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

Welcome, everyone. I'm Katy Huberty, IT hardware analyst at Morgan Stanley. And I'm pleased to be joined by Seagate's CEO, Dave Mosley. Since becoming CEO of Seagate in 2017, Dave has led the company's investments in mass capacity, cloud and edge applications and has put the company on a secular growth path with improving profitability. So I really look forward to discussing those topics today. Before we begin the discussion, let me just point you to Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, Dave, thank you so much for joining us today.

Thanks, Katy.

I want to start out talking about some of the color that you gave at the Analyst Day last week. You discussed secular growth drivers in the mass capacity business, which now makes up over half of revenue, but also expanded product road map that argues for a larger addressable market and improved profitability longer term. Just walk us through how those investments and new developments impact the long-term financial model for Seagate over the next several years.

Thanks. Before I respond, let me just quickly remind everyone that I'll be making forward-looking statements today, and you can learn more about the risk factors associated with these statements in our SEC filings, which are available on our website. Well, like you said, Katy, last week, we had an Analyst Day where we walked through quite a few of the details for -- behind your question. The way I think about the market, mass capacity is now the big growth driver for us. So we forecast that market last week at about $24 billion of TAM in 2025. And we love how we've positioned the company to go after that. And then there's also other segments of mass capacity, which are starting to open up, which may be even more opportunity to just get data moving around the world, plug it into the cloud a little bit better than it's moving today. And that's an even bigger revenue opportunity, we believe, for ourselves. And we -- because of the transitions that you made reference to the mass capacity becoming more of a part of our portfolio, less client server actually still impacting the business. We were able to update some of the models. In particular, shows some revenue growth associated with mass capacity growth. And then operating income, we were able to slide the range up there, which is really reflective of the fact that we're a lot more efficient with our OpEx, CapEx and everything else associated with mass capacity simplicity.

That's great. And this is a long-term model, but you also see some dynamics in the market that we can talk about in more detail. And so when should investors think about Seagate being able to operate in this model of low to mid-single-digit revenue growth, 30% plus gross margins and then in that, 15% to 20% operating margin range?

Yes. I think it's been a tumultuous year for everyone in the supply chain. And obviously, if you go back to middle of last summer, there were a lot of disruptions in the overall demand picture, just based on what was going on in the world, even the supply picture because factories weren't operating and so on. We think that the narrative of pushing to more mass capacity in the cloud is a strong narrative for the next couple of years. We're still -- we still have some legacy reverberations of what's gone on because of the economic disruptions that we all saw in the last year. But those should abate over the next few quarters and put us in a position to get into these margin ranges. From an operating margin perspective, we were already in that range before we entered that terrible supply demand disruption last year. Going forward, we think getting into the operating margin range is going to be fairly straightforward for us. Gross margins really come as a function of longer lead times for everything. You have to know what product you're building because there's such a long supply chain, and you have to know that your customers are going to be there on the back end. So it's a lot more deliberate discussions and a lot more heads and media as part of the bill of materials. So all of that goes part and parcel for updating the margin range.

And at the Analyst Day, there was a lot of Q&A around your live storage offerings and how that allows you to go after a very large addressable market of $50 billion, capturing more data at the edge. One of the questions that I'm getting from investors is what drove your decision for Seagate to participate in building those storage systems versus just partnering with your classic OEM or hyperscaler customers? What does Seagate bring to that market where it makes sense for you to participate from a systems standpoint?

Yes. That's a really interesting question because I think my quick reaction to that is we will partner with all of our traditional customers, whether they're hyperscale or OEM customers. And the reason is this is really about bringing more data to the table. So many people in their ecosystems today have very defined models for applications and what data and how you ingest the data and so on. There's a lot more data out there. And to the extent that we can partner with people and bring more data into their ecosystems, I think it's a win-win for everyone. That's the way I think about it. There's not really a competitive space that the live -- the end-to-end live platform is competing against. Our brand, if you think about our brand and what's out there in distribution or the consumer market is really simple, efficient. It's almost like a USB drive, plugged into a PC. So there's a complicated application space with lots of compute and things like that, but then you have, just the mass capacity plugged in, I think, completely analogously with the live to the cloud and other offerings on-prem. So we believe we will partner. To the extent that we're already working on mass capacity solutions for everyone anyway, we -- it's an easy discussion with people. And from an as-a-service perspective, everyone's going to be going and doing as-a-service. So if there's as-a-service aspects of this, we can partner on those as well.

Okay. And that sort of segues into a question around what the go-to-market looks like? Are you going to build out a sales force to sell this offering to end customers, whereas in the past, you focused on your OEM and hyperscale customers? Or what does that go-to-market look like?

Yes. Thanks. I think just to put it in the right context, we're going to approach this very deliberately, very slowly over time. From my perspective, we want to make sure that customers stay very happy with our service and so on. I like the reach of 1 to 1 relative to big partnerships rather than 1 to many. So I don't see us building a big sales force or a big customer acquisition vehicle. I think our traditional partners have those vehicles, frankly. And so that's the way we're going to be thinking about this more of a back-end kind of model, if you will, an operational model. And we think that's the value we can really bring.

That's great. So just digging a little bit more into the near-term demand environment. Seagate's a company that typically benefits pretty significantly when demand is improving. And so as we think about postpandemic economic recovery, how robust do you see that recovery over the next year, particularly in your legacy and enterprise nearline business?

Yes. On the legacy side, so that was the side that was really crushed late -- last summer, and it started recovering a little bit ahead of plan for us, frankly, and I think that recovery is going to continue. Now it's not -- legacy is not coming all the way back. There's a natural legacy decline that we were in the midst of anyway. But I do think you'll see some areas where the legacy markets -- because they provide really good value on-prem, in particular, people haven't made an investment for a while and come back to that. Relative to mass capacity, I think the edge markets, the smart city market, the VIA markets are going to be big, and you'll see that investment people are making. As people come back on sites, they want safe city, safe hospital. They want smart factory applications. So we feel like there's going to be a big demand for that. And then the cloud itself is such a complex space. It's not -- there's not a one size fits all model. But in general, what happened during the pandemic is a lot of businesses pushed into the cloud. They couldn't -- if their business was really strapped, they couldn't necessarily invest in capacity at the time because that capacity costs money. But over time, they're going to be very, very reliant on the cloud, and we think that's a big reason why the cloud is going to grow for a few years here, exactly to your question.

Right. The storage OEMs that reported last week talked about calendar 2Q this year, so for the June quarter, as the demand inflection. Does that jive with what you were seeing in the market?

Yes. And if I go back to -- even in last July when things were tough, we looked at that -- we looked at how the recovery might happen, and we had our own forecast. So we've been preparing for exactly that, which is one of the reasons why we guided revenue relatively flat. At that time, a lot of people looked at and said, and consensus was not there, right? But we saw that kind of recovery coming. So I think we've been prepping for it in operations and our discussions with customers and so on.

Yes. And as you said, the data point support another year of strong double-digit cloud CapEx spending, which is fueled by, yes, enterprise adoption of cloud, but also some of the consumer cloud companies had to pause their spending last year, and that's coming back. So how would you characterize your visibility into cloud spending this year? And do you have a better graph than you did a month or 2 ago about what the back half of this year might look like?

It's slowly building. So these discussions with customers are really interesting. If we talk about the 16 terabyte, which we've been making in high volume for 1.5 years or 2 years now, and then the transitions that we might want to make, 18 terabytes and beyond that we've discussed, we're having very deliberate discussions with the customers because the lead time for those products is so long, exactly to your point, can be 6 or 9 months. And if they need a lot, and they're going to be doing either renovations of their existing data center or they're building new data centers, they want to know that the parts are going to be there for them. So it's enforcing kind of discipline up and down the supply chain, allows us to go help our suppliers, which, frankly, some of them are still struggling with COVID-type environment. We've got to make sure they're all ready for the push as well. I mean this is getting discipline up and down our supply chain, which is really encouraging for us.

Yes. And whenever investors see strong cloud demand, they're always looking to the other side of that curve and when demand will slow. And that's certainly how the market has played out over the last 5 or 6 years. But is there an argument that the pandemic has reshaped the cloud cycles and sort of smoothed out the cycles where different hyperscalers are spending at different times, and the market is just at critical scale where we won't see as much cyclicality going forward as we have in the past?

I think there is. I think the pressure on the cloud service provider, this is where your data is now to continue providing that value will continue to show. And again, there's so many different models inside the cloud. I don't think it's a one size fits all argument. But I do think that relative to, I'll call it, quieter times where you could actually make prescriptive investments or even new technology changeovers, like, the -- introduce more efficiency back in your data centers, now we're up against such massive growth that I think the response to that growth is really the primary driver. And not necessarily just in storage. I mean, the front end of this, it was a lot about just service level agreements on the compute side, the network side. But I think the storage side is going to come and be a prolonged cycle this time.

Okay. You mentioned 18 terabytes, which is also a big discussion with investors. And I think the reason for that is at 12 and 14 and 16 terabytes, there was one HD vendor that led, and that drove specific industry and competitive dynamics. Whereas with the 18-terabyte, it feels like the industry is moving towards that capacity point more in tandem. So can you talk about timing of when you think 18-terabyte becomes significant for Seagate's business, and how that compares to what your biggest competitor has said around their timing being in the second half of calendar '21?

Yes. I think our 16s are so firmly latched into our factories. It's a very, very high-volume product, and it has been for quite a while. I think some customers are just happy there, and they'll stay there for quite some time. It's the same platform that gets us to 18. So we make the pivot in heads and disks, basically. There's some small other changes, but we've intentionally done this platform strategy to make ourselves more efficient. So we know the platform, we know when we can ramp it. We were actually very happy with the 18s mid-last summer. A lot of it's about having long discussions with customers about where they want us to be on the transition. We're aggressively transitioning now with a few customers, and we said that in our last earnings call. I'm very confident in the platform to get the customers what they need. From my perspective, there's not too much difference between the 16s and the 18s. And we're going to continue to push this platform not only to 18, but to 20 and beyond, right? It's the same platform that we get all that leverage from.

That's great. And how should we think about price per exabyte declines going forward, specifically the benefit as HAMR ramps? And then how do you think that improved aerial density will ultimately impact both demand in the market, but also the profitability in your business?

Yes. I think it's interesting because what aerial density usually affords is you to take components out of the system, right? So if you have a let's say, a mid-capacity point, let's just pick on 8 terabytes for now, and you can do it with one fewer disk and 2 fewer heads at saving cost, that's how we think about aerial density transitions at Seagate. It's not really just about your ability to hit that highest capacity point, which gets a lot of attention. It's really about how you transition the entire portfolio. So small incremental changes, like, we've seen at the top of the PMR S-curve don't really help all of that. I mean they can on the margins. But big jumps, there are 20%, 30%, 40% jumps in aerial density will help it tremendously. Help us use our heads and media factories, which is, again, the big part of the bill of materials, the long lead time items to a much more predictable outcome. So that's the way we think about playing the aerial density hand. And again, just like any other fab in the world, you can imagine if your fabs are relatively full, do you want to make a transition very hard when your yields and scrap and things like that may not be where you want them or do you make the transition more deliberately? I think that's a more mature way to think about how we'll do transition.

That's helpful. I want to spend the last 10 minutes or so just digging into some of the financial model implications of what you see in the market right now. And you mentioned earlier that you had been guiding to flat revenue growth in this fiscal year, which ended June. Now for some time, and the Street really didn't reflect that maybe more so recently, but there's some questions as to whether you can hit that target. So just to put some context around it, the March quarter guide implies 10% sequential growth in the June quarter. In order to reach that flat growth year-on-year, consensus is modeling something lower than that about 6% growth. So talk about what drives your confidence that you can hit that larger sequential uptick in the June quarter?

Yes. Again, it's still a very volatile world, of course, but looking at the recovery that was happening all the way through starting in Q1 when we were disturbed, if you will, and when we said these things into Q2 and Q3, the exabyte recovery has been fantastic. And we see that, that growth is going to continue to come in the cloud. And so that's what we're positioning against. What exactly the finish lines are on the various quarters, I mean we'll play that as we have better visibility as we get into the quarters. But from our perspective, the exabyte demand is clearly out there and coming back.

And specifically, if you think about the June quarter, which are the markets that are most likely to grow sequentially? I think you've talked about both cloud and surveillance. And then I guess, the recovery in some of the legacy markets that we talked about earlier. Is that the right way to think about it?

Yes. The mass capacity markets are definitely picking up steam. I mean, obviously, the VIA markets, which we've talked about before, have kind of a bit of seasonality to them. Most of the other markets are not really exhibiting that seasonality anymore. And some of the legacy markets, to your point, they were so disturbed early that this is a little bit of a bounce back and people are driving their own revenue streams to desire our products and things like that. So I think that's just a function of how deleted -- depleted the supply chains were because everybody was managing cash really carefully, couldn't get supply, demand wasn't out there. That's 6 months old now. I think as things come back, some of those legacy markets should reinflate as well.

Okay. That's great. And then with cloud remaining strong, this recovery in enterprise legacy demand, and you've talked about modest capacity additions, all of that should really tighten up factory utilization. We and our own proprietary data are seeing a better pricing environment. As those come through, how should we think about the near term, meaning next 2 to 4 quarter impact on gross margins? Is that enough to drive you towards the low end of your long-term target of 30% to 33%? And then what are some of the headwinds to gross margins that you have to manage through over the next couple of quarters?

Yes. So I'll start with the headwinds, which still exist. I mean, freight logistics around the world is still an issue. There's just some of the logistics lanes are just piled up and you have to pay to get attention. And to the extent customers say, I need it right away. You may either not be able to get it to them or there may be just additional costs that are borne by that. And so I do think that's going to abate at some point in time. I think upstream in our supply chain, there's a lot of suppliers that still have issues with their -- getting their workforce to work safely, and they -- that drives more cost. There's some transitions that have to happen inside the supply chain with making sure you're staged for the next capacity node and so on. So a lot of that is related to help disturbed things work. And those will abate over the next few quarters. We've been saying that. I think exactly to your point, on the other side, the long lead times that we're seeing right now for parts makes us be very deliberate about what exactly we're building, what yields and scrap we're going to have. Remember, most of the mass capacity drives have so many heads and disks in them. So we have a very firm handle on what that is. And I think that will -- and because of the demand environment being what it is, people want predictability relative to those end dates, if you will. So what we're starting now may still be late fall by the time it comes out. We're having great discussions on that front, which all serves to allow us to kind of reinflate the model.

Right. So we're in an environment where customers are really focused on getting the product they want when they need it, maybe more so than trying to negotiate on price?

Yes. I think -- as I think about the industry, the idea of building a bunch of products way ahead in anticipation of somebody taking it. It's not consistent with qualification cycles, the quality levels you need to hit, the scrap levels you need to hit. So from my perspective, that's not a clean way to run the business. It's much better to have kind of this long-term predictability and make -- and the customers will reward you for that. They need that actually in some of the sizes of the investments that they're making. So all of that affords us up and down the supply chain to be more predictable for everybody.

Right. And that brings us to another question on the same topic, which is that you lowered the CapEx guidance from 6% to 8% of revenue to 4% to 6% of revenue on the last earnings call. And some investors were asking how they reconcile this strong recovery that we could see from very low levels in legacy and secular growth in mass capacity? And how you reconcile that with a takedown of the CapEx guide? So just give some context around how you've maybe changed your thinking around when you add capacity and just managing it relative to the demand forecast.

Right. If I go back a long ways in time, then we were consolidating factories and building facilities actually to do factory consolidation as part of client server coming down, that was all within 4% to 6% range. We were playing in a 6% to 8% range for a while as we installed new tools about mass capacity and the pivots that we intentionally made. I think from here on out, we believe that we've made the right investments in the heads and media fundamental fab equipment even in back end test, that gives us enough capacity to be able to achieve what the market needs from us for the next few years. And so we think 4% to 6% is a better model range right now. 4% to 6% is still a lot of money. It has -- affords us a lot of flexibility. We're not going to be really building new facilities. But we're going to be installing tools that are part of technology transition capacity. And we know how to do that very, very well. So we'll be very deliberate with it because we need to be able to use those tools to make the right parts. And 6 or 9 months later, those become the heads and media that will be in the products that we're selling.

And it's not always understood about your business model that as the legacy markets come down, you can reuse at least some of that equipment in the mass capacity market. So there's some flexibility in your manufacturing plans to fund some of that mass capacity growth with what you have.

Yes. We've completed not all of that pivot, but we've completed quite a bit of that pivot. And been able to, to your point, take advantage of that as well on top. So if you just look at how many dollars we spent in period x, 2 years ago, it's probably not the right way to think about it because we were as well pivoting some of that legacy capacity over to mass capacity at the same time.

Right. Right. And then finally, on OpEx. You've talked about holding it in the $330 million a quarter range. Should we think about that as a COVID level or even a post-COVID level of outback as some of the travel and entertainment costs come up? And does your long-term operating margin guidance leads some flexibility for you to invest or bring up operating expenses longer term as you chase some of the new opportunities like what we talked about with live cloud?

Yes. Some of the platform consolidation, when you think about 5 or 10 years ago, we had desktops and notebooks and mission-critical in all different kinds of flavors. This platform consolidation has allowed us a lot of efficiency, flexibility. And the long cycles of learning also are also allowing us to be much more prescriptive with what we're doing with OpEx. So that's all an efficiency gain, if you will. So I think the $330 million number is a good number for us to manage within. And we have quite a bit of discretion to be able to move underneath that from $1 in R&D to $1 in sales and marketing or $1 in IT or move money into IT for some of the live build outs that we're doing. I think we have a lot of flexibility there.

Okay. Great. So just to wrap up, you spent time with investors last week, you sort of saw the -- where the questions are coming from. What would you say is most underappreciated about the Seagate story after a day of spending time with investors?

Yes. Thanks. It's interesting because I don't think people understand data infrastructure well. The data infrastructure of the world is super-dependent upon various tiers, and hard drives are firmly entrenched here. Flash is another entrenched tier and has a lot of opportunity in a lot of different places in the data sphere as well. And memory, DRAM also, there's probably going to be niches open up. But just the sheer enormity of the data infrastructure investments that are out there and how those investments are growing, I don't think people have enough appreciation. Now there's narratives about 16s versus 18s or flash versus SSD, but people aren't understanding the enormity of it. And when you see how big it really is, and when you think about how many customers are making these investments and -- I think that's the takeaway that I have is people are sometimes surprised that how fast the cloud is growing, how big the edge is, how much data is actually deleted at the edge. It's not a surprise to us because these are the markets we serve, and we think there's great opportunity going forward.

Yes. So investors aren't seeing the forest through the trees in terms of getting caught up in some of the nuances around product transitions and the growth of cloud relative to on-premise. Is that correct?

Yes. Right. All things, sometimes they're distilled into a zero-sum game. And the datasphere is definitely not a zero-sum game. There's a lot of growth.

Yes. Absolutely. We couldn't agree more. That's a great place to end. Thank you so much for your time today, Dave.

Thanks, Katy. I appreciate it.

Have a great day, everyone.