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

Thank you, and good afternoon, everyone. Welcome to Day 2 of Stifel's Cross Sector Insight Conference in 2021. I'm Patrick Ho, Semiconductor Capital Equipment and Storage Analyst here at Stifel. I'm really happy to introduce our next company, Seagate Technology, the leading provider of data storage solutions with a focus on hard disk drives. With us today, we have Shanye Hudson, Senior VP of Investor Relations and Treasury; and Jeff Fochtman, Senior VP of Global Marketing. Thank you to you 2 for attending today.

And as we begin this fireside chat session, I wanted to start with the, I guess, news of the day or the news of yesterday, where Seagate positively preannouncing upside to its June quarter, both in terms of revenues and earnings. One, can you give a little more color in terms of the positive preannouncement. And maybe focus a little bit, both, in terms of what drove the upside on the top line as well as, what I believe, are very strong earnings upside and what are some of the drivers there?

Yes, absolutely, Patrick. Thanks for having us. And it's great actually to be back at the conference. Before I begin, just a quick reminder for everyone that we will be making forward-looking statements today, and you can, of course, learn more about the risk factors associated with these statements in the SEC filings posted on our website. So to your question, I think, look, as we were heading into the quarter, we spoke about an anticipated kind of improvement in mass capacity demand overall. So cloud demand has been strong for 18-months plus. We were seeing recovery in the enterprise space. We anticipated the VIA market, video and image application market, picking up as some smart city plans were taking shape. And those trends that we had anticipated, we're certainly seeing. And then kind of layering on top of those are some of the more recent demand drivers that are associated with crypto farming. So this is primarily demand that we saw in the channel, all very positive. And these trends not only led to the top line improvement that we had, I think, at the midpoint of the revised guidance range. We're up a $100 million from what we guided in April. But also they're accelerating our ability to balance supply with demand. And associated with that is our ability to expand gross margin back into our long-term model ranges of 30% to 33%. So on our call in April, we said, have confidence in being able to achieve that as we exited fiscal year '22. And I think as some of these demand drivers are consuming supply a little more quickly, we now think we'll get there a little bit sooner. So again, very positive news. And I do want to -- maybe, Jeff, hand it over to you because we are excited about what we're seeing in some of these new kind of storage-centric blockchains, Chia being one. So I don't know if you could maybe add some perspective there.

Yes. Thank you. Perspective on blockchain, on crypto, on Chia specifically, because it is very topical. We get a lot of questions. It's certainly not the largest segment, but it is a high growth segment. What I would say is, going back even farther, Shanye mentioned in April, if you go back even farther and look at our earnings going into FY '21, as we mapped out the year. I think it's been a very positive year, and it's a very positive quarter. And what I would say is as we map that out, you look at risk and opportunities. And we've had more opportunities come in than risk from a business perspective. And probably the largest of those, what I would call, an opportunity, not a necessarily planned TAM, but an opportunity TAM that came throughout the year and in the last quarter, that's how we're looking at this surge. It is still relatively small. I mean, it's exciting and viral. We can all look at the net space adders and things like that. But if you think about it, the hard drive industry shipped over 1 zettabyte of storage in calendar year 2020. So it puts those numbers into a perspective. But those -- it's also not a small perspective. It just puts it in perspective. So we have seen upside, especially in channel markets where the drives are sitting and are available. So it's something that we're looking at closely. But in regards to the Q4 performance is certainly an opportunity that we've been able to take into the mix.

Right. That's very helpful. And obviously, it is a topic of the day. So I appreciate the feedback on that. Let's go to the market opportunities and the Seagate story specifically. And maybe we'll start off, first, on the mass capacity storage demand outlook. And to start off, specifically, with Seagate, you guys have done really, really well recently with the ramp of the 16-terabyte drive now for a few years. Maybe first with that, can you detail why that ramp has been so successful? And maybe, secondly, related to that, as you begin the ramp of the next-generation 18-terabyte drive, how does the common platform that Seagate has discussed previously -- how does that make the ease of transition for both existing customers a bit easier, and how it drives potential new customers with that common platform [ transfers ]?

Yes. Great question. Thank you, Patrick. Touching on the 16. It's about having the right product and the right timing for customer demand and the ability for customers to consume that product. And if you look back at 16, it clearly has been the highest ramping, the fastest ramping nearline product that we've had in our company history. So if you think about it, it's just clearly the right product at the right time for customer pulls and latch. And as we move forward, the way to think about these platforms is, well, I kind of think about them like car chassis platforms. And each time you develop a new chassis there's a lot of things to figure out. A hard drive has well over 300 parts in it. So if you think about a bag of parts and introducing a new bag of parts, a bomb, if you will, to the market, there's a lot of change when you're introducing a brand new platform. And when -- and that's changed for us as a manufacturer, and it's also changed for our customer to qual those products and see how they fit into these unique architectures. So when you think about our bag of parts or bomb or our 16 that has performed better than any nearline product you've ever had, we're making very little changes moving forward as we look into 18 and 20. So while there is new innovation at each capacity step, the amount of change in what is a very complex system made up of subsystems -- everything from head, to media, to suspension and the many other things that drive these plus-300 parts in a hard drive -- we're changing out very few pieces in that bag of parts as we move forward to future capacities. And that allows us to ramp each of these very quickly when the customers are able to adopt them. And it's important for us to realize that there is no one product that suits the full market also. So while we can get to the new capacities and ramp them very quickly, we also are serving many different products. I always laugh -- a hard drive is just a rectangle, but the amount of differentiation in the many different rectangles that we're shipping every day, it's almost overwhelming. It's very high at scale. We're talking in hundreds of millions of parts and products. And so we want to keep the platform simplified, but we also want to serve a complex market with many different customers. And having that simplicity, we're in a really good position right now from 16 to 18 to 20.

Great. Maybe as a follow-up to that and something that I truly believe for the disk drive market as a whole. I think investors don't fully appreciate the shift that we're seeing to pull mass capacity storage, the growing demand for data that's not only created by humans today, but also by machines, over time. And that's going to require a lot of this mass capacity store. I know Dave has talked about some of the other emerging opportunities like the edge. He talked about IT 4.0. But we're also seeing other opportunities emerging like smart vehicles, smart cities. Can you discuss some of those emerging market opportunities and how they supplement, I don't want to say the core data set of cloud spending, but how these emerging marketplaces, I guess, further support the need for mass capacity storage drives?

Yes, I would love to. Being on the go-to-market and the business side, I really have some firsthand experience for watching some of the emergence of these IoT-based platforms that are creating a tremendous amount of data. And what I would say is, if you look at what is the opportunity for mass capacity, you really need to follow the data. Where data is created, it needs to be stored and activated and utilized. And we're seeing unprecedented growth in the creation of data in the world through IoT. What was millions of phones is being surrounded by -- or billions of phones is being surrounded by billions and eventually trillions of sensors. And so we do have some nomenclature at our company. We talk about IT 4.0, and we're just in the beginning of a decade-long growth of data into IoT and sensor platforms. And much of that data is used once and then deleted, but we're starting to see in areas like autonomous vehicle, in areas like video, where you're moving from, call it, simple security into multiple value-add or multiple data value creation zones like efficiency and productivity on top of security. That's where we're seeing growth. And if you think about mass capacity overall, basically in hard drives, we've gone through this bathtub curve, if you will, where we've moved out or there's been some decline in legacy markets or client markets. And this rise of mass capacity is something that Seagate has long predicted and seen, but we had to really wait to see that in production to go. Now that we see it, it's -- I think it's much more known out there, and people understand that it's not really in these mass capacity markets, it's not about SSD or cannibalization into hard drive. It's more about this layering of tiered storage to these mass data opportunities. And the drivers are very many. We could literally dive into almost every vertical market in the world and talk about how centers or digitization is on the rise.

Right. That's really helpful, Jeff. Let's move to some stuff on the technology and your HAMR technology. And at your recent Analyst Day, I was quite impressed to see the road map and more details of the technology itself and how you guys productize future generation drives based on this technology. I guess 2-part question. First, can you remind investors how your laboratory areal density tracking helps drive the product cycles for HAMR-based drives? I think you've mentioned a 3- to 5-year type of -- I don't want to say lag -- but as you go from the lab to products, there's that 3- to 5-year time period, can you first discuss that and why that gives you an advantage from a technology perspective?

Sure. Yes, I'd love to. HAMR, heat-assisted magnetic recording is the full future for hard drive recording technologies. It's a new type of technology to write the bits much more densely and that allows us to keep driving costs and TCO for our end users down. So HAMR being the default long-term technology, Seagate has never wavered on that, and we've been working on it for a very long time. And actually, we brought it to market with a 20-terabyte last year in 2020, like we said we would. That said, the staging of HAMR has been in place for a long time. And hard drives haven't changed from this staging of technology to eventual ramp in delivery. Hard drives, even though the actual technology in the sciences are always changing, this concept of technology staging, market seeding and then market expansion has been going on with new technologies for the 40-year history. So in very many ways, that switch from conventional to perpendicular recording, which took actually 6 to 8 years to fully envelop the industry from a delivery-to-TAM perspective, is exactly what we're seeing now that HAMR is in market. And it won't happen overnight. The interesting thing about HAMR is just like these older technologies, our CTO department -- and John Morris, our CTO, talked about this in our Analyst Day, can really -- has scientifically mapped a way to predict what we're seeing in the lab, 3 or 5 years out to what we can actually put into market. And there's always a band, a degree of efficiency that you can gain or lose over those predictions. But let's just say over 40 years of history, no one has this sort of history or depth of experience in the hard drive space other than Seagate. We really feel we have an advantage to be able to "call the ball" on what a further-out projection or further-out time line looks like. And what that looks like for HAMR drives means larger steps in capacity onboarding. So it's not only getting to higher capacities like 30 terabytes, 50 terabytes. It's seeing those steps expand versus what we've seen in the past. And again, that's actually nothing different. If you looked 10 or 15 years ago, the steps of new capacity introduction in hard drives were smaller, where we're dealing with 250 gigs and 320 and then 500 and then 1. And you're going to see those steps continue to increase as the new technology of HAMR, which enables the higher capacity, come on. So you won't necessarily see steps in 1 or 2 terabyte increments. You will see steps in 5, 6 or 10 increments that we will, at the right time in the market, layer and throttle those in. Based on that sort of lab prediction, long-term view that you mentioned from our CTO's office, which is looking really good.

And maybe the one thing that I would layer on top of that is we always talk about HAMR, and it's impressive to talk about 30, 40, 50-terabyte drive. But the other kind of advantageous thing is once you have that areal density, you can also produce cost-optimized drives at lower capacity points. So I would imagine similar to what we see today, where our 16, and, shortly, our 18-terabyte drives are kind of what's driving the high end of the market, we still have a tremendous pull for 6 and 8-terabyte drives. And so when we're producing a 30-terabyte HAMR, we can produce a cost optimized, say, 16-terabyte drive with fewer heads and disks. So it's kind of a double benefit, so to speak.

Yes. And that's a great comment and point, Shanye. And again, that actually mirrors and mimics exactly how new technologies have been staged and put into the storage market in the past. They are again, getting back to this idea, we have a 3.5 inches our select form factor of a hard drive, but there's so much differentiation in different capacity points, different market needs, regional geographic needs. All of these things add up to a fairly complex ecosystem that we're able to take a new technology and serve many different markets as we onboard it and make it the de facto standard.

Great. And maybe as a follow-up to those comments, one of the things I hear from people who, I guess, are still doubters of the HAMR technology is, it costs more to manufacture. It's -- it doesn't present some of the same cost advantages. How can you dispel some of that where you are still delivering cost advantages from a cost of ownership perspective of drives versus, say, SSDs, even with the transition to HAMR?

Well, yes, it's a great question. Frankly, we're hearing less of it nowadays because I think with this zettabyte of storage shipment that hard drives -- the hard drive industry achieved last year, and with the amount of exabytes that we're able to put in the market -- I think if you really dive into it, the zoning of these different storage tiers are so different that I think there's very much of a moat between a mass capacity drive and the SSD price point that you would need to achieve to store that much data. That said, Seagate's mission, inherently, is to help the world store more data. And right now, too much data is being deleted. Our mission is to help drive cost down in storing that data, which is one of the inhibitors. There's data cost, storage cost, and then there's complexity. And we actually want to help on both. We want to help on cost and complexity. So to your point, our goal with HAMR is to drive cost down for end users to be able to store more data and create more value. And we have that mathematically calculated. Obviously, there's going to be differentiation in the market every single year based on supply and demand, which is something that we're looking at really closely right now from the fundamental business practices, and that will drive different pricing behavior. But we do have the ability to drive the pricing curves down, cost down over time with the onboard of the HAMR technology that matches the slope of the data needs in the world.

Right. Let's move to, I think, another exciting part of Seagate, which you've introduced over the last few years, the Lyve platform, where you've introduced multiple iterations of different products from mobile, to the rack system, to cloud. Maybe first off, and I'll go background. Dave's talked about reducing not only cost, but also the excess waste that you get in terms of data that's not stored. Lyve platform seems like a better utilization for customers to get the best storage needs capable. So first, can you describe how this developed in terms of the Lyve platform? And maybe secondly, Lyve Cloud was your most recent introduction, but it's a very different type of offering or product. It's actually a subscription-based model type of scenario. If you could give a little bit of color of how that brings value to a customer versus your traditional product offerings?

Sure. I'd love to touch on Lyve -- Seagate Lyve with -- part of what got us where we are on this initiative is, and we actually believe part of Seagate's core IP is our knowledge of the many disparate storage markets, literally every ecosystem storage or technology in the world we serve, and we have customer interactions with. And what we've learned over the last 5 years it's something I mentioned in the last comment is that too much data is being thrown away. This cost complexity issue is really tough to solve. As data grows, the complexity of managing that data becomes very hard. And if you think about it, we've moved from cloud orientation to hybrid, multi-cloud orientation. And in our view of helping the world store more, generally, we're doing that by delivering hard drives to our value-add partners. But we see an unmet need to help store more of the world's data as these sensors turn on, as more and more cameras flood more and more sensors. What we're still seeing is 70% of the data is used once and thrown away. We would like to see that get more value. So what we developed is a proposition that's very much in line with the Seagate brand. And by that, I mean it's storage centric. It's not about adding compute. It's not about trapping data. In fact, it's about frictionless data. How can we bring data from the endpoints and bring them into the edge and migrate that data at the core frictionlessly. So we're a storage-centric offering that has shuttles and data movers, but also has a cloud that's built on this metro edge. Our collaboration with Equinix allows us to build a cloud that's very close to where data needs to be ingested. And with our storage centricity and no egress fees, what we're willing -- what we're really learning and being fed directly from our many customers that we've served for many, many different years -- because this is a value-add in the world, whether it be a parking spot to onboard mass data before you decide what compute cloud you want to send it to or what you want to do with its data on its life cycle or whether you want to permanently house something. We can offer that value and store more data, reducing the cost, reducing the complexity. For us, it's very much built on vertical integration. When we talk about efficiencies and lowering costs, the #1 most efficient product and technology of doing that is hard drives. So while it's a new orientation for us to go direct to customers to offer this frictionless storage-centric service, it's very much built on our mass capacity drives and very much built on this idea of partnership as you see us doing the Equinix platform, which is something that is very much true to our roots. It's also, we think, a benefit to end customers who know and trust the Seagate brand to be a steward of data, but not someone who's necessarily mining or trying to get value from their data. We believe that people's data is their data. And that's what the Lyve concept is all about.

Great. That's really helpful. And maybe as a follow-up to the Lyve platform and these new offerings. Something that you actually brought up in your most recent Analyst Day was the customer interactions and how the changing customer base, particularly as we go to these bigger data center, hyperscale type of customer. You talked more about customer collaboration, satisfaction, key criteria is that -- Shanye is going to laugh at this. I always think about semiconductor companies you have to focus more and more on their evolving needs. And that's something that you brought up at your presentation at the Analyst Day. If you could just give a little more color about how that customer base evolution is changing some of the tactics that Seagate is doing in terms of, okay, we got to address these customer needs, I think Lyve platform is an example of that? But how do you continue to I guess, foster and learn from your customers about what they're looking for in terms of storage capabilities?

Yes, it's a great question. And the fact is we serve so many markets. And what I would say is 4 or 5 years ago, we really put this total customer experience, this TCE initiative into motion at Seagate. And I really respect and thank our sales team so much, which drove us to that. And to be candid, a lot of this generated from where we had strengths, but also understanding where we had weaknesses 4 or 5 years ago. And what I would say is we were very strong in enterprise and OEM markets and the emerging cloud space, if you look back 5 or 10 years ago. We were strong in consumer at that point, but there were other markets that we weren't as strong in. We weren't that strong in serving distribution channels. We weren't that strong in serving smaller customers that needed to be touched in those distribution channels, or other markets -- NAS market is a really good example. And not only did we tweak our product line and reduce some branding related to product segments, but the real thing we did is we tried to ease customer experience across every single market. That's where our opportunity was. Our opportunity was to balance ourselves and basically be great everywhere, not only in pockets. And while we have a long way to go, there's a lot of initiatives in play. We have achieved that balance where literally in every single important segment in the hard drive industry, we have that same TCE, those same scores, if you will, the same NPS and QDR ratings in these different ways that we track and measure ourselves against what is the customer saying? It's not only what our business model and our results are saying. But how did we do on the way getting there? And what are those customers seeing? And we've really balanced that now across all those segments. The value to that is there's this feeding from all of these customers that you now have better relationships with, there's this feeding factor about what our road map should look like and where opportunities are coming from. And funny enough, I mentioned the distribution channel is maybe where we were weaker 5 years ago. That's where a lot of the emergence of IT 4.0 is coming from. That's where some of this crypto and the farming and mining is being pulled from. So the fact that we shored that up and listened to those customers, it's really paying off now in regards to how we've delivered our road map and the engagement we have. And one of the things that came out of that, just to your exact point, is how we can serve those markets directly with Lyve, both at a device level, at a systems-level and with Lyve as a service, which is what many of these customers and all of these channels are asking for. But having that make the experience right. Let's walk in their shoes across every segment is basically the mentality that's delivered results. But it also delivers the benefit to us of the future knowledge in seeing where things are happening, where things are emerging. So it's really sustainable and benefits us.

Great. We got a few...

I just want to add because I think you coined the term nail it and then scale it. When it comes to Lyve in our Lyve Cloud platform, we're we are being very deliberate in our build-out because we want to ensure that we delight our customers, and we are true to that total customer experience. So it's not just about growing fast to get revenue. It's growing to sustainably deliver revenue and deliver to that.

That's exactly it. Thank you, Shanye. Yes, the nail it before you scale it is how we look at every product, but especially something emergent like Lyve. And it's based on a long-term view based on customer experience and go slow to go fast is what Dave Mosley often says.

We've got only a few minutes left. So I want to focus on your recently introduced revised financial target model and your capital allocation strategy. So maybe Shanye, 2-part question. I'm not going to go through all the details of the revised model, but I was impressed with the margin profile of both 30% to 33% gross margins and 15% to 20% operating margins. First, can you give us some of the key levers on the margin profile that can deliver -- that can help you achieve those goals? And secondly, from a capital allocation standpoint, you remain very diverse in terms of dividend buybacks. And you're investing in terms of potential capacity expansion when you need it. Can you discuss the capital allocation and how you're going to put free cash flow to work?

Yes. Okay. Sure. A couple of parts there. If I start kind of with our financial model. So we raised our growth outlook to a CAGR of 3% to 6%. And I think you would be remiss not to hear Dave or Gianluca talk about focus on optimizing profitability and optimizing free cash flow. So it's key to your second part of your question. And so we're looking to grow profits faster than revenue and I think we've demonstrated the ability to be very mindful in the OpEx line. We reintroduced a gross margin target of 30% to 33%. And I think your opening question, we have several levers on how we would kind of get there from where we were last quarter, it was nominally 27% to the low end of that range, I would say, even last quarter, mass capacity margins were already touching the low end of that range. So we've had headwinds around COVID-related costs, particularly elevated freight that we foresee over the next couple of quarters. But we're also proactively doing other things. So cost-optimized drive is kind of what we were talking about on the HAMR side. We're absolutely using the power of our kind of 2 terabyte and above areal density disks to do that in lower capacities. I think last quarter, we said those were still less than 20% of overall revenue. So those grow -- that's the tailwind for us, as we continue to move towards higher percentage of mass capacity, which I think if I was looking at the first 3 quarters of 2020, mass capacity was maybe 55% of revenue. In the first 3 quarters of 2021 fiscal year, it was 65%. So it is going in the right direction. And then, of course, supply-demand balance, and that was -- that's been part and parcel to what we're focused on from our capital investments and what we think is going to get us back to that gross margin target a little bit sooner with the strength that we've talked about during this call. If I quickly touch on our capital allocation, you're absolutely correct. I think the company has had a very strong capital return program, and we're a strong generator of free cash flow. Our focus on profitability is supportive of that and it really is -- our first priority is ensuring that we fund the needs of the business. And then beyond that, we have returned both from a dividend and the share repurchase program. I think dividend is very programmatic to us, so very committed to that. Annually, we -- management reviews that with the Board and potentially raises the dividend. I think we have, the past 2 years in a row. We're a little more opportunistic as it relates to share repurchases. And again, if I use that first 3 quarters of fiscal '21, I think we repurchased something like 31 million shares, and the price was on average just below 60. So well below where we're trading today. So we think that was probably a very good investment for our money. We'll continue to be opportunistic like that as it relates to share repurchases. I kind of stop there.

Great. I do wish we had more time because I think I'm quite excited about the future outlook of the disk drive industry as well as the opportunities for Seagate. But Shanye, Jeff, thank you very much, again, for your time. Appreciate the comments, continue success, stay safe, and thank you again.

Thanks, Patrick.

Thank you.