Seagate Technology plc (NASDAQ:STX) Wells Fargo TMT Summit 2020 Conference December 1, 2020 1:20 PM ET

Company Participants

Gianluca Romano – CFO

Shanye Hudson – IR

Conference Call Participants

Aaron Rakers – Wells Fargo

Aaron Rakers

Perfect. Thank you, everybody, for joining us. I’m Aaron Rakers. I’m the IT hardware and semiconductor analyst here at Wells Fargo. Pleased to host a quick conversation with Gianluca Romano, the CFO of Seagate and I believe Shanye Hudson from IR is also joining Gianluca as well.

So first of all, Gianluca, thank you for joining us this afternoon or morning depending on where you’re at. But why don’t I hand it over to you, I think you have one quick comment maybe on the safe harbor.

Gianluca Romano

Thank you, Aaron, and thank you, everyone, for joining us today. As a quick reminder, I will be making forward-looking statements today, and you can learn more about the risk factors associated with those statements on our website.

Question-and-Answer Session

Q – Aaron Rakers

Perfect. You nailed it. I think you’ve probably done that a few times before. So let me kind of just kick off. And for those in the audience, if you’d like to ask a question, feel free to e-mail me at aaron.rakers@wellsfargo.com. But why don’t I just start the discussion with just the demand profile. Obviously, the hard disk drive industry is transitioned to a point where a 60%, 65% or so of the industry is now in a nearline hard disk drive market. So on that piece of the market, I guess, just update us on how you’re thinking, how you see demand currently? And any kind of thoughts you might share as we kind of start to think about calendar ’21?

Gianluca Romano

Surely. So — and I can maybe discuss a little bit about our business highlights for the current quarter and the future, as you just asked. So in general, I would say, looking at the current market environment with about four weeks to go to quarter end, we remain very comfortable with the guidance that we gave at $2.550 billion of revenue, plus or minus $200 million, and EPS of $1.10 plus or minus $0.15. So, the quarter is shaping out as we were planned. And also in terms of mix, I would say, is fairly similar.

You were asking about nearline. Inside the airline, we have cloud and we have the enterprise OEM. Cloud was already strong in the last several quarters. Even in the September quarter, where the total revenue for the Company was sequentially down, we said, cloud was still having a fairly healthy demand was not as the record of the June quarter, but still very good. And in December, we expect a sequential improvement. The enterprise OEM is a part that maybe suffers the more for COVID in the September quarter.

Now sequentially, we guided $250 million increase in revenue, a big part of that increase is actually coming from the enterprise OEM. So, also this part is recovering fairly well. Of course, now the COVID impact for that part of the business was bigger in the last couple of quarters, especially in September, when you work on-prem and now you cannot access the site and now you have several problems coming from the COVID. The business was, for sure, slowing down.

Fortunately, we see a good rebound already in the December quarter, and we expect also a sequential improvement in the next couple of quarters. On surveillance, that is now part of our mission, our mass capacity part of the business. Surveillance was very impacted mainly because the COVID impact was first in Asia — was coming first in Asia and then, of course, move to the rest of the world.

But already in the March and June quarter, the surveillance part and video image application overall segment was really impacted, was down sequentially. In September, we saw the fourth quarter of a grain rebound. And in the current quarter, we expect a similar level, maybe even an improvement, sequential improvement on surveillance.

When you look at the legacy part of the business, consumer was good in September. We expect to be good also in December. As you know, it’s a little bit seasonal. So this is a good part of the year. The rest of the business, mission-critical also starting to recover, still not a strong quarter for mission critical, but starting to recover from the low June and September.

And the compute, desktop, notebook and gaming and DVR that’d be the part that now is fairly stable sequentially, I’d say. On the product road map, I would say our 16-terabyte is still very strong. We have a good market share because we have a very good product now because we are focusing on market share. As you know, our focus is always on free cash flow and profitability. Market share is just the result of our product.

We said in the past that calendar ’20 was mainly a 16-terabyte story and now we see that. And we are now ready to move into our 18 terabyte. So, the calendar ’21 will be a year of transition between the 16 to the 18, and you will gain Seagate 18-terabyte continuing to grow quarter after quarter through the calendar year, very importantly HAMR. So, the 20-terabyte HAMR, I’m very glad to announce that we shipped the first 20-terabyte HAMR drive for revenue at the end of November, just a few days ago. This is a milestone, a technology milestone for the industry.

We are extremely happy that Seagate is a company that was able to achieve this result, and we expect HAMR in the future when we will ramp high-volume of HAMR to be a very, very important product, especially in the cloud space, and also not to be that product that will continue to decrease our cost per terabyte and keep the gap, but now is already there today with the NAND technology.

Aaron Rakers

You went through a lot of my questions in that, but that was an awesome, very thorough answer. So I appreciate that, so maybe kind of double-clicking on a few little items. Just remind us again of the mix within nearline between cloud, and I definitely want to ask your opinion on cloud digestion and kind of that, that trajectory or sustainability of 30% to 40% capacity in shipment growth. But first of all, the mix between cloud and traditional enterprise OEMs, just remind us of what that mix is?

Gianluca Romano

Well, if you look before, let’s say, COVID, so December last year, it was about 50-50 for the last three quarters and even in the current quarter, we see cloud to be higher. I’d say, right now, it’s probably about 10% higher than enterprise.

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Aaron Rakers

Okay. And your thoughts on cloud digestion, I mean, because if I look at all the data points this last quarter, I mean, server CPU is definitely decelerated, right? We saw pretty sharp relative to the first half deceleration on server side of the world. But you guys sound very positive, constructive on just the continued investment phase in cloud and in the hyperscale customers. So I guess what are you seeing that might be different there? And what’s your view on going through those ebbs and flows of invest and digestion in the cloud vertical?

Gianluca Romano

Yes, we had — now if I look at the volume, we had a record quarter in March, another record quarter in June. September was not a regular quarter, but as we said, was still a good quarter, was a very healthy demand, not at a record level, but very good. And we expect the current quarter to be stronger, sequentially. I don’t know if it will be a record or not, but will be strong. So, we don’t really see the digestion in cloud. I think right now in cloud, you have a certain number of customers, more than a couple of years ago between U.S. and Asia and China. So the important is that when those customers build a new data center and then fill the new data center with a lot of hard disk for storage.

So important is where they are not all aligned because we’ll be a problem also on the upside if everyone is building a data center at the same time and then we need to — they want to fill the data center very quickly. We will not be able to achieve that level of capacity to answer to the mean. But at the same time, it’s important that they don’t stop building data center altogether. It’s not really a matter of demand. I think their demand is actually growing very strongly. It’s just a matter of when they build the new data cycle. So that new data center is what is creating a little bit of the cycle. If they’re not all aligned, you don’t really see the cycle. You see one customer going up, one customer going down. But in general, you see a trend that has continued to grow.

Aaron Rakers

Yes. So it’s that diversification element of the business that’s really kind of changed over the last 12, 18 months, if you tend to agree with that?

Gianluca Romano

Yes.

Aaron Rakers

Yes. And so in those nearline drives, given that we’re talking about configurations, and it’s remarkable to think about the technology involved in hard disc drives. But you’re talking about nine platters, 18 heads kind of floating on top of the bottom of those platters. The visibility attribute of what you get from the hyperscale customers and the cycle, the lead time that it takes or that’s required to build those type of drives. Has that changed? When I think about the business profile of Seagate or some of your competitors just that need to give you more visibility and lead time for these products?

Gianluca Romano

I think it is changing. I think now that after several quarters of continued growth, they see the need to give us more visibility, just to be sure we produce enough to answer to their demand. So I would say, not all the customers are the same, but now with at least some of those customers, we have very good visibility. I say the relationship is really good with everyone, but now between their process, our process to have full visibility is not easy, but we are, for sure, improving. They know that the cycle time to build and our disk is six months, at least six months. So no, they want to give us visibility. Sometimes it’s more a process issue than anything else. But relationship is good, and I would say, it’s for sure going in the right direction. I think we can still improve in terms of capacity to plan in advance, but it is going in the right direction.

Aaron Rakers

I want to go back to the comment you just made. It’s a six-month process to build these nine platter drives. That’s what you just said, right? That’s test cycle as procurement components that’s everything.

Gianluca Romano

Yes.

Aaron Rakers

Okay. Taking that and taking the fact that you monetize heads and platters, not drive units themselves. One of the many questions — one of the common questions I get from investors on Seagate are just the drive industry in general is you’re very duopolistic in the competitive landscape. Obviously, there’s customer concentration, but it sounds like that’s diversifying itself a bit. So, how do I think about the drivers? How do you think about the drivers of gross margin expansion?

Gianluca Romano

Yes. You made a good point. The customer concentration is for sure there. But I would say in the RDS drive business, the supply concentration is actually higher is now two or three competitors. Gross margin is finally a matter of your cost per terabyte and your price per terabyte. We think in the future, HAMR will help us in continuing to decline the cost per terabyte, probably at a pace that is higher than what we have seen in the last couple of years with — at the end of its PMR or CMR technology. So that will be positive to our gross margin. The other point is, of course, pricing.

I would say the pricing environment is a little bit better than what it was a year ago or 1.5 years ago. That’s good. I think we need to balance supply and demand. We discussed at our latest earnings release, how we have looked again at our CapEx. And also at our capacity installed, and we actually realized that we have some capacity installed, but is still not utilized. So is not a good choice for us to spend too much in CapEx right now. We are still investing. We are still spending, but a little bit less than what we gave as the overall guidance before.

We said between 6% and 8% of revenue, probably will be a little bit below the low part of that range. So still an important investment, but lower than what we were expecting. And we need to balance the supply and demand that will be healthy for all the pricing environment. And I think for the entire industry, not only for Seagate.

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Aaron Rakers

Yes. And thinking about the gross margin line because mix is obviously a variable, and the mix is continually in the right direction. But also, are there — is there any structural reason that you see that we couldn’t be thinking about to drive gross margin in general for the industry back in that 30% level?

Gianluca Romano

Absolutely not, I think, of course, no, you need to go through the COVID situation, all the additional cost of COVID, maybe another quarter or two, hopefully not too much longer than that. As the mix is going in the right direction, if the industry is able to balance supply and demand in the right way and now having a normal pricing environment. That should drive the gross margin in the direction you said.

Aaron Rakers

Yes. Yes. No, that’s very helpful. And COVID-related impacts on gross margin, those transitory elements that I would think about hopefully, over the next one or two quarters, your competitor earlier just said that they expect similar, right, continued COVID-related costs. So how impactful is that for Seagate right now to kind of think about lifting out the model?

Gianluca Romano

Well, in the last two or three quarters, we had a lot of additional costs for freight. Last quarter, we were able to ship at least some of the volume through ocean, so mitigate a bit that additional cost. In the current quarter, demand is higher. So I don’t think we will be able to achieve the same result in terms of split between ocean and airfreight. Everything seems to be more urgent. So we will have to use more air freight.

So, we expect a fairly important impact from the COVID cost on freight, a little bit on labor to keep everyone safe and all the safety measures that we need to adopt in all the factories and other locations. The part that is for sure improving is underutilization charges. So in the last two or three quarters, part of the COVID cost was underutilization charges, I see that to become a very small number already in the current quarter and in the next couple of quarters for sure.

Aaron Rakers

Okay, very helpful. I want to go back to HAMR. First of all, congratulations on shipping the first HAMR drive for revenue. The technology involved in that is remarkable incorporating the PICO laser and everything else above there. But you’ve also been very clear that HAMR at the 20TB would be somewhat of a low volume run, kind of a learning curve, if you will. And so, the competitive landscape might move to a 20-terabyte non HAMR drive. So how are you thinking about the competitive positioning for 20TB HAMR and the progression of that, that road map to the point where it becomes gross margin accretive, if you will?

Gianluca Romano

So today, we will have the two technologies in parallel. So, the 20-terabyte HAMR, as you said, is a great technology milestone, but it’s not a product that we want to ramp in high-volume. It’s the first HAMR product. It is not cost-optimized at this point. It’s still a small capacity. It’s kind of strange, a better 20-terabyte is a small capacity drive, but for their technology, it is. You will see the second-generation to be 24 or 25 and then a 30, 40, 50 terabyte in the next few years.

We show a road map with a 50 terabyte in, I think in fiscal ’26. So in just a few years from now, we will move from 16 terabyte today to 50 terabytes. So that is why HMAR is so important. We need a little bit of time to go through the call with all the major customers, but then will order and consume hundreds of thousands of HAMR drive.

We will do all this with our 20 terabyte and then we will go to second-generation and start ramping high-volume of those products. So for a while, you will see a good mix between the PMR technology and HAMR technology. For sure, 2021, the vast majority of the volume will be in PMR.

We have a very strong platform for our 16 terabyte. That platform is the same that we are using for 18. As I said, 18 you will see more and more volume, more 18-terabyte starting now this quarter and then next quarter and continue to ramp. That platform can go through a higher capacity, can go to 20 and can also go down. That is very important for us, so try to use the same platform for many different capacity points.

Aaron Rakers

Yes, that’s a really important point, right, because I think platform was a key emphasis on the 16TB. For those that aren’t familiar, can you just help us understand what you mean by platform? I think I know, but I’d love to hear that what exactly you’re referring to when you say a common platform?

Gianluca Romano

It’s basically very — is basically the same drive. The aerial density is different. So you can use basically the same drive with the same disk and has and going at capacity or you can, let’s say, destock, so reduce the number of disk and the number of heads. And use the same overall hard disk for lower capacity. That is good for fraction cost. So, the less different platform, different design, different drivers you have in the line, and the best is our — the lowest is your cost per terabyte overall.

Aaron Rakers

So what we’re talking about is a nine platter stack, 18-head at the max side, that can go to 20TB on pick conventional PMR. You can get there without having shingled at 20TB. Is that a fair scalability?

Gianluca Romano

Yes. I think we can go to 20 terabyte, the normal PMR result.

Aaron Rakers

Okay. In a couple of minutes I have left that. I just want to touch on a few little model things. You hit on earlier the CapEx investment side. At what point as nearline grows in a bigger proportion and you’re really talking about heads and the media investments? Is there a point in time where we’ve got to consider that, that CapEx trajectory needs to take a little bit of a step function higher to make those investments, be it clean room facilities, wafer capacity, et cetera?

Gianluca Romano

Yes, it’s possible. As I said before, it’s not that we are not investing. We are still investing several hundreds of millions of dollars. So we think we are managing well the balance between supply and demand. At a certain point, if demand becomes stronger than what we expect. And we discussed in the past, we expect 35% to 40% CAGR in terms of exabyte volume for the mass capacity.

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But if it’s becoming even stronger as it was last year, for example, where we grew much higher than 40%, we can always invest more. The important is that we have a good return from that investment. I would say in the past, we have maybe anticipated too much the spending in the CapEx and then the installation of the capacity. Once you have your capacity installed, now you see more volume than pricing just because you don’t want to be underutilized in your factories. So we are trying to avoid the underutilization, but, of course, meeting all the demand that we can possibly serve.

Aaron Rakers

And not to say that you’re going to give me a number, but there’s a certain threshold of, I guess, capacity that you can shift today based on your heads and media at some level, it’s just — is there any level? I want to say that a long time ago, you talked maybe about some of that capacity level where maybe you kind of saturate your capacity footprint you have. Is that anything you’ve given an update on? Or maybe I’m just mistaken on that?

Gianluca Romano

No, you are correct. I would say, even internally, the simplistic way to look at CapEx and supply correct. I would say, even internally, on your and demand is now looking exabyte how much exabyte capacity you as installed and what is the demand. Of course, then when you go a little bit more in detail, you have all the difficult part. We know how much is this segment, how much is other segments. So we also need to balance a certain segment level.

And this is why having a common platform is also very important to give you the flexibility to serve different capacity points without having major changes in the manufacturing. So, I would say, right now, when we look at the capacity installed and demand is not perfectly balanced, and we want to bring now Seagate and the industry in general is the right balance. And I think it will happen very quickly. On one side, demand is growing very strongly. On the other side, our CapEx can be fairly flexible. So, we are good at that in maybe two or three quarters.

Aaron Rakers

Okay. That’s perfect and then final couple of questions for me. Is there anything — I mean, one of the things that Seagate done a remarkably great job at is managing the operating expense line, I think in the past, you’ve talked about normalization at kind of $330 million or so roughly for the next few quarters. Is that the right way to think about the operating expense? Is there anything we should be thinking about over the next couple of quarters?

Gianluca Romano

I would say probably for the short-term is a good model. I think it’s important to understand that no part of our R&D was focused on the HAMR technology and we think we now have a technology. So maybe we have some opportunities there.

And also focusing more and more on the same platforms for different capacity point also should result in a lower need for R&D and OpEx in general. So, we always try to optimize our OpEx. A few years ago, we were above $400 million. So now being in the $330 million range, I think, is a great result, but we are not slowing down our efforts. So, we continue to look at opportunities.

Aaron Rakers

Okay. That’s great. The final question I want to ask you because I think investors look at Seagate and they say, duopolistic competitive landscape, great execution on capturing share and nearline relatively small capital intensity from a business model, good return on invested capital. So look that all basically boils down to is sustainability of free cash flow generation, and obviously, part of that is then in terms of capital return to shareholders.

So long-winded question, a long way to get to my question is. When you look at the Company, you think about the free cash flow generation, how you think about the right level of cash needed on the balance sheet? And kind of leaning more into that capital return, how are you thinking about the capital return element relative to the cash needed operationally?

Gianluca Romano

So in general, we said in the past, as a total liquidity, we look at about $2 billion as our minimum level that includes our cash and the revolver. Today, we have a $1.5 billion of revolver available that we have not utilized at the end of our last quarter. In terms of capital allocation, we met with the Board a few weeks ago. We went through our annual review of the dividend and of the free cash flow.

And there, of course, the future projections that we have, and that gave confidence to the management team and the Board to approve an increasing dividend which is the second year in row when we lose increasing dividend, we want to be more and more programmatic on this dividend increase.

And we said in the past, we will review now every year, what is the situation and possibly continue to do those yearly increases. And we also got an approval for additional share repurchase, additional $3 billion. We — at the end of last quarter, we had $1.2 billion still available. So the total is a little bit above the $4 billion.

For the share buyback, we try to be more opportunistic. We think the share price is very attractive, and depending from where the share price is, we will be more active and less active. So will not be the same amount every quarter. But again, I think, it is showing the confidence from the interim team and the Board on our free cash flow generation.

Aaron Rakers

That’s perfect, Gianluca. I really appreciate you taking the time spending with us, going through some of the questions today, and have a great rest of the day. Thank you so much.

Gianluca Romano

Thank you very much.

Aaron Rakers

Thank you.



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