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

Good afternoon, everyone. Before we get started, if you are a member of the press or media, please disconnect at this time. This is a restricted line. Any unauthorized party in this meeting or any unauthorized use of the information communicated in this meeting is subject to prosecution to the fullest extent of the law. Any unauthorized person, including the media that is on the line at this time. Please disconnect. Please note, today's call is being recorded.

Perfect. Thank you, everybody, for joining us this afternoon. I'm Aaron Rakers. I'm the IT hardware and semiconductor analyst here at Wells Fargo. Pleased to host a quick discussion with Seagate. We've got Gianluca Romano, CFO, and we are lucky enough to have John Morris, the CTO from Seagate to join us this afternoon. So first of all, guys, thank you for taking the time out of your schedule. Really appreciate it.

Thank you, Aaron. Thank you for inviting us today.

Perfect. So ...

Maybe -- sorry, and before we start, let me just remind everyone that we will be making forward-looking statements today. And you can learn more about the risk further associated with these statements in our SEC filings on our website.

Great job, nailed it. So John, I don't -- I get to talk to Gianluca a lot. I don't -- we've talked -- spoke a few times, but I wanted to start with you because I think the technology curve, where we're going from here? I mean, the hard disk drive industry has structurally changed dramatically over the last couple of years. And it's a significant amount of demand coming from the cloud guys. And what's also interesting is that there's a bit of a bifurcation in the technology road maps. And so I wanted to understand that a little bit more from a Seagate perspective. You've outlined 50-terabyte capacity points in near line by 2026. Can you just walk us through the pillars of innovation that drive towards HAMR, and how you're thinking about the technology hurdles that take us from where we're at today to that level of capacity?

Yes, sure. It's a great question. First, just as a reminder, we generally see technology transitions every 10, maybe 15 years. And we've been able to run perpendicular for a long time as an industry since about 2005, and we've gotten a lot of growth out of perpendicular recording. But we're kind of -- we are reaching a point where there's diminishing returns and it's about the right time to introduce a new recording technology, which is what we've been focused on for a long time, is kind of laying the groundwork for that new technology to be ready to a kind of dovetail in where perpendicular is at and then provide us another 15 years of growth off the new S-curve that we introduced with the technology. So what we're focused on right now is to ready HAMR or heat-assisted magnetic recording to allow us to get that 15-year opportunity with the new S-curve from HAMR. And it's a really interesting technology in that it opens up a completely new design space by introducing the laser with the head. We can open up our media design space. And that combination of those 2 things, the laser in the head, a new magnetic alloy in the media, really opens up that opportunity for a really robust and sustainable areal density growth over the next 10 or 15 years. And so -- but generally, I would say the industry is pretty well aligned to HAMR as being kind of the next big thing for recording technology. And also, generally, there's pretty good alignment that at capacities above 30 terabytes is when that technology is really going to make sense. So with that in mind, we're deep into product development with a HAMR platform. And so it's in -- we're in a mode now where we're doing integration of the technology, not unlike what we typically do for any product. And we're progressing very well to our plan, with our first major volume platform. And we gave some outline on what that would look like a couple of years back, actually in our last analyst event as well. And I would say we're feeling really good about it. It's achieving our expectations. And we've got good customer engagement in the early phases and we're pretty excited about where we're at.

That's a good overview -- go ahead, Gianluca.

Let me add that, no, we have proven the technology with a 20-terabyte HAMR, but it is actually in the market today is we have not ramped high volume because not optimized from a capacity standpoint, so we will ramp much more on the next product. But important for us was to prove that technology was working, and also to give the opportunity for our customers to use the drive in their data center and getting ready for the next product that we will start testing much more.

That's -- both of you guys, that's a great overview. I mean what I'm a kind of starting to see is that it's not the hard cutover, right, to HAMR that maybe some of us maybe on the investment side, we're a little bit misaligned on our thoughts on is that it feathers into the product portfolio. And you just mentioned, John, 30 terabytes and beyond is a kind of the real inflection maybe for HAMR, which is going to take us out still a couple of years. Do you see still abilities to drive incremental steps of areal density -- per platter areal density increases on PMR? Or is it more platter count expansion that takes us from 20 to 30 before we see maybe a real meaningful cutover to HAMR as needed?

Yes, great question. Yes, absolutely. There are ongoing incremental areal density gain opportunities with perpendicular recording, and we and others in the industry expect to be able to make additional gains, and deliver additional capacity, and do that with higher areal density than what we're shipping today.

And is that a form of again, where I started off, you've got -- I'm sure you hear a lot energy assist or magnet -- MAMR versus HAMR. And is that a discussion that should be had? Or is that -- I mean, you got ways to take PMR if it's not necessarily energy assist and other things to drive before -- I guess what I'm trying to get at is a roadmap from here to 30, how I think about that?

Yes. There's -- we absolutely have capability to increase areal density with perpendicular with just an evolution of our designs that were already in volume production on. And we -- we are not introducing any major design changes in our perpendicular recording system, it is really just an evolution of what we've done on 18s and 20s.

That's great. And Gianluca, it probably ties back to your comments that you've been making, taking 18s and 20s and keeping on that common platform has really been an important narrative to the gross margin profile for the company. So do we see that common platform approach playing out well into the mid-20s or even 30 -- towards a 30-terabyte capacity point range or even beyond that?

Well, I'll say for sure, it worked very well for our 16, 18, 20-terabyte is in the market already today. Now, I think we can leverage on that platform also for next PMR drive, now if we decide to develop more capacity points. I would say HAMR is very important also, not only for the high capacity, but because of the high areal density per disk. Now, we can also then, at a certain point, use HAMR technology at a lower capacity point with a lower bill of material and, of course, try to optimize our profitability.

That's a good point. That's a really good point. John, back to you. I mean one of the things I've been interested in is as the technologies evolve, as the demand from these cloud guys continues to be easily surpassing that 30% long term or 35% plus long-term kind of growth CAGR. To supply that demand, it's also in both more platter counts in the drives. Is there you've gone -- people thought it went from 8 to 9. Now there's discussions around 10. Is there an idea that these hard disk drives go even beyond 10 platter counts as to satisfy the demand that you're seeing out there?

Well, let me start off. I mean, it's feasible. There's space to add additional platters in the drive technically. But as Gianluca indicated, our objective is to leverage areal density gains so that we can better facilitate lower cost and a lower overall total cost of ownership. So adding additional heads and platters. It generally is favorable for total cost of ownership, but it's not optimal for total cost of ownership. And we've got a really heavy focus to engage with our customer base and understand the major drivers they have in total cost of ownership and incorporate that feedback more directly in our drive architecture and drive design. And what it generally leads to is a desire-to-grow capacity via areal density gains or intrinsic gains in the recording system, so that we basically have fewer parts in the drive, not more parts in the drive. And so we'll continue to focus on that. It is one of the big enablers that HAMR provides us as a vehicle for capacity is it gives us, as Gianluca highlighted a minute ago, it really does give us an opportunity to hit the capacity per unit that the industry is looking for to achieve their use case solution, but do it in the most efficient and lowest cost -- lowest overall total cost configuration. So we'll continue to work on that. But just circling back, there's technical capability to add additional heads and disks. And it is an option that could be exercised if necessary, but our focus is going to beyond intrinsic areal density gains.

That's perfect. And on that same line of discussion, there's just always this battle between SSD cost curve and data hard disk cost curve that remind me again of what you think you can drive to as far as areal density gains? And how you're thinking about the slope of those curves or for that matter, the crossover, if there ever is like SSDs relative to drives, as you see it?

Yes. So we highlighted previously that we have technical capability to achieve 20% CAGR with areal -- with our HAMR technology. That's fairly comparable with the kind of cost CAGR that the flash industry is communicating and generally, what we would say, there's always a bit of plus/minus on those numbers. So generally, what we would say is there's a pretty rough equilibrium in the technical capability of both flash and hard disk magnetic recording technology to maintain roughly similar CAGRs. And because of that, an equilibrium that results from it. We actually -- we're not seeing a point in time that there's a crossover and the cost per terabyte of the technologies. We do believe there's going to be healthy separation, well above the threshold where there'd be a total cost of ownership closure. And I would say that's just -- in general, we don't see a point in time that there is a crossover and total cost of ownership.

Right, right, okay. Very ...

I would say if you look at the NAND business, the major change in their structure from a cost standpoint is when now the industry moved from planar to verticals. And then from 32 layers to 64, so they doubled the gigabytes per wafer. And then 64 to 96, and then started to decrease the benefit of 96 to 112 or 128. So the benefit from the changing technology NAND already happened a few years ago. Now you will see less impact on still cost declined lower than what happened in the past.

Yes, I would -- yes.

In hard disk is the opposite situation. We are now at the end of the PMR technology that is not providing any more a lot of cost reduction per terabyte. And when we move to HAMR fairly soon, then you will see that cost curve to decline very rapidly, and not much better aligned to the NAND curve.

Yes. That's a great point. And at the same time, I mean, when I look at the amount of capacity shipped in the enterprise market, we haven't really changed over the last handful of years, right, we're still shipping the same amount of flash as relative to hard disk drives that we shipped several years ago. So it hasn't -- you're definitely supportive of that comment. Before I shift over to Gianluca to talk a little bit about the business. One of the things that I don't get many investors ask me about, but I'm curious is that the MACH.2 dual-actuator solution in your product portfolio. Can you just help us understand the importance of that, what that drives, and competitive differentiation of that technology in your portfolio?

Absolutely. That's a great question. Thanks for asking. One -- in many use cases, there's this notion of stranded capacity, which is a kind of like a portion of this available capacity on a drive that can't be used by the application because the performance is too low to achieve the end user SLA, the end user service level agreement that's desired for that use case. And in collaboration with a number of our customers, we initiated efforts to architect and the dual-actuator drive to address that challenge of stranded capacity. And I'm really happy to say that we had great collaboration that was really focused on solving a very specific challenge in achieving that performance at lowest total cost of ownership in this use case. And we did that work with a leading cloud service provider, and we're now in volume production with that drive, and we expect this to be a kind of the leading edge. There's more -- there will be more opportunity, and we're broadening the collaborations that we have, not just with cloud service providers, but with other parts of the infrastructure community, including areas like content distribution at edge. And our expectation is over the next several years as drive capacities increase, there's going to be increasingly greater demand for that type of drive architecture, so that the SLAs can be achieved at a lower total cost of ownership than any alternative would provide.

Yes. Very interesting. And you're seeing more -- are you seeing more of the cloud guys come to you and want to optimize architecture? I mean, is there any customization that you're actually being asked to work with specific cloud guys on at the drive level?

Yes. I think generally, that's fairly standard practice in the industry that there's a certain level of customization. Frequently, it's firmware customization. So think device features that they can activate through the host interface, but it's a standard practice in our industry to work with the end user in these mass capacity use cases to architect device features that deliver greater value in their deployments.

Yes. That's perfect. So Gianluca, in the 12-or-so minutes we have left. Ask you a few questions. And John, to the extent it ties back to what you're involved in, please jump in. I'm not going to ask you how the current quarter is going, but I'm going to ask you just to a kind of help us appreciate what you've been saying, what you're seeing? Any kind of things that you can share with us from a demand profile perspective right now?

Yes. The end demand is really strong and is well aligned to what we discussed at our last earnings release. So we don't see major differences from what we discussed about a month ago. I would say every quarter is presenting a different challenge since like beginning of calendar '20. So it's about 2 years now where every quarter there is something that we need to take care. And of course, I think the company did a very good job every quarter to overcome those challenges from an operational standpoint. And I think this quarter is exactly the same. The supply chain is a bit disrupted for sure. But I don't see at this point any impact to our trend in terms of long term operations in terms of volume that we can ship into the market. Maybe the ...

And when you talk about -- I'm sorry, Gianluca, go ahead.

I will say maybe the only financial impact that was not completely planned is a continued increase in the freight charges. And now we discussed that for several quarters. The last time we gave an indication of the impact was in the June quarter, and that was about $30 million, about 1% impact to our gross margin. In September, we didn't really reported the exact amount, but we said it's actually higher than the June amount. And what was a bit of a surprise already at that point. We saw that $30 million was probably a number that was going to be fairly stable for at least a few quarters, and then actually improve from that and decline. But now, for several reasons, we see the freight charges actually continue to increase. So the December quarter, I believe, at this point, looking at the volume that we are shipping, and the rate for the freight, I think, will be even higher than September. So that is the part that is behaving a bit differently from what internally we were expecting. Now we were expecting to be fairly stable, but actually, that part is continuing to increase. But apart from that from an operational standpoint, from a volume, from a shipment, we are fairly aligned to our plan.

When you talk about supply chain, and I can appreciate the freight cost, I'm certain you're not going to exactly quantify what that impact is. I don't think you guys gave a guidance on gross margin specifically in the quarter. But on supply chain, is it more about stuff that's outside of your business? Or are you faced with any supply constraints or labor shortage is impacting your ability to supply relative to demand?

Well, I would say we have different challenges. Some are internal, some are external, but we will not be finally impacted in the quarter -- for the shipment in the quarter. As we have done in the past, now we have actions in place in order to recover from those challenges and the impact. Now some, of course, is a little bit of more inventory. So we have some strategic inventory to overcome short-term shortages. And of course, we have a lot of safety rules in our own site. So we've tried to avoid as much as possible any impact from the COVID situation. So it's no different than the prior quarter, I think it's difficult to manage, but I think we will have the volume that we need.

Yes. That's perfect. In the last couple of quarters, one of the things -- there's 2 things that I felt that has started to resonate in the hard disk drive industry. Obviously, it's a competitively narrow landscape, right, which is historically good. I've also started to see, and I think we've talked about it too. Gianluca, is that there seems to be some invoked discipline, increased discipline, if you will, around pricing behavior and maybe that segues into a kind of the structural gross margin discussion of the industry, maybe stripping out COVID and freight cost dynamics. So can you unpack that a little bit? What are you seeing from a pricing perspective, do you agree with the discipline that we've alluded in the industry?

Yes, you are absolutely right. I think the discipline is mainly on the CapEx side. So in the past, also because of the decline in the legacy business, there was a lot of capacity that was not utilized. And of course, now the focus from now the players want to use as much as possible that capacity and the focus was on volume more than profitability. About a year ago, even a little bit longer. I think the industry is becoming more disciplined on how we spend our CapEx, and the timing of the spending, and that is a much better alignment now between supply and demand. That is why the pricing is behaving differently. It's not because of the players, it's because of the discipline in the CapEx, and driving that alignment between supply and demand that is finally giving a more stable passing environment and, I would say, a more reasonable return and profitability to this industry, but for sure, they serve a much higher return from all the investment in R&D, and the manufacturing that we have done in the last several years.

Yes. That's helpful. And the mix obviously is an important variable to that as you -- and appreciating that HAMR ramp is a consideration. But if some were to come to you and say, look, there's more, again, ex-COVID freight cost aside, there's more of an upward bias to you putting gross margin closer to that high end of the range of 30% to 33% or maybe even we see a scenario where we could move above that. Would you say, hey, wait a minute, are, there's no way there are certain things to consider? Or do you think that discipline starts to change that gross margin thought?

Yes. I think in the last few quarters, we moved from like 26% to 31% despite COVID. And now the last time we quantified the COVID impact was already 1%. So I would say if you excludes the COVID impact, we are already in the upper half of that range of 31% to 33% that now we indicated as our long-term target model for the next couple of years. So we actually went faster in that gross margin improvement than what we were thinking, not maybe a year ago. So I would say when the COVID cost will start to abate, I think that improvement will stay with Seagate. And that will increase our profitability on top of the continuous increase in the mix going to mark capacity. The continued increase in moving demand to the cost-optimized products that we have that are the products that have 2-terabyte per disk. And then, of course, there is -- but it's a normal efficiency in our manufacturing that tends to not decline our cost per terabyte. And if pricing remains fairly stable, all that will continue to improves our -- increase our gross margin.

And to the extent that, that were to play out, would -- is there anything that you would structurally think differently around the operating expense management of the company? I mean I think you've been obviously executing above, I think a little bit above this last quarter, your high end of your 20% EBIT operating margin. Would you reinvest some of that? Or would you continue to let that drive EBIT leverage in the model? Just curious.

Well, I'll say that are different items. The first one is we spent a lot in the past on developing the HAMR technology, not the product, but the real technology. And that I think is behind us. So that part is now could eventually be reduced. But at the same time, we are now focusing a lot on going fast in the product development for the new HAMR product, another 30-terabyte, and then the 36 or next to the following generations. And also very important for us is we have a new business, what we call Lyve. That business requires some OpEx, now is it's not an enormous amount of OpEx, of course, but there is a little bit of a shift in our OpEx between the core hard disk business and the Lyve business. But in total, I don't see a major change in our OpEx level.

That's very helpful. And then a couple of minutes we've got left. I think I would be remised not to ask you about, a big part of Seagate story is that you've been a solid free cash flow generator, and you've been very much shareholder friendly as far as capital return. So I think you've shrunk share count by over 15% over the last couple of years. So as you look at the balance sheet, just free cash flow generation, remind me again of how you're thinking about capital allocation, capital return strategy?

Yes. I would say our strategy has not changed in the last probably almost 2 years. So what we have done is, first of all, we have relooked at the CapEx. So we have reduced our CapEx. This is contributing to a higher generation of free cash flow. So free cash flow is really strong right now. You have seen in the last couple of quarters, we were well above the $350 million a quarter. Last quarter was like $380 million. I think now this trend can continue. And a little bit less than half of that free cash flow is going directly to our shareholders through dividends. And we want to be very programmatic with dividends, with annual dividend increase every time we can. In the last 3 years, we increased the dividend. We increased by 3% twice, and by 5%, almost 5% last year. So it is a good part of our shareholder return, but share buyback is also very important. We are less programmatic and maybe more opportunistic with the share buyback. So I would notice that a fixed amount every quarter. We are a little bit more variable depending from the share price from the other opportunities that we have, the liquidity that we have available at that time. But of course, we now have taken advantage of the lower share price in the last year, we were buying back at $50, $60, $70. So I think so far, has worked very well, and is still a big part of our strategy because even at the level of today, we believe -- we strongly believe the company is still well underway.

Yes. And those were great share repurchases. In the -- literally less than 1 minute I got, on that topic, liquidity, right? You've got about $1 billion of cash from the balance sheet. You've got obviously some leverage on the balance sheet. Remind us again the liquidity that you feel comfortable running the business with? And then I'll let you get on with your day.

Yes. No, I think we want to have about at least $2 billion in liquidity, and now we have more than $1.7 billion in our revolver. So we are well above that level. We already informed the Street that in October, we raised a little bit more debt. So our cash balance is also increasing right now. We have a repayment coming due in February, now about $200 million. So we will repay that debt note that is maturing in February. But I mean, so far, we have ample liquidity to now manage our business and continue our share buyback.

That's fantastic. Great overview, guys. I really appreciate you taking the time this afternoon. And again, thanks so much.

Thank you, Aaron. It's always a pleasure to talk to you.

Thank you.

Thank you.