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

Good afternoon. Hi, I'm Tim Arcuri. I'm the semi and semi equipment analyst here at UBS. Very pleased to have Seagate next. We have Gianluca Romano, who's the CFO at Seagate. Seagate might be the best performing stock that I cover this year. So things have been going obviously very well for you.

So let's just start off on the point of, obviously, supply/demand is very tight, and you've maintained your strategy of not expanding unit capacity. And so can you just talk about what's driving this supply-demand tightness?

Yes. Thank you, Tim. And before we start, let me remind everyone that I will be making forward-looking statements today, and you can learn more about the risk associated with this statement on our website. Well, supply/demand is very important, of course, in every industry is now more than 2 years, but demand is above supply. And for us and I think for the industry is important is to increase exabyte, not to increase units. Now we think in the longer term, the way to meet demand or at least get closer to the real demand. is moving our customers into our highest capacity drives. And with the technology, we can go from 2 terabyte to 40 terabytes that is in today, to 50 terabytes and beyond. So we don't think it's needed to increase the units. I think the best way is to generate what our customers need that is more exabyte through our product road map. And I think the industry is fairly well aligned on this.

And is there a point though, that your customers force the issue, do they come in and they prepay for you to expand capacity? And have you been offered any prepayments from your customers? And if you were offered prepayments, would you even take them at this point?

Well, actually, we don't really need our customers to pay for capacity. If one day, we will decide to have more capacity in terms of units, we will pay for that ourselves and not having any link or any constraint from our customer on how we use our manufacturing. But as I said before, we don't see the need right now to increase the units.

And is there a -- like what's the endgame? Is there a point at which gross margin gets to x 45, 50, maybe even? Is there a point where you feel like you're sort of earning your portion of the profit pool of the ecosystem where you then say, okay, we'll start to add supply?

Well, no, we focus on improving our profitability more than 2 years ago, I would say, 10 quarters ago. and we're starting to implement the 2 orders, and we start to implement a certain pricing strategy. But I think it's not disruptive to our customers. It's very consistent, but it's not increasing pricing in a way that is surprising or in a way that is disruptive to our customers. That has worked very well for our profitability. Now we improved our gross margin by -- we double actually our gross margin in less than 10 quarters. We don't have a specific target. I think the situation is today very similar to what it was 10 quarters ago. So there is no reason to change our strategy. I think we need to continue to be consistent to move our customers to higher capacity drives, moving the mix up is where we improve our profitability the most because with a fairly consistent pricing, we can take all the reduction in cost per terabyte and using that as an improvement for our gross margin and operating margin.

Got it. Now this question might be hard for you to answer but is there a way to assess how much you're undershipping demand? And I guess I asked the question because you're booked out through 2026, you're booking into 2027. So I guess by definition because you're booked all the way out through next year, if you were shipping to demand, then your revenue would be 2x what it currently is. So what is the sort of if the supply chain was totally unconstrained, and if you were producing as any drive is what everybody wanted, how much higher would your revenue be?

Well, it will be significantly higher. I said a few times today in other meetings, the gap between supply and demand in the last 6 months has actually grown. Now I don't think our disk is the main constraint into data center buildup. So over our other part and other components in the data center that are probably the main constraint. So we are fairly high in the list and it's nice to be there, but we are not the blocking point. And I think with our product road map and with our customers qualifying fairly quickly, our highest capacity drives that will generate enough exabyte to supply what is really needed in the short term. Of course, it's not covering extra inventory or a safety stock but is covering the data center that have been built and are being built today. No, I have no evidence of any data centers that is built and there's not enough are this driving store. So I think this is a very good situation for us. We have this gap between supply and demand, but we are not the blocking point in building new data centers.

What do you think it is? .

I think today is power, but now in the future can be other components in the past, some semiconductor components that were the blocking point and right now is probably power.

So let's talk about demand. There have been some emerging. I mean, obviously, AI is now trickling over and is driving an increase in demand for hard drives. Can you talk about some of the applications that are AI-driven that are driving demand for Seagate?

Yes. I would say AI is one of the applications that is driving storage. It's not the only one. But for sure, in the last few quarters, we have seen a fairly huge increase in consumption, storage consumption from AI. Part of that, but I think it's still the beginning is the video part. So AI video is starting to be used and starting to consume a fairly important part of the storage. In the past, we have seen the application, the new application to be adopted, maybe a little bit lower than what people were thinking. And I think probably even AI in the last 2 years was not adopted as fast as some people could think. Now we see an acceleration. And to the AI infrastructure is getting bigger. The AI application are starting to generate more and more data and video could be a major driver for more storage need in the next several years.

And how do you prevent -- we hear some examples of customers migrating what maybe might have been HDD over to SSD. I know there's this there's this push-pull between what's going on in SSD and what's going on in HDD. Can you just talk about that? I know that you don't view it as really competing for the same workload. So maybe you can talk about that.

No, I don't think -- as I said before, I don't think there is any data center that is short in our disks today and that push our customers to spend or 8x more to buy the storage where they need for that specific data center. Now I think it's more a theoretical solution in case this became the crossing point for new data centers. In that case, maybe some customers could decide to spend a lot more money to buy different components to do storage, a component that is not used for storage today in the data center, but it's used to run the application could be used for storage, but the cost is so much higher that we have not seen it happening and I don't see that happening. As I said for I think was the data center that are being built will have enough for disk to cover the storage part.

So you think that to the extent there is some examples where lead SSD times are shorter, and so they're just buying just in case they're maybe buying as a testing case?

No, I think NAND and DRAM and other components are growing in the data center because they are used to run the application. And as I said before, many applications, including AI, are growing, so they need more DRAM and more NAND and because they generate data, they need more storage. The storage is on our disk.

Got it. And just the point about -- and I asked you about this a lot, the idea that your lead times are 52 weeks plus now. And these are very, very wealthy companies, the wealthiest companies in the world and if they need -- they're going to make sure they get what they need. So how do you prevent them from double ordering? And maybe double ordering is not even the right word because they would just place orders out further because it isn't like you could ship anything else today anyway because you don't have the capacity. So how do you prevent that from happening? Or would you say, well, fine, let them double order, all that doesn't just fill our backlog out further. And if they don't take it at that point, then we'll kind of deal with it then.

Yes, that's the right point, no. We pushed demand to the future. Today, not serving the full demand. We are just pushing part of what we meant to the future. This works well until we -- eventually our disk becomes the bottleneck of a buildup of data center. And as I said before, we don't see -- we have not seen this happening. So we are just pushing this as an industry, I think we are pushing this demand out in time. As every technology industry, I think we will have cycles even in the future, but pushing this demand to the future will at least decrease the impact of the down cycle when and if it will happen. So it was worth for us and for the industry, I think it will work well also for our customers because until this industry is providing enough exabyte for what they need today and tomorrow, they will not have problem on storage.

Great. And I know you don't give us orders, you don't give us book-to-bill. But I guess maybe to get an idea of how the trajectory of bookings are -- are bookings volatile quarter-to-quarter now? Or have they continued to get better, if you did give us a bookings number, it would just -- it would be up every quarter? Or do they come in lumps?

Now of course, there are different negotiations with different customers in different quarters, but we already said for calendar '26, we have already basically allocated all our near line capacity to our top customers. So when we go longer, for us is less important because what we want to have is orders covering products that we start in our manufacturing. And because the lead time is about 3 quarters, especially for a hammer. We want to have orders in place so that we have a certain mix with a certain price, a certain time to deliver. And we have covered more than 3 quarters. We have over now 4 or 5 quarters already. When we go longer, the reason why we go longer is only because customers are asking. And they asked to have a certain confidence on a certain level of exabytes that we will allocate to them even after the next 4 quarters, so for calendar '27 and maybe '28. So those are different kind of agreements. They are not firm order where we have for the calendar '26. It's basically an agreement on how many exabytes we will allocate to them in the longer term. And then when we get closer in time, we will based on what they are qualified, or which products are qualified, we will define the product, the volume for that product and the price.

Great. Let's talk about the tech road map and obviously, we'll talk about HAMR. It sounds like 5 CSPs are qualified and 3 more are being qualified in the first half of next year. Can you talk -- it seems like the velocity of these qualifications is actually picking up. So maybe is there some seeing the cover that went first, seeing them go first now has that sort of grease the skids to now say, Well, they've qualified it and now we all want to qualify it too. And then can you also speak to sort of when we should expect the exabyte crossover to be for HAMR?

Well, in general, customer cares about exabyte. And to get more exabyte, they need to qualify drives that have higher capacity per unit. So this is why they want to qualify HAMR drives because they are the one the highest capacity per unit. We needed a little bit of time to qualify the first customer in the cloud space. And after that, when we find the right configuration for the first customer, every other customer went very fast and actually went faster than what we were expecting, which is why after our Investor Day, we gave a certain model. And we have a little bit outperformed that model until now, mainly because we were able to move more customers quickly to HAMR and move the mix up. So we have now 5. We have 2 or 3 more, but 2 of the 5 are already qualifying the second generation HAMR, which is a 40 terabyte drive. So they go as fast as they can and we didn't have any issue on qualification, except that fast delay on the first drive with the first customer.

And then relative to crossover, I think -- I believe you said that crossover will happen in the back half of next year, second half of calendar next year. .

Yes. We said by the end of this fiscal year, so by June, 40% of our exabyte will be sold with HAMR product and 4 quarters later, so at the end of our fiscal '27, 70% of the volume will be sold with HAMR products.

And why would it take -- if everyone's qualifying HAMR, I think that the crossover would happen faster. Is there -- can you just talk about that?

Well, I would say, first, we qualify, then we take the order and we have to ramp and sell. So it's maybe a little bit different than what was happening in the past. In the past, when we had a new product, we were ramping and then trying to find home for those products. Now we are in a very different situation. And we want to be sure that we have a customer qualified before we dedicate manufacturing to a product that otherwise remain unsold. And of course, demand is so strong today, that you don't want to have manufacturing allocated to something that you need to wait another 2 or 3 months before you can sell it. So we go a little bit lower but we are very reliable no, and we are very consistent. So we need to qualify more customers in the ramp. I think now going to of our capacity in basically 3, 4 quarters and then going to 70% is a good ramp. And of course, now if we can go faster, we'll go faster but I think is a good model.

Let's talk about gross margin for a moment. Gross margins expanded 400 to 500 basis points in the last calendar year. How much of that is from better price ad versus better utilization versus other factors?

Would say mix is a very important factor to improve our gross margin. Of course, now if you look our gross margin 10 quarters ago was probably up what it is today. And part of that improvement at the beginning was the underutilization charges that started to be absorbed. But after that, before -- between the pricing that has been consistent for 10 more quarters and the mix of moving customers to the higher capacity drives where we have the lowest cost is actually the main factor to improve our gross margin. And that's been for more than 2 years now.

And do you think -- I remember a conversation we had maybe on a bus trip or something, and we had a conversation about how high you can push gross margin. And I think your comment was, well, there are a lot of companies in the hardware supply chain that in the continuum of all these companies, you have very, very low margins. And so I think your point was there's no reason why someone who sell this mission critical of a product as we sell, no reason why gross margin can't be much higher. And I think you weren't saying 50%, but I sort of read that there's no reason why if you look at the continuum of who captures the value, there's no reason why your gross margins couldn't be 50%. Can you kind of talk about that? Do you think -- is there a point where the customer begins to push back and say, Listen, I can't let you have gross margins this high?

Well, first of all, I don't think our customers are looking particularly at our margin. Now I think they look at the return that they get from our product. And I think they get a very high return. We are very consistent in the pricing strategy, but it's no reason to change it right now. Actually, I think if something eventually happen is gap from between supply and demand is a little bit bigger, not smaller. So I don't see any reason why we should change. And very importantly, we are just at the beginning of our second generation. This is a product that will reduce our cost per terabyte much more than the first generation HAMR. And that will be another boost to our profitability. So we don't have a specific target. I don't think our customers are looking at a specific limit for us and then starting to push back more than what they do today. So I think we will be consistent. And I think for the next 2 or 3 years, where we have visibility, it looks no different than what has been in the last 2 or 3 years.

And then if we kind of play this out and if and when things do reach a peak and we look back and we say, oh, that was the first sign of you as a company. That was the first sign we saw that happen. And in retrospect, that was the thing that should have made us concerned. Is it -- would you expect it to be -- the demand in the longer term would begin to fade because you're booked out in the near term. So you'd think that the stuff booking into 2027 would often first if that -- if we did see finance often, that's where it would soften versus that. That's sort of how you think about -- you have people looking at this and what's the first sign that you're looking at every week to make sure things are out?

Yes, I think you're right. I think when we start looking at new orders coming at a lower volume than the current orders, that's probably a sign that or there is a slowdown in data center buildup or they have built some inventory, but they needed it to be less for a while. Another sign is when we can be a little bit more exabyte in a quarter, and we put that volume in the market. Now today is going to be sold very quickly even if the right is actually higher than the normal orders. So if we don't see that volume being purchased quickly, that's another possible sign. So we monitor those. Of course, we talk a lot with our customers also. So we are not even close to that situation today, but there are 2 very important metrics that we need to monitor.

And let's actually talk about cash for a moment. You're generating a lot of cash. And let's talk about capital return. How should we think about capital return as you pay down debt because you're essentially almost at the point where you want to get debt to. Can we see a scenario where you ramp up share repo? And what are the metrics there?

Yes, we will. I would say we have reduced the debt from more than $6 billion to $4.5 billion at this point. Maybe we can reduce it as a bit more, but probably not much more. We have addressed part of the convertible in the current quarter. Maybe we will address a little bit more in the next few quarters. But generally, no, we have always been very focused on shareholder return. We have increased our dividend again in the last board meeting in October. And we have started the share buyback in the September quarter. So I think in the next few quarters, you will see higher level of share buyback.

Great. And let's talk about demand growth. So I believe demand growth somewhere in the mid-20s CAGR over the next 3 years is sort of what you've said. And in the near term, though, it seems like it's higher than that. Is that the right way you're thinking about demand growth CAGR?

Yes. When we gave the model was not for a few quarters, it was actually for 3, 4 years. So that 25% extra by CAGR, you need to look on a longer period of time. In the short term, we have done better in term of volume, in term of revenue, in term of profitability. I think the model is a good model. I think it's a model that will show a lot of improvements in the company, top line and bottom line. But of course, every quarter, we try to do as well as we can and to optimize all our manufacturing, all our opportunity to improve profitability, and we have done better than what we were expecting for a few quarters, and we will continue to do it.

Great. And let's go back to the HDD versus SSD question. So obviously, NAND pricing is going up a lot. So the gap -- as you can push to higher capacity drives, you would think that the gap probably doesn't close a whole lot, given that NAND, if at all, given that NAND prices are going up so much. Can you just talk about that? Where does the TCO gap stand today? And sort of what is your outlook as you bring on HAMR because things seem to be going the opposite direction. You're scaling density and NAND prices are going up.

That's correct. No, I think the gap between the NAND cost and that are this drive cost is actually going to increase in the several quarters and years. is just at the beginning. So usually the cost decline that you get from a new technology is more relevant at the beginning. So when you go from 30 terabyte to 40 terabytes, you increase your capacity per unit by more than 30%. And then 40 to 50, you have another 25% and start to maybe decline a little bit. The cost improvement that you get at the beginning of a new technology is huge, like NAND when they move from planner to vertical was a huge decline. But with the time tend to decline. So NAND is still declining in terms of cost, possibly not in terms of pricing, I don't know that is very variable. Our risk at least for us, but we have HAMR, we will have major cost decline right now and for the next several years, especially when we go to the first 2, 3, 4 generation of HAMR.

And how do you plan to free up more capacity for HAMR? Is there an area where you'll start to buy heads from TDK? And what is the biggest constraint right now on capacity? Is it heads?

Well, that is a little bit of a problem, right? Because when you move from the old technology to the new one, the cycle time is longer. So cycle time for the ad, cycle time for final test. So to build the same number of units, it's not easy. We need to improve our efficiency internally in order to try to keep a lease number of units so that the improvement that we can get from the technology transition will actually result in our full 25% and doesn't get declined because the units start to go down. So we have a fairly -- no, you said it was not very aggressive, but I think we are fairly aggressive around to her, and we are the only one producing HAMR heads. So it's not that we can use someone else to help us in getting more heads. But no, we can have eventually if there is capacity available that I doubt -- so today, we don't buy any external -- but if in the future, there is some had available that we can use to keep the units where they are. So not to decline the number of units because of the longer cycle than we can, of course, use it. Now I think we don't talk in specific customers or suppliers, but I think TD generally is supporting another producer of our risk. So I think they consume the majority of that. But if they don't, for any reason, I will be happy to take some of those adds in the future just to keep the units worth yes and reducing the impact of longer cycle time of me. But again, eventually, it very short term because when we move to HAMR, we don't have any opportunity to go outside.

Sure. And maybe just last question. So we all there's been this trend on these conference calls to ask companies, well, what's your portion of -- if there's a gigawatt announced, how much do you get from that gigawatt, and I'll begin with Jensen saying that he gets well, ultimately now between $35 billion and $40 billion per gigawatt -- and so not on a per gigabyte basis, but on a customer CapEx basis, when a data center customer spends $1 billion, how much of that -- is there a rough way to think about how much of that goes to HDD?

Well, statistically and looking historically, I would say we are mid-single digit of the CapEx as artist industry. So every quarter is different. But now if you look at the longer term, mid- to high single digit is probably where they are this is.

Great. We've run out of time, but thank you, Gianluca.

Thank you very much.

Thank you.