Seagate Technology Holdings plc ($STX)

All right. Good morning, everyone. I'm Krish Sankar from TD Cowen. I'm the analyst covering Seagate where we are fortune to have Gianluca, the CFO. Also Shanye from the IR team here. Seagate, obviously, as you know, one of the leaders in hard drives. Gianluca, thank you very much for your time. And while I'm on it, I'll also tell every investor on this like please do vote for TD Cowen [indiscernible].

So with that, let's start. I think -- look, I think what is kind of interesting is that I think there seems to have been some confusion last week. There are some folks assume that there's capacity addition. But I think can you just clarify what's going on? Because I think what has been pretty like consistent with what you have spoken in the past is mid-20% exabyte growth. probably not real unit capacity addition does anything change is still that the narrative today.

Yes. Thank you, Krish. Always nice to meet with you. Before we start, let me say that I will be making forward-looking statements today, and you can learn more about the risk associated with those statements on our website. So short answer to your question is no, we are not adding any unit capacity. We think our technology road map is really strong. So we can generate the exabyte that we need through technology transition going from fourth generation met second generation. We already discussed at our earnings release about third-generation MR that is 5 terabyte per disk, so a 50 terabyte drive, that we will start qualifying at the end of next calendar year. So our road map is really good. We think we generate about 25% increase in exabyte year-over-year through technology road map. So we don't need more units.

Got you. And then what about head capacity addition? Is tha a slightly different story compared to units or...

No, really, I would say, no, we produce as a media. So they add to read and write the data and the met is a disk. We also buy a lot of other components externally, but the technology is in those 2 components as the media. So depending how you assemble the drive, if you are drive or a drive or attendees drive for the same number of units, you can need a little bit different number of heads of media. So depend where the mix is going. But generally, I would say our focus is keeping the units very stable and, of course, increase the exabithat we generate through this change in mix, change in technology and transition every 18 months, 24 months to a new generation of MR that give us, in this case, not from for generation ever to second generation Mr give us more than 30% increase in exabyte and then from the second to the tort so we can grow through technology, we don't need more units.

Got it. And also, along the same path, when you look at it, clearly, demand is strong. I think last time we spoke about kind of but I kind of sold out for all of 2027. Is that still the case? What is the visibility into 2028? And how to think about some of the LTAs that you signed?

Yes. So we have 2 different kind of agreements. For the next 4 to 5 quarters, we have orders. So an order as specific products, specific volumes, specific price and time to deliver the broad -- so we always want to cover the next 4 to 5 quarters because this is the time we need to produce an artistic or to produce an MRR this drive, you need about 3/4. So we want 3, 4, 5 quarters that are fully defined. When we start the product in our manufacturing, we know exactly who will buy it and in what price. After that, we have LTAs that are agreement based on exabyte. So for our customers, it's very important to know what kind of storage they can get 2 years out in time, 3 years out of time, even longer because they need to plan their new data centers. So the price is less important. The mix is less important. They don't even know what products they will be qualified 3 years out in time. But they want to know how many exabytes were allocated to them because they know how many data centers they can build. So we have agreement on exabyte. But then when we arrive into that 4 to 5 quarter range, we translate the exabyte LTA into an order. -- the point is I know what is the product that they are qualified. We know how much we can ramp up the product. And so we have -- usually, we have a list of products where they buy not only one. We define the price and we define exactly when we ship.

But historically, if I remember right, the pricing was negotiated on a quarterly basis, but now has it changed to an annual basis?

Is depending from the customer and the duration of the orders is 3, 4, 5 quarters.

Got you. The other interesting thing I remember is that in the past, you mentioned that 70% of hard drive demand comes from new data center openings. How do you track that? Because obviously, there are a lot of things that goes into a new data center opening? Obviously, they are a deal with like permitting process, power supply, things like that. So how much visibility do you get? And in that build-out process, where do you come in? Are you like a late-stage purchase from a data center build-out standpoint early you qualify?

Yes. We have 2 major segments, data center and edge. -- data center today is probably 80% of our revenue. So it's growing, has grown a lot in the last 2 or 3 years. In particular, public cloud is the subsegment inside data center that is growing the fastest. So we're already 80% of revenue, more than that in terms of exabyte. So we see this trend continuing. Now data center is growing faster than any other segment. But we also see a good demand on the edge. So today -- and the edge is where we compete with NAND. So low capacity drives 2 terabyte terabytes, 8 terabyte right more because NAND price is so high, but it's a good opportunity for Artis to increase price. And we don't have purchase order in that segment. So we can be more -- we can increase price faster. And now demand is also higher. But again, it's not the majority of our business, only 20% of our rating. -- data center, much more structure. We have those purchase order in place where the price is defined, price is increasing, but it's a different kind of trajectory. And in the data center, as you know, we don't really compete with NIM. So the NAND price has no influence on our demand. NAND is used to run the application on the compute side, RDS gives useful storage. So very different applications.

Got you. I mean it kind of makes sense because I think hard drives is probably up to 2% of data center CapEx while NAND prose 40% now with the price increase. So you're not the problem, Chile, but they think that the very good. Is the memory price increase, i.e., DRAM NAND price increase slowing down data center build-out?

So far, probably not much. I'll say what we try to do is not to be the main problem. So we don't want to be a component that is limiting the development of the data center. So in the past, you have seen the power being the bottleneck probably still the bottleneck, the GPUs were bottleneck possibly DRAM is becoming the bottleneck. So we are always number of 2, 3 or 4 in the list. Now it's a good place to be. Now we still have our power in the negotiation. We are not limiting their development. So we are not a problem for our customers.

And the other thing that are noticed is compared to last year, I think last quarter is obvious from your numbers and your competitors' numbers, the pricing is getting better or a little more better than historically. So stores like more like mid- to high single digits. Now it looks like we'll be low double digit. Obviously, it's still not a product trend, so you could probably increase pricing further may not be an issue. But what is the thought process behind price increase? And how sustainable is this run rate over the next couple of years?

Well, we know it's sustainable because we already have PO in places. So we -- as we said at our earnings release, we see not only this quarter, but no, we guided more precisely, but we also discussed about the next quarters. And we said every quarter, you will see revenue increase, and you will see profitability increase. Of course, a good part of that improvement is coming from pricing. We are executing a very good strategy that is not being super aggressive with price, but be very, very consistent. So every quarter, you see the price up. Every quarter, you see that exabyte up, no units, but exabyte. So revenue is growing very well and profitability is growing extremely well.

And then the other thing that was kind of interesting, when you look at last year, I would say, the inflection for hard drives really started when started seeing videos -- AI videos and things like that. Today, how do you see that? Is that still a big trend? Or is it like more data retention? What is the driver today and into next year for the next leg of the power drive demand?

Yes. I would say there are different drivers. I would say the positive part for our risk is that on storage, on our disk. You don't need a different mix, different kind of RDS depending from what kind of data you want to store. So if it is a video AI or a traditional video or data in form of text -- they all get store in the same artist. So it's a good simplification for us in terms of what we have to produce and what we have to generate. I would say VDI is huge. Retention started probably 2 years ago. So when companies and people were starting to use AI, the 4 things we all did is stop deleting data because if you want to have good result from running AI, you need to have a lot of data. So data retention already started 2 years ago. And then you started to have AI generating data itself as an application. And the beauty for us in terms of data generation and data storage is, AI is very quick. So generate a lot of more data than humans. It works 24/7 every day, no problem. And generate data that you need even if -- even as a step through the final result. So everything that AI generate gets stored and then get used again to generate something else until you arrive to the final result. So a lot of benefit from AI. But it's not the only application. Of course, robotics is...

And the other thing that Karen noticed is compared to last year, I think last quarter, use the service of surveillance. So...

In that case, they buy big drugs. They buy 20 terabytes historically so -- but not a lot of observation some alectinib. -- be low double digits, a lot of application but a lot of storage Obviously, it's a product center. You could probably increase a not issue, -- but.

What is the thought process behind the pricing disease -- and how in the audience side of the question.

We know it's sustainable because we already have.

So the other thing when you look at your to call down double about the next the cost -- is the port moving to HAMR like you think that is below double digit for this cost trying to improve obviously it's still not a product things pricing not be about -- what is the thought on.

Now it's sustainable because we already look as a product as we said going from fourth-generation Marcotterabi drive to second-generation M40 terabyte drive. The unit cost is fairly similar, but you have Tetrabymore. So we have actually a fairly huge decline in terms of cost per terabyte. When you look at the entire company, the entire P&L, doesn't depend only from the last broader. We sell from 2-terabyte drive to 40 terabyte dry. So the cost in the period depends how this mix move up. And so it's not only the large product. But with the time moving more and more into EM, especially at the beginning of the technology where you increased 23% going from full generation to second is a good improvement of our cost decline. When you go from 40 terabyte 50 terabyte in percentage, that is 25%. So it's still the same similar unit cost you had the same 10 terabyte 14% is a bit lower. So depending on how you calculate. But I would say, of course, Mr is advantageous for the cost. But every period is different. Every quarter is different. It depends on how many PMR we are still selling and what is the segment in specific quarter that is getting more volume. So it's not so linear -- but I would say Emmerlonger-term will be, of course, the way to reduce cost in the industry. Otherwise, with the old technology with PMR technology continue to add on disat,tan ends can toad until your space in the box. But -- so the cost per unit goes up because you need to increase the bill of material. With them, you keep the tens, 20 ads from 30-terabyte 40 terabyte drive 50 terabytes. So the bill of material remained consistent -- of course, the components are not the same. So there is an increase on some of those components. So -- but the unit cost is fairly similar.

Are there any pressures on that because 1 of the things is like, for example, you get a glass from whole someone, but they also have increasing demand from the optics and photonics folks. So is there anything any disproportionate pricing where other sectors are actually willing to pay a premium causing your cost to go up because you are to probably match that to secure those components.

Well, no, supply chain, of course, is very important. And as I said before, we buy a lot of components. We buy electronics. We buy memories, but as you know, are fairly expensive today. and we buy a lot of other mechanical components. So of course, every year is different. -- years with higher inflation, here with lower inflation, here where there is a shortage of 1 component, so we need to spend more -- so my discussion is keeping those at the same level, you have this clearly no strong reduction in cost per terabyte. But as I said before, every period is different. Right now, we have memories costing more for sure. So -- but you cannot compare -- it's not because of the technology, it's because of the component. -- but you need to adjust your estimate based on how you see those components cost evolving, yes.

Got you. Because I think, clearly, the demand is very strong, doing these cost down already at like 50% plus gross margin. I think we all speculated that it's a rational duopoly, so you should be at 65% gross margin. And it seems like there's a path to get there easily, maybe exceed, but I think realistically, get to mid-60% gross margin. From your view, I mean, I'm not looking for guidance, but is that a fair assumption given the trajectory of demand and trajectory of your cost downs?

I would say the assumption of continuing to improve is very fair. No, we actually said that just a few weeks ago. We said we are this quarter plus other 4 of improvement. And no, this quarter, we are guiding a gross margin that is above 50%. So if we continue to improve, we continue to improve, so we will go. But we don't have a gross margin target. So it's not a number that when we achieve, we just say, okay, let's buy enough, we stop there. We like how we run this strategy, and we have done it for 12 consecutive quarters. This is 13. We have other 4 that we know are coming, and we will continue to do that. And then 1 day, we will say, okay, this is the result that we have achieved. But we don't see an end at this point yet.

Got you. Because the other interesting thing you said earlier on, you're not adding unit capacity. You're still growing exabyte 25% to 30%. At that CAGR, your hyperscaler customers are not pressuring you to add more capacity. They are happy with the 25% to 30%.

I don't know if they are happy. I'm seeing there is pressure to do more because their unconstrained demand is for sure, higher. But every year, there is some components that get short. Right now, it's DRAM probably short and power is still short. So from that unconstrained demand, you need to go from what they can really build. And it's our assumption, it's not their assumption. Our assumption is if we increase the exabyte by about 25%, we will not be the component that is getting the development of the dataset. Well, we could be wrong, but we think 25% is good enough not to become the top of the list problem.

Got you. Because I mean, the reason I'm asking is it seems like you're doing 25% or 30% exabyte growth, slowly increasing pricing more than before, but customers are not pushing back, so they seem to be okay. In other words, if you go to, let's say, 35% exabyte growth, you're not the bottleneck. So your hyperscaler customers will still be constrained. So the marginal benefit is not much for you or them for you to go to like higher exabyte growth, right?

Yes. I'll say so far, this strategy has worked very well. We more than doubled our revenue. We more than doubled our profitability. So there is no reason to change. I think as -- this strategy has given us a great result. And our focus is to continue to execute the same strategy for the long time. And we have written 12, 13 quarters, so it's already fairly long. We don't see the ascending. We have another 4 quarters coming. And we will have more later because no, we see the exabyte that our customers are demanding for year 2 and year 3 and year 4 is actually way higher than what we have in our plan.

And then also, I think your own forecast is that I think probably next month or so, I think 40% of exabytes would be from Hammer -- and then maybe a year from now, 70% of your exabytes would be on Hammer. Is that still the plan? Or do you think that Hammer percentage is going to be higher than expected?

Well, we are ramping Hammer well, especially because the second-generation Hammer was qualified a little bit earlier than what we were thinking with the 2 major cloud customers. Of course, the percentage depends also from how much we produce on the old technology because now to achieve those percentages will be very easy just, not producing a lot of PMR when you have a lot of Hammer. It depends. We are trying to optimize exabyte and to optimize exabyte, we produce a lot of both, Hammer and PMR. So let's see. I think force priority is to achieve this 25% exabyte increase. Now as you said, in the past, we were able to do more. And that more is probably coming more from PMR than Hammer. Now we are ramping more Hammer. No, Hammer is ramping very well. I think we will be around those percentages, but it depends every quarter how we manage the 2 technology.

Got you. I think if you do the math, you're probably going to generate close to like $3 billion of free cash flow this year. I've been out to a dividend payment. You are about $4 billion in debt. How would you pride as the free cash flow? Is it like to mainly paid on debt? Would you consider repurchases of the stock price? Or do you think you probably need more supply chain preparedness for the ramp that it probably makes sense to invest more in your own business?

I'll say, longer term, we have as we have done in the past, our free cash flow is always focused on shareholder return between dividend and share buyback. In the short term, we have reduced our debt, going from about $6 billion to now a little bit less than 4. Now we can go over. Now we still have a little bit of the convertible to buy back. We did something recently. We will do the remaining possibly next quarter and maybe reduce debt even lower. But no longer after we have reduced the debt, now the free cash flow mainly we go to shareholders.

Got you. Got you. And is there any -- like do you see like in the past, like you mentioned that I think heads or media takes a year to bring it online. So even if you decide to add capacity today, you're probably looking at least a year before that becomes useful exabytes into the marketplace. Is that still the same? Or do you think there is like a more tightening potential in the supply chain where lead times can come shorter than today?

Well, I would say the cycle time of the wafer where we produce heads is about 9 months, let's say, 6 to 9 months depending on which technology, which product. If you need to build capacity like a greenfield, while that takes more than a year, I would say, possibly at least 2 years. So now we need to build their factory and then get the tools and qualify the tools. So it's long term.

I mean if you decide that capacity, would greenfield make the most sense or it will be more existing brownfield?

Well, right now, we are not look into that because no, we don't think we need to add units. I would say, if we arrive at the point in time of a certain decision, we will see what is the best solution. But again, in our plan, we don't have an increase of the number of factories that we...

One of the things you spoke about cost reduction. When I look at your footprint, manufacturing between the heads of wafers, the media, everything you're in like Singapore, Island, U.S., is there a consolidation angle in this to help get the cost reduction? Or do you think the footprint stays the way it is?

[Audio Gap] china, Thailand, we do assembly and final test again, Chinese used for our Chinese customers. Thailand is used for everyone else in the world. And then probably the only factories that are similar are the oen U.S. and Northern Ireland where in both places, we produce ads. But because we need that level of volume, no, I don't see any reason to change it.

Got you. close to running out of time. I just want to see if anyone had any quick question. I'll try to squeeze one more in. Double-digit ex like mid-20% exabyte growth. And clearly, like pricing is pretty robust. I'm just wondering, like there's an expectation that you should see double-digit growth revenue-wise, even in 2017 and beyond, if the current demand scenario continues, let's just linearly extrapolated, is it a fair assumption that they should -- the revenue growth should be double-digit because...

Yes. earnings release, Dave, the CEO said, we expect revenue to grow for the last several years and at least 20%. So he said at least. So probably will be more than that.

All right. I think go, thank you very much for your insights, always for having you. Thank you.

Thank you very much.