Seagate Technology Holdings plc (STX) Earnings Call Transcript & Summary

Hello, everyone, and thank you so much for joining us here on the Citi Global Technology Conference, where this year, we're going virtual, of course, given coronavirus. My name is Jim Suva. This fireside chat is with Seagate technologies. And importantly, we have the Chief Executive Officer, Dave Mosley, joining us; as well as Shanye Hudson, Senior Vice President and Investor Relations. I do want to remind people that there are disclosures associated with this, and they can be found on the Citigroup website as well as Dave will have a few comments about the disclosures. And anybody subject to MiFID II needs to be reminded, they need to have that research agreement in place. Anybody with press or measure -- press or media, need to make sure they are not connected, and we will disconnect you automatically. Press and media are not invited to this. This is for investors only. So I want to first welcome Dave Mosley, and he's the Chief Executive Officer of Seagate. And Dave, I think you had a couple of opening comments that you wanted to make. Dave?

Yes. Thanks, Jim, and thanks to all of those of you joining us today. Before starting, just a quick reminder, like Jim said, that I'll be making forward-looking statements, and you can learn more about those and the risk factors associated with them in our SEC filings, which are on our website, www.seagate.com. Let me just start and give a little context around the quick update on the current business environment. We're about 2/3 of the way through the September quarter, and the end market demands are trending well to our expectations. Coming off record levels in the June quarter, the cloud data center has continued to be strong. And we're obviously biased there because we have a lot of 16-terabyte demand. But the customer demand is actually very broad-based, spanning all geos. So we can talk about that if you have questions about it. Demand for video and image applications, including surveillance, has actually continued to pick up through this quarter. And while the enterprise markets, the on-prem enterprise markets that I talked about in July actually remain soft. Although we do see indications for demand to improve as we progress throughout the year. So the net-net is that the September quarter is tracking pretty well with our expectations. And most importantly, the demand trends are improving in a couple of the key end markets, which supports our outlook for a flattish FY '21 versus FY '20 in revenue. Over the long term, which is really what we're focused on making our investments around, we remain confident in the growth of the data center and all the mass capacity that drives secular demand for mass capacity storage due to just data growth. And Seagate's obviously been a leader in mass capacity storage for quite some time. We continue to execute our technology transitions, our road map, product road map and our capital investments in order to meet the demands of the world, which are growing from a data perspective, leaps and bounds. We're also leveraging all this knowledge and our expertise and interfaces and interface technologies in the data center to actually service a broader world that's what we call the growing edge. The architectures, interfaces are changing a lot due to all the data movement that's going on in the world right now, what we call data sprawl. To that end, we plan to discuss some of this in our data -- Seagate Datasphere event that's coming up pretty soon. On the 24th of September, we're going to host it all virtually. So I encourage you to participate if you can. There's information on our website or you can contact IR and find out more about that. Really, what we're talking about is how all the cloud data movement that's happened during the transitions that we've seen in the last 6 months, which have been wild, are going to actually mean that the on-prem side needs to grow as well to meet latency and cost and security requirements. So the cloud is going to grow very strongly, but we really believe in the edge as well. We think that's -- all these trends have been accelerated because of recent events, not decelerated. So we're pretty excited about it. We're going to talk more in our conference about that. With that, I'll -- Jim, I'll open it up for questions.

Well, I think you kind of took my first questions about how is near term, and it sounds like it's shaping up within expectations, which is great to hear. You did make a little comment that I picked up on. You said some demand end markets are improving. Just kind of curious, which ones are those? I mean my kids have started school, they are doing a lot of cloud computing, cloud education, but yet the construction workers in my neighborhood really aren't doing much construction yet? And you talk about edge. So which end demand markets are you seeing are improving, Dave?

Right. So as I tick down through it, Jim, we talked about the on-prem enterprise being really strained. Private cloud, anything going on on-premises where people couldn't even get on-premises in July was being strained. And we see that through our distribution channel and some of our client server markets as well. Surveillance, though, it's a mass capacity application, and it has a lot to do with on-prem. It was strained as well. The good news for us is mass capacity surveillance is starting to come back. And so that -- I made comment to that earlier. And I think that's a function of not only people getting back on-premises, but also looking for applications that help solve problems, smart city's problems, smart factory problems, smart hospital problems, all these things. So we do see that strengthening. The distribution channel itself is actually strengthening quite a bit in the quarter. And this is something that, frankly, the bow whipping that was going on in supply chains between April, May, June, July, with factories being turned off and people having to pull inventory in because they were worried about getting any and then seeing the true-end demand was quite a ride. I think some of it's starting to stabilize there. The on-prem enterprise mission-critical and small medium business that we made reference to is recovering, but it's very slow and exactly to your point. And we're there for those customers, we need to pay attention to them. Some of them will come back. Others maybe change their business model. We believe the end demand around mass capacity storage is still going to be there, but the routes to market may actually change a little bit. We've just got to ride that through with everyone.

And Dave, with coronavirus and the pandemic, has it impacted your operational ways of doing things? A lot of companies are trying to be more nimble, trying to adjust your business practices, companies are trying to be more efficient. But if you're doing temperature checks, you're doing a lot of more social distancing, is it an impact to margins long term, near term? Are you through the worst of it? Some countries saying, Seagate can't do normal business, others saying you can open up I'm in the Bay Area. Things are -- traffic is picking up. It seems like it's almost normal. If you look at traffic now, but yet a lot of the parts of society, restaurants and hospitality really aren't even close yet to coming back. How should we think about the ways of the pandemic, the operational challenges, what you've done and looking ahead, we should think about things?

Right. It started early on in China, for example, some of our China factories, we learned a lot in the very early stages of the pandemic, about what are all the things we need to do, keep people safe, which I think we've done a great job of the -- it's a severe challenge, and you have to make sure you put safety first for all your people, obviously. To that end, we do still have permanent shifts, if you will, that caused some cost impact inside the supply chain, inside of our own factory, social distancing, bussing, things like that have changed permanently. I think as time goes on, we learn how to adapt to some of those things. And I would say that generally speaking, the cost impact will be less and less over time as we learn to adapt. But we still have to be mindful of safety first all the way throughout our supply chain. There's aspects of Seagate, where we can do things remotely. There's other aspects where we obviously can't and upstream in our supply chain as well, there's a lot of parts coming at us. So we have to make sure we're just mindful of that, sending the same messages to everyone.

And Dave, how should we think about Seagate's positioning in the current state of the competitive market? HDD versus flash, big debates of who's going to win out? Or reality, does one not need to win out versus the other? Can they coexist for a decade or longer ahead, how should we think about your competitive position relative to competitors?

Yes. If I think back ancient history now, there were some devices where hard drives were there that they got displaced by other technologies. I think when we start talking about legacy markets, some of them have longer tails. But we forecast that for a while that some of those markets are going to go down in volume quite a bit, in exabyte shares quite a bit. And they really have. I mean notebook is a shadow that's worn yourself from a hard drive perspective. Desktop, same thing, the low capacity. There still are high capacity applications in desktop, for example, in the distribution channel and even in PCs, where we still see healthy growth. And we think that, that tail should assume to somewhat. Right now, legacy markets are a small fraction, a smaller fraction than mass capacity are. And that's why we pivoted quite some time ago towards our investment there. There are other legacy markets here, exactly to your point, where because of the installed base of, say, SaaS slots out in the world, mission-critical isn't going to go away right away. It's been generally declining because nobody is really investing in it, but it's still a great cost performance solution for some aspects of that market. Consumer is another example, to your point about people working from home. The consumer business or the gaming business inside of the consumer have actually been quite healthy. But those are still legacy markets where we're not really investing a lot. So...

And how should we think about industry growth rates? I think many people are kind of pinpointing around ballpark 40% CAGR. Is that right? Is the pandemic influencing this at all? And when I hear 40%, I tend to think about: wow, is there enough supply to meet demand?

Well, so that's where we have come from. If you think about the CAGR for mass capacity, most of that's been satisfied by oversupply, if you will, of heads and media, that we had during the client server explosion. And remember, the peak of client server was 2012. So this is -- it's not ancient history, at least not to me. But we've had to pivot factories quite quickly off of making so many notebook drives on the world into so many mass capacity drives on the world. I think we're -- to your point, I think we're largely through that. 40% sounds like a great CAGR. We've already achieved a point where more than half of our revenue is mass capacity. And from an exabyte perspective, it's even stronger than that. So we think at some point, then legacy becomes de minimis, and it's all mass capacity at that 40% CAGR, in which case, you get some kind of stabilization. I think that's your question.

Right. Now here's the head scratcher to me. High data growth, yet the industry and Seagates and all the players have struggled to have consistent revenue growth and margins. We've seen a lot of volatility to margins. And a lot of data growth whether I store it locally, in the cloud, hybrid, public cloud, private cloud, all these things. Simply -- and there's been consolidation in the industry. Why theoretically has revenue growth and margins not been stronger and more predictable?

Yes. I think over the last couple of years, our revenue has been relatively flat, I'd say. And so when do we see that high CAGR that you referred to, the 40% CAGR really kicking in. I think COVID is actually accelerating that CAGR. That's my opinion. I think the cloud is -- people are getting to become more dependent upon the cloud and less dependent on legacy. But all of this is an interchange right now between some of the legacy businesses hanging around, we're hanging around and hyper competitively, too. I mean there was a lot of competition for those less legacy slots. Eventually, data growth just overwhelms. And I think we're at that inflection point. The question is, does it happen 2 months ago or 2 years ago, I don't get really into that. It's more -- we're making the investments over the long haul for those mass capacity applications, and I think we've made the right investments.

Got you. Let's talk about the recent June quarter results. I think you saw pretty good demand in mass capacity if my memory is correct. But I believe the surveillance saw some softness. And of course, small, mid-sized businesses saw a bit of a pause too. Can you talk us through a little bit about those end markets? And would you expect some type of recovery or resumption from some of these, especially the surveillance. I mean small and mid-size, you drive around, you can see which restaurants and small companies are being affected. But what about the surveillance side of -- do you think that will come back? And if so, what necessitates a return to those areas?

Yes. I do think on the mass capacity side, that surveillance market is already coming back. We -- I'd count that as some of the smart city applications that you're starting to see. Some are reflective of COVID, and some of it's just the normal mass capacity migrations we were seeing in the market anyway. If I think about facilities for large enterprises, they're becoming more and more data intensive. They need that data stored locally to process it to make good decisions off of it. A lot of that data is video data, video and image data, but there's other kinds of sensors as well. And we think there's a lot of opportunities, not just smart cities, but factories and hospitals and all the other things that will become smarter over time with new applications. That's what we're seeing right now is the demand for some new applications. I don't think there is going to be a lot of new camera installs first up, but I do think that using that video data to garner some more information out of the existing video streams will happen. And so that's usually where the hard drives lie, where the mass capacity storages lie there. On the cloud side, I would say that COVID disrupted everything. It certainly did on the cloud side as well. It's driven a lot of demand that's -- you can see it in the cloud. Vendors talk about this a lot, but not all that demand comes straight away in the very first day. Sometimes they have to make sure that they meet service level agreements and everything else with their customers. So they have to call some really hard priorities. And juggling the growth that's happening in the cloud is a tough, tough problem. We are convinced that these transitions we're talking of, because of the new economy, if you will, the new data economy, will actually accelerate the cloud. But it's going to be a little bit choppy at the start, I think, and we like the fact that we have such a great portfolio. Our 16-terabyte is up the ramp, our 18-terabyte's ready to go, we can meet this demand whenever it comes.

And Dave, you actually dovetailed exactly into my next question. Can you talk a little bit about the technology and the road map a little bit, what you can about -- I believe 16-terabyte is doing well. I think 18-terabytes is kind of getting ready to ramp. Is my memory correct in that? And how should we think about -- we hear a lot about HAMR and MAMR and customers, do they have readiness for that to adopt it? Or how should we think about the road maps of your technology outlook?

Yes. Our 16-terabyte platform, we made a conscious decision about 5 or 6 quarters ago. It's just a let's cut from the old and go on to this new platform because we have a lot of confidence in it. It's leverageable. That's why we don't have to change platforms every 2 or 4 terabytes, we can actually leverage this thing way out. So the 16's quite far up the ramp now. We're really happy with the performance. And importantly, in order to turn to 18, we've changed the heads, changed the media and changed a little bit more. It's not a big change. And so we have a lot of confidence in our ability to pivot whenever the customers want to go there. The componentry, if you will, is way down the cost curves. We don't have to pay to amortize toolings. We're really confident in the cost structure of the platform, the quality of the platform. There's no initial start-up hiccups, if you will. And since we control the heads and media, I think we can actually control the ramp as well. There's not -- it's leveraging the PMR technology in the past. So there's -- none of the new heat-assisted or other energy-assisted, that people are talking about, technologies in there. Although with our 20-terabyte, which we will ship by the end of the calendar year here, we are going to introduce HAMR. So HAMR is heat assisted. It's actually markedly similar technology from a wafer perspective, there's some differences. Sure, there's differences, but it's not a complete wafer rip up. And importantly, it goes into the same platform that we've been staging the same 16-terabyte, 18-terabyte platform. So that derisks the technology transition that we have to go on. What we said in the earnings call in July is we're going to introduce this to the market, and we're going to learn. So we have to get some out there in the field. We learned from controlling the products in our factory, release in the field and learn from the field. There's a lot of customers that are very interested in what we want to learn because look, at the end of the day, they don't want to build more data centers. They'd rather have higher capacity drives satisfying all the extreme data demand inside smaller footprint of data centers, and the way they do that is getting higher and higher capacity drives up. So we have a very attentive audience on this. They're going to help us in some cases, and we're pretty excited about it.

Great. And then how should we think about gross margins looking ahead? You mentioned 16-terabytes doing well, the ramping of it. Also, I'm just kind of wondering about puts and takes. I think if my memory is right, you have a long-term gross margin target around 29% to 33%. I don't know if that's accurate or if you can correct me on that, but talk about the puts and takes of margins and how we should think about that versus all the good things you talk about, the rampings and the technologies that are going on behind the scenes?

Yes. The way we plan the business is, I'd say, midpoint of those ranges, and we have to -- there's a lot of variables, obviously, that come in to how we plan that. But to first order, think of it as how much supply are we going to need for the demand. What do we think the business picture looks like 1, 2, 3, 4 years from now as to how we're planning. So we're still planning for those ranges. I think COVID has changed everything. So we obviously took some cost increases as a function of that. And the demand picture has been fairly choppy because of COVID. So the tactical fight that we're in the middle of right now is largely more -- from a margin perspective, largely more driven by those dynamics. Long term, we expect certain parts of the market to continue to slop off like the legacy. We expect a lot of growth in -- the secular growth in mass capacity, we're pivoting all of our plans, our CapEx and everything else towards that. And I'm very confident we can stay in those margin ranges, maybe even grow them. I think we're going to be thinking about that as fundamental constituents of the bill of materials become more in our control heads and media. That's what we make. And that will have to do with how much capacity do we really want to add versus what we're getting paid for.

And that 29% to 33%, is that still accurate? Or is that my memory that I have from a long time ago that I need to kind of take that off the table? Or how should I think about that?

Well, I think, yes, you remember that from a long time ago. I think in -- tactically, we don't really manage the business like that. But if it serves you to model somewhere as far as how you model this out in time, that's still the way I think about it.

Perfect. COVID, the impact to your earnings, I think you quantified it or bracketed it last quarter? I think you said, if I remember right, $0.25 to $0.35 or something. Is that accurate? And will that kind of step down like a $0.05 per quarter, $0.1 per quarter? Or how long will this happen or prolong stuff? I'm sure a lot of it has to do with what the government allow you to do, don't allow you to do and outside your control. But assuming the world progresses and we don't have another hiccup, how should we think about the impact that is impacting your earnings right now? And am I also correct with that $0.25 to $0.35?