goeckeler, CEO

So Joe, to give you a clearer picture, we expect supply growth in calendar year '25 to be around 8%, rising to approximately 17% in '26. We anticipate constrained demand to be around 14% because that's the current limit from the supply side. However, unconstrained demand, which we recently thought was at 20%, is now likely in the mid-20s. Therefore, we believe that supply will be adequate to meet the mid-teens demand for '26.

Operator, Operator

Our next question comes from Mark Newman with Bernstein.

Mark Newman, Analyst

Congrats on a great quarter. So just digging a bit deeper into the supply-demand dynamic. It seems like things are going great. I wondered if you could give us a little bit more clarity on the portion of your contracts that are shorter-term versus longer-term? Because obviously, longer-term contracts, as was discussed a little bit earlier, has a lot of positives in terms of giving you more confidence in the demand for longer term. But on the other hand, when you're talking about pricing, some of the pricing data out there is inflecting up significantly right now, but longer-term contracts may not actually inflect obviously, because they're longer-term contracts. So I just wondered if you could break out for us what portion would be shorter term, say, a quarter or less or what portion would be 6 quarters would be useful? And I have a follow-up on HBF as well.

Luis Visoso, CFO

Thank you for the question. Currently, we have very few volume price commitments that extend beyond a single quarter. What we mentioned in our prepared remarks is that some of our major strategic customers are seeking assurance on supply. They've expressed interest in starting discussions about potential volume price commitments for the year, and possibly even longer. We are in the process of exploring those opportunities. As it stands now, we have minimal commitments for volume and pricing that go beyond a quarter.

Mark Newman, Analyst

And then if you could give any more clarity on the road map for HBF, high-bandwidth flash. You discussed earlier in the prepared remarks about starting to work with some customers. Any updates on potential time line there?

David V. Goeckeler, CEO

We announced a timeline last quarter for having the memory available in 2026 and the controller in 2027, and we are still working towards that timeline. We are engaging in numerous customer discussions to explore use cases in both edge and cloud environments, focusing on how our product can be integrated into the architectures customers are developing. We remain very optimistic about the technology's direction and the potential use cases. We continue to advance the technology while having productive conversations with several customers regarding deployment and precisely defining requirements. This is an ongoing process.

Operator, Operator

Our next question comes from Karl Ackerman with BNP Paribas.

Karl Ackerman, Analyst

I have 2 as well, please. As you seek to qualify more hyperscalers on your enterprise SSD portfolio, would you anticipate simply transitioning client and edge wafer capacity to enterprise? Or would that come primarily from new capacity coming online on your K2 fab?

David V. Goeckeler, CEO

No. We are consistently growing because we are expanding with the market, and we do not intend to increase capacity for any specific market. It will mainly depend on the mix, either on a quarterly basis or, if we reach a stage with longer-term commitments, we will have greater clarity on what that mix will be. However, our primary objective is to maintain as much flexibility as possible and then optimize for the best financial return in any given quarter with the supply we have available.

Karl Ackerman, Analyst

Got it. For my follow-up, I guess, how should we think about cost declines going into the December quarter? And if we zoom out, is it fair to assume cost declines can approach, I suppose, high teens as you transition aggressively toward BiCS8?

David V. Goeckeler, CEO

We stopped discussing cost declines some time ago, but I can provide some insights on this. We are moving past a period of significant cost headwinds in our business, which we have openly acknowledged in recent quarters. Now, as we transition to the BiCS8 ramp, we are eliminating underutilization and fab start-up costs. In the December quarter, these cost headwinds will shift to cost tailwinds, which is a positive development. As we ramp up BiCS8, we will continue to see cost reductions, although costs can vary significantly from quarter to quarter. We prefer not to provide an overall estimate, but the figures being suggested appear to be quite aggressive and perhaps too ambitious.

Luis Visoso, CFO

Yes, Karl, our focus is obviously on driving our gross margin, and we feel good about the progress we're making here, right? We added whatever, 350 basis points quarter-over-quarter, 720 basis points in 2 quarters. Still, you would say we're 4 quarters below our model. So we need to get several quarters ahead of that number. But we're very focused on gross margin and driving that up.

Operator, Operator

Our next question comes from Mehdi Hosseini from SIG.

Mehdi Hosseini, Analyst

Two follow-ups. What's the update on the UltraQLC 256TB? I think last earnings call; you said that you have a Tier 1 data center customer that should be ramping in the first half of calendar year. And what's the update there? And I have a follow-up.

David V. Goeckeler, CEO

No, that was the 128 that we're going to be ramping in calendar year '26, and the 256 is expected to start hitting the market in the middle to late next year, with ramp-up likely the following year. I want to be cautious about discussing product timing that hasn't been officially announced. However, the qualification currently taking place across Stargate is for the 128T drives.

Mehdi Hosseini, Analyst

Okay. So you have one customer for 128 that should be ramped in the first half of calendar.

David V. Goeckeler, CEO

We currently have several customers undergoing qualification. We also have customers set to begin qualification next year, and you will notice an increase as the qualification process can be lengthy, often taking several quarters. Therefore, you can expect the ramp-up of that product to start in the middle of next year. Throughout our entire enterprise SSD portfolio, we are collaborating with five hyperscalers on various technologies we are developing. We are optimistic about the increasing adoption we are seeing on a quarterly basis.

Mehdi Hosseini, Analyst

And as a follow-up, assuming that there won't be much of a wafer capacity add at the JV, should we assume that as this 5 as the 128 terabyte ramps middle of next year, you would allocate more bits towards the customers, and therefore, there will be a more accelerated mix shift towards the cloud mix?

David V. Goeckeler, CEO

Yes, we don't want to get too ahead of ourselves when it comes to forecasting quarters. However, I mentioned that you will see sequential growth in our data center portfolio throughout fiscal year '26. Therefore, you can expect to see an exabyte shift in that direction as well.

Luis Visoso, CFO

And remember, even if we don't produce more wafers, those BiCS8 wafers contain a lot more bits, right? So that productivity allows you to produce more bits and therefore, to supply more of our customers.

Operator, Operator

Our next question comes from Wamsi Mohan from Bank of America.

Ruplu Bhattacharya, Analyst

It's Ruplu filling in for Wamsi today. I have 2, one for Dave on bit growth. Dave, you had strong mid-teens bit growth in the first quarter. Can you talk about how you're thinking about bit growth across the different markets, data center, client, consumer in the second half? And you talked about some products in allocation. Should we assume that's across the product line? And I'm assuming all of these orders are noncancelable. So any comments on the expected growth by end market in the second half and which products are in allocation? And I have a follow-up for Luis on margins.

David V. Goeckeler, CEO

Do you want to take that one? You want me to...

Luis Visoso, CFO

I can. Yes. So we feel good about our growth across segments. Obviously, data center is the segment, the end market that's growing the fastest. And therefore, we expect to grow there faster in the back half, as David alluded to at the beginning. But we do expect to continue to make progress on both the consumer and the edge market. So I would say our growth will be a little bit heavier on or higher on the data center end market.

Ruplu Bhattacharya, Analyst

Okay. That's helpful. Luis, if I could follow up on margins, you mentioned that in the first quarter, excluding the start-up costs and underutilization, the gross margin would have been 33.1%. You're estimating about 900 basis points of growth sequentially at the midpoint, which is quite strong. Can you discuss the factors contributing to this? Should we anticipate another round of price increases? How much is mix influencing this? Additionally, I remember you stating that there are no more underutilization costs and that cost reductions aren't being discussed. Are these the only two factors, or is there foreign exchange or something else also affecting margins, which you have a strong outlook for?

Luis Visoso, CFO

Yes. If you are comparing the 33% versus the 41%, 43%, you are comparing that already excluding start-up costs underutilization. So you're looking at it the right way. I would say the majority of that is the pricing that we're implementing. In my prepared remarks, I mentioned that during the quarter, we saw an improvement in pricing during the quarter. So the margins at the end of the quarter were better than the margins at the beginning of the quarter, and we expect that to continue. So pricing is a key driver of that. And obviously, as we shift more into BiCS8, we'll see lower cost per gigabyte. Again, that's not an area we want to spend a ton of time talking about, but we do see a little bit of a benefit there. So combine the 2, we feel good about our gross margin expansion, which should continue.

Operator, Operator

Our next question comes from Asiya Merchant from Citigroup.

Asiya Merchant, Analyst

Can I just clarify on the guide at the midpoint, I think it's 2.6%, and I think that's up like low double digits. I thought pricing in itself was up low double digits. So if you could just clarify that for us and you're still looking for bit growth unless I'm missing something here in my calculation. Then I have a follow-up.

Luis Visoso, CFO

Yes, it depends on whether you're looking at the midpoint, the high point, the low point. But yes, we expect pricing to be double digit, and we expect some low single-digit bit growth, as we mentioned in our guide. Inventory levels are low, as you've seen. That's kind of the construct, right? So depending on which range you're looking at, that would be the combination of bits versus pricing. So I think the key message is most of the growth in revenue will be pricing driven in the quarter.

Asiya Merchant, Analyst

Okay. For my follow-up, I have several questions regarding the data center. I wanted to clarify if I heard David correctly about the edge, client PCs, and mobile phones, specifically regarding our confidence as we look ahead to calendar '26 for growth in these areas. It seems that some expectations for unit growth might be higher than what some industry forecasts suggest. Could you elaborate on what is fueling this confidence in edge devices, especially PCs and mobile phones?

David V. Goeckeler, CEO

Yes. We have seen a slight increase in phone units, but the content per unit has grown significantly, which is a strong figure across 1.2 billion units. PCs are essentially flat or slightly increasing, with average capacity rising in the mid-single digits. This indicates good exabyte growth across these markets. Additionally, we've discussed substantial exabyte growth in the data center. The NAND market is highly diversified, with three major pillars, and we are experiencing growth in all areas, especially strong growth in the data center. By 2026, the data center is expected to become the largest market in NAND based on exabytes, leading to fundamental changes in how the market operates, which will be evident over the next several quarters.

Operator, Operator

Our next question comes from Steven Fox with Fox Advisors.

Steven Fox, Analyst

I just had one question for Dave. I guess I'm trying to figure out like how some of these long-term agreements might play out. I mean it seems like we're at a historic impasse with NAND and the demand coming from the cloud guys. So I don't know if you want to give any of this away, David, but like is there any kind of values that we should think about in these negotiations, whether it's sharing of cyclical risk, sharing of cash, CapEx, things like that? Anything you could sort of talk about? And then how does that trickle down to like customers that aren't lucky enough to be able to have longer-term supply agreements?

David V. Goeckeler, CEO

So Steven, it's a bit early to go into that level of detail. The key point is that customers are reaching out to us. As I've mentioned previously, with data centers emerging as the largest market, all the markets and customers are crucially important. However, these major players are now proactively contacting us about supply across our portfolio, extending into 2027. This marks a different dynamic. We’re having discussions with them to better understand what these relationships may look like, which is very positive. As I noted earlier, we need to make long-term decisions regarding our spending, and we have significant R&D capacity that is focused on future nodes to stimulate growth in this technology. We are making substantial long-term investments, and it’s encouraging to see our customers, especially the largest ones, actively engaging with us regarding multi-year supply dynamics. The specifics of how this will unfold is something to watch for, as we are still in the early phases of these discussions.

Operator, Operator

Our next question comes from Krish Sankar with TD Cowen.

Sreekrishnan Sankarnarayanan, Analyst

I had 2 of them. First one, Dave or Luis, your data center revenues grew very nicely. I'm just wondering, is there a way to figure out how much of that is related to AI data center and neocloud versus traditional cloud? Is there a way to put a percentage around it? Or is it all majority AI? And then I had a follow-up.

David V. Goeckeler, CEO

Yes. I would say it's majority AI-driven growth.

Sreekrishnan Sankarnarayanan, Analyst

Got it. And then I think, David, you kind of talked about a 40% growth next year for data center exabytes and then even better growth in '27. I'm just curious, is that the right way to think about it, data centers is a 300-plus exabyte market this year going to mid-400 to 600 plus in '27?

David V. Goeckeler, CEO

Yes. We estimate it will be in the high 300s for 2026, which indicates robust growth compared to 2025. In 2024, we experienced 130% year-over-year growth in that market, starting from around 230. In 2025, we followed that with high teens growth, and we expect to see mid-40s growth in 2026. So yes, there is strong growth in that market. Additionally, we're observing that customers are starting to shift the dynamics of how we view the supply-demand landscape. More updates will follow.

Operator, Operator

Our next question comes from Nam Kim with Arete Research.

Nam Hyung Kim, Analyst

I also have 2 questions on HBF. I know it's still early, but how do you see the long-term growth potential? And can you provide any qualitative color or early market sizing? And then second, how are you approaching this given competitors' greater TSV stacking experience from HBM? What competitive advantage do you think Sandisk can bring to HBF?

David V. Goeckeler, CEO

I will defer on both of those questions for now. We will provide more insights into the market potential and the total addressable market figures later. To emphasize, this is an inference-based solution, and we are not targeting the model training segment or aiming to replace high-bandwidth memory in that space. However, we see a significant opportunity in the inference market, particularly within the device sector, due to the density we can achieve with flash. Regarding our competitive advantage, I will hold off on discussing that at this time. We have invested a lot of effort into the actual NAND design. As I mentioned a couple of quarters ago, NAND designers typically focus on expanding density, which has always been a primary goal. When we shift the conversation to increasing bandwidth or improving technology durability, we discover new avenues for innovation. We've been considering these aspects for several years and have developed some design innovations that make HBF a very appealing technology, but we are not yet ready to publicly disclose those details.

Operator, Operator

Our next question comes from Mark Miller with The Benchmark Co.

Mark Miller, Analyst

Congrats on a great quarter and great outlook. Just with the strong sequential growth you've seen in data center, do you think you're picking up share there?

David V. Goeckeler, CEO

Yes. We think we're growing faster than the market is growing, right? And we think we're going to see that throughout the fiscal year.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to David for any closing remarks.

David V. Goeckeler, CEO

Okay. I just want to thank everybody for joining the call, all the great questions. We look forward to talking to you throughout the quarter. Thanks again.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.