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

Good afternoon, everyone. My name is Sidney Ho. I cover semiconductors and semi-cap equipment here at Deutsche Bank. The next company, virtual fireside chat we have Seagate. Seagate supplies hard disk drive for both the enterprise and the consumer markets and is currently the market leader in the fast-growing nearline hard drive market that serves the cloud service providers. Today, we are very pleased to have Seagate's CFO, Gianluca Romano with us. Welcome, Gianluca.

Hi, Sidney.

So before we start -- sure. Before we start, for those investors who are listening to the webcast through our portal, if you want to ask a question, there is a box on the left-hand side of your screen, I think it's the bottom of the left-hand side, where you can type in your questions. I will ask the question as we go through our discussion. So okay. Before we go into Q&A, I think Gianluca wants to make a few comments. Please go ahead, Gianluca.

Thank you, Sidney. Thank you, everyone, for joining us today. Before starting, a quick reminder that I will be making forward-looking statements today. You can learn more about the risk factors associated with these statements in our SEC filings, which are posted on our website. So let me start with a couple of quick comments before we go into the Q&A section. As we have recently shared, the September quarter has continued to align well with our expectation that we discussed at our earnings release in early August. In particular, the cloud data center demand inside our nearline segment is still demonstrating a very healthy level of demand. And also in the video and image application, the surveillance segment is improving, and now is sequentially getting stronger as the quarter progressed. At the same time, as we discussed during our earnings release, the part of that is a little bit weak is in the enterprise OEM and that has remained soft through the quarter, even if we start looking some sign of movement. And we expect that improvement to become even stronger in the near future. We see some indication for our on-prem enterprise investment to improve as we progress through the year, primarily for large businesses, a little bit less strong in the small and medium enterprises. So net-net, the September quarter is tracking well with our expectation. And very important for us, the demand trends are improving in a couple of key end markets. We support our outlook for a flattish fiscal year '20 revenue compared to -- fiscal year '21 revenue compared to FY '20. I would say, probably I will end up talking about the mass capacity EB volume. As you know, our model is for a CAGR of 35% to 40%. We have achieved a much better result during FY '20, and we previously disclosed and we want to confirm that also for calendar year '20, we will have an higher volume increase than the 35% to 40% that we discussed in different occasions. Okay. With that, I think we can move to Q&A.

Okay. Great. I'll probably come back for a few questions on your remarks. But first of all, I want to start off with a few near-term questions that we ask every company at the conference. Starting off with Huawei. Clearly, getting a lot of headlines lately, especially given new restrictions that were announced last month. First of all, can you remind us what the revenue contribution of Huawei to Seagate is today? Second, can you give us an update how you think those restrictions will impact Seagate in the short term, when I think short term is like calendar Q3, Q4? And I maybe in the longer term, how does that work out? And if you want to continue to sell to Huawei, would you be required to get a license approved by the Department of Commerce? Sorry, a few questions here.

Yes. So of course, we are still going through the final assessment. But from what I have seen until now, I don't see any particular restriction for us in terms of being able to continue to ship to Huawei or any other customers in China. So we don't think we need to have a specific license. And no, we don't disclose the level of revenue of specific customers. But as you know, we should report if the customer is above 10%. So you can assume that it's not at that level.

Got it. Got it. With regards to the U.S.-China trade, is there a way to think about how much inventory has been built up in the supply chain? And where do you think the biggest risk of inventory build is?

Well, maybe there was some inventory increase at the beginning of the calendar year. But, at this point, we don't see any sign of inventory buildup. So we think we are in a fairly normal situation in term of inventory and shipments.

Okay. The next question I have, again, for everyone here is. If I think about the COVID impact on supply chain, can you give us an update on your manufacturing network? Is it mostly at normal levels now, both within your facilities and the supply chain? Or are there still bottlenecks that could be -- that still need to be addressed?

All our facilities are fully operational. And of course, we operate aligned with local guidelines and regulations. I would say, we are not at full capacity everywhere because we cannot have, in some location, all the head count that you would need to run at full capacity. But in term of factories operation, we are active everywhere. The underutilization cost will decrease sequentially already starting this quarter. So we are improving, but we are still not at 100%.

Okay. Staying with COVID, you talked about both revenue and operating costs being impacted by COVID in the calendar second quarter. Can you talk about how some of these headwinds have trended in the current quarter? When do you see some of these costs going to come down? And if you are having any success passing along any of these higher costs to your customers?

Yes. I would say the cost is -- start to decline. So the cost impact is mainly on freight charges, labor cost to support our people in different locations and to comply with all the safety regulations, and underutilization charges. I would say, right now, we can have more people at a factory, so the underutilization charges, in particular, are starting to decline. And hopefully, in the next few quarters, you will also see a lower cost on the labor side. And probably, finally, in a few more quarters, you would also say the freight charge decline. So I would say will be a slow decline, but for sure, will improve already starting this quarter. In term of revenue, it's difficult to say. The enterprise OEM segment is, for sure, impacted. I would say the enterprise in general, so even mission-critical is impacted by COVID. In general, the legacy part is suffering because of COVID, maybe with the exception of consumer that we see improving. And in the mass capacity segment, for sure, surveillance is coming back strongly, and cloud is still very healthy. Now we did 2 quarters, 2 record quarters. The March quarter, the June quarter, they were a record quarter. So it's difficult to continue to have a record quarter. But we said that, that part of the business, we see still very healthy.

Great. Which is a good segue into some of the near-term business environment. Maybe starting with the nearline side, in your last earnings call, you talked about nearline's going through some demand softness. You also seem to be pointing to weakness, mainly coming from the enterprise and the OEM market rather than the cloud data centers. I think your competitor seems to be including both sides weak. And today, you also -- earlier, you also talked about cloud continue to be pretty strong. I'm curious why -- is there a way that you can help us understand why you guys may be seeing different kind of trends within the cloud side of things?

Well, I don't have visibility on how our competitors demand maybe is related to products. As you know, our 16-terabyte is really, really strong. And in particular for the cloud is where we sell the majority of the volume. So from our point of view, the cloud is still very healthy. The decline in revenue that we guided sequentially from the June quarter to the September quarter was mainly related to the enterprise OEM part, not too much on cloud. And then we -- I just discussed about the legacy part of the business. But again, we don't see for the current quarter, and we don't expect cloud demand to deteriorate in the next few quarters.

Okay. That's good to know. Maybe on the enterprise and the OEM side of things, you just talk about things have kind of stabilized. I think that's in line with companies that talked -- some of the OEMs have talked about that last week as well. So just remind us, how much visibility do you have -- normally have for the enterprise market? Maybe while you're talking about that may as well, talk about the cloud customers. How far out can you see the demand profile looks like?

Well, the cycle time to produce an hard disk is about 6 months, in some cases, even longer. So that is a visibility that we need to have. If a customer wants to have enough supply at a certain point of time. So I would say we have -- we start with very long-term forecasts that are more [ trained ] than forecast. And then now you go with a 2 quarters forecast, that is much more detailed and then you have the 1 quarter purchase order. So it's a bit different depending from the time, but we have, I would say, at least a couple of quarters where we can rely on a fairly good visibility.

Got it. I guess just got a question coming in. It's a little bit more near term, so maybe you can help us out there. Is the calendar third quarter, the current quarter, more back-end loaded just because of all the dynamics you talked about enterprise and OEM stabilizing and nearline continues to be -- the cloud side continues to be strong or less back-end loaded than normal, I should say?

Yes. You should define what normal is because it sounds like there is no normal anymore. But I would say, if I compare to the last 2 quarters, I would say is less back-end loaded. The month of August was actually fairly strong, for sure, better than what we had in February or May. No, I would not say this is a normal trend. We are still not at the linearity that we had before COVID, probably. But at least, we are going in the right direction. And then obviously, it's also giving us confidence in the result of the quarter, but we think is still aligned to what we guided. And also in the near-term future and the long term for the rest of the fiscal year.

Okay. Staying with nearline, we've seen cycles in nearline on the market before. I think a couple of years ago, we have a couple of weak quarters. It's a big cycle up and down. How would you compare the current cycle with those past cycles? And what evidence would you point to support that assessment?

Well, I would say, the cloud is becoming a bigger part of the nearline segment. For sure, if you compare a couple of quarters before COVID, between cloud and enterprise, it was about 50-50 in terms of volume. Right now, cloud is, for sure, a bigger part. And we don't know what will be in the future. But as I said before, cloud is strong, it's healthy. We don't believe there is any kind of seasonality in the nearline business. The cycle is more the cycle in the individual customers and how aligned are those customers. If you have several customers that have the same cycle, so they go through the to the data center creation and then they need to install all the hard disk. And then so for a period of time, they can have kind of a digestion period. But right now, there are not 2 or 3 customers. There are 7, 8 customers and will become more in the future. So I think in the future, you will have less of a cycle, you will have maybe a customer increase in demand and another customer that is in a digestion phase, but it's not a segment cycle, it's more a customer cycle. And hopefully, they will not align to it, so that we don't go through peaks that are very difficult to manage, both in the upside and in the downside.

Great. So maybe longer term, if we start thinking about longer term, obviously, there's some digestion going on right now. And you kind of talk about nearline market as a segment is growing 35% in terms of exabyte, that's kind of your target. Have these expectations changed at all over the last few months, given what we've seen. Would be great if you can talk kind of separately about hyperscale guys as well as the enterprise guys? And is it one that more like 50%, the other one more like 25%? Or is there a way to think about the relative growth rate going forward?

In general, we said a good way to model it for the long term is about 35% to 40% CAGR for the mass capacity part of the business. If you look at our results in fiscal year '20, we achieved a much higher growth. I think was almost 80%. We also said that for the calendar year '20, we expect the volume to increase more than the 35% to 40%. So in the short term, as I was saying before, we still see a very healthy business. In the longer term, it's always difficult to know, of course, I believe that 35% to 40% CAGR is a good CAGR to model in the long term.