Seagate Technology Holdings plc (STX) Earnings Call Transcript
December 8, 2021
Earnings Call Speaker Segments
Good afternoon, and welcome back to the Barclays Global TMT Conference. I'm Tom O'Malley, SMID caps semi analyst at Barclays. We're happy to be joined this afternoon by Gianluca Romano, Executive Vice President and Chief Financial Officer of Seagate. Gianluca, how are you doing today?
Very good. Thank you for having us here, Tom.
Thank you for being here.
So why don't we start out with the mark-to-market of the HDD industry today. Obviously, this market is vastly different than it was 5 years ago or even 10 years ago. How are these changes impacting your business? And can you just highlight the biggest changes that you've kind of seen over that time period?
Sure. And before I start answering your question, let me remind everyone that I will be making forward-looking statements today, and you can learn more about the risks associated with those statements on our website. So going back to your question, I would say the hard disk industry is now very different from what it was 5 years ago or even 10 years ago. What has really changed is the market that we serve. 5 years ago or 10 years ago, the market was mainly focused on compute, desktop, laptop and consumer, mission-critical, gaming, DVR, all those applications that require low-capacity hard risk drive. A few years ago, a new trend started, that is extremely important for hard disk that is we call the mass capacity. Mass capacity is basically including near line, so the cloud, the enterprise OEM, the video and image applications and the [ NAND ]. Those segments started, let's say, 5 years ago, were probably only 20% of our hard disk business. So fairly small. It started to grow very rapidly, but in terms of dollars from a very low base. So it took a few years to achieve a lease parity with the legacy part of the business. In fiscal '20, I think actually we had a cross point between mass capacity and legacy. Fiscal '20 is actually the first year that the total company revenue started to grow again, a little bit, not much, 1% in fiscal '20. And then fiscal '21, despite the COVID situation, we were able to grow 2%. And as you know, we have now given a very strong estimate and expectation for our revenue growth in fiscal '22 that will end in June for a low double digit. So there are also other differences between the past and today. Because of that decline in the legacy business or the low capacity, but there was for sure a situation in a period of time where the hard disk industry had oversupply. And because that capacity coming from the legacy business was really available. And the companies were also now investing a lot of money, expecting the big growth in the mass capacity part of the business. For a certain number of years, the industry in general, not only Seagate, but the industry in general was in oversupply. That was, of course, not helping the pricing situation. Right now, I'd say since, at least a year, we are in a very different position. Now there is a much better alignment between supply and demand. I would not say that the industry is fully utilized at this point, but for sure, the alignment is much better and much closer to totality. And this is helping the pricing environment to be much more favorable. And of course, we see that in the revenue growth and the profitability. As you know, the focus for the company, for Seagate, in particular, is free cash flow. So we really look at what is the right level of CapEx in order to satisfy demand, but not go into an oversupply situation again, at the same time, increase our profitability and finally, have a strong free cash flow.
Great. That's really helpful as background there. So you've been really helpful with outlining what you see as this new growth trajectory for the business. And you've also kind of painted this picture, in which the industry is more rationalized. Would you say it's safe to kind of characterize this industry as a growth industry from here on forward? Or do you still think you'll see some of the cyclicality that you did in the past, just given the fact that you're so heavily aligned to now cloud spending and then hyperscale spending as well?
We expect the industry and Seagate, in particular, to continue to grow. At our Analyst Day, we also gave a range for that revenue growth with at -- between 3% and 6% for the next 3 to 5 years. And this year, we are actually doing much better than that. So I also think we will have opportunity to -- from time-to-time to be even above that range. I would say the revenue growth is happening because mass capacity is now more than 70% of the total hard disk business. And the mass capacity is not really cyclical, especially if you look at the cloud part of the business. So we have probably 10 big customers at this point. So we are not really on a small customer base. It's now becoming a much larger customer base, is in different parts of the world. It's not only in one region. And you always have some customers that are building new data centers and then fulfilling those data centers with new hard disk drives and other customers that are maybe in a phase where they utilize those new data centers, what we call digestion phase. But because we have so many customers, they always balance out and the overall trend, as you know, is an increase in data storage. So the overall trend is always up, is not the same every quarter. But what is important for us is, it's not cyclical, it's not seasonal and it's not bumpy as it was in the past because it was so much concentrated in 3 or 4 customers.
Okay. That's helpful. So it seems like at least in that particular end market, which is mass capacity, is becoming a greater portion of the business. Demand trends seem very good. Now let's look on the other side. You've managed to grow the business through some really difficult supply conditions. And could you just comment on that dynamic right now? Can you talk to the supply-demand dynamic in the marketplace? Are you seeing that improve? Are you seeing that worsen? How is that impacting your business right now?
Well, I would say in the short term, supply and demand are fairly well aligned, similar to the prior quarter when we gave guidance for the December quarter. We said December quarter to be very similar to the September quarter. So revenue was similar. EPS was similar. I would say in the last 2 years every quarter has a different challenge because of the supply chain and internal or external because we had our own issues in the past in some of our factories and some of our suppliers. I would say every quarter, we were able to overcome those challenges and perform well, perform at a level of what we guided or better. It's not easy. I say, December is probably similar. There are challenges in the supply chain. I would say not directly in our factories at this point, likely, but there are a lot of disruption around the world. But we are still confident and Dave discussed earlier this week and during the earnings release, we think we will be able to have enough volume for the demand that we committed. And so we are aligned to the guidance that we gave in terms of the revenue. I would say maybe the negative part is the cost in term of freight. The extra freight cost that we were thinking was already very high in June, and we quantify that one we said is about $30 million additional freight costs, so about 1% of our gross margin. We thought at that time it was already so high, but was not going to be worse. But actually, September was even higher. And I think December, looking at the volume that we ship and the rate, I think, it will be even higher. So on the cost side, there are some impacts, in particular, on the freight. Of course, we have opportunity to mitigate those increases. But I would say the negative item of the quarter for the time being, I would say, is for sure the freight costs.
So it seems externally, there's additional pressures. But internally, it seems as though you're still hanging on pretty well in terms of what you've seen in [Technical Difficulty].
Yes. yes, in terms of our production lines, the volume, the ads and media, the final test, right now, hopefully, right now we have no...
Okay. Helpful. Another one that I'm sure you hear about a lot. So we've talked about the supply dynamics. We talked about the demand dynamics. But something that people will ping you on often is just the deviation between you and your largest customer, particularly with the guidance into the calendar year-end -- excuse me, not your largest customer, your largest competitor, Western Digital. So obviously, you can't speak for their business, but could you walk us through why you may be seeing some deviation there? I think people will jump to some conclusions. But just from your perspective, why would one business perform a little differently than the other?
I would say we see the industry more or less in the same way. No, I don't see this big deviation. I would say probably the -- it is what they said, they had a customer that is pushing out a little bit their demand. I think it's just timing. So whatever they don't ship in the December quarter, I guess, will be shipped in the March quarter. It's kind of normal from time to time. You have those customers moving a little bit the timing of their purchase. It's not -- when you manage a business, this is not an issue. I mean it's not an issue for the quarterly result, but the base of the industry, the demand, as they said, I think, is strong. We see that very strong. The other point where they, I think they mentioned was that China, [ Northern ] China, in general, [indiscernible] China channel. We didn't ship too much into the channel into June quarter end or September quarter end. So maybe this could be a difference, but again, it's mainly timing. So I think it's important as the industry is really healthy and that the players in the industry, they get the same view of the long term. In the long term, I think we all see a strong demand, especially in the mass capacity, in particular, in the cloud. And actually, Dave discussed a little bit at our earnings release on what is the expectation for the next few quarters, and we confirm that we are confident on strong demand.
Helpful. And then the component that you just mentioned, obviously, mass capacity is strong. We've talked on the cloud, in particular, but then there's also the other component in VIA, which you've seen some really nice strength in as well coming into this year. So often, a lot of the conversation centers around the cloud. But could you talk about what demand drivers you're seeing in the VIA business? And why you're seeing so much strength there? And now continue -- I know historically, it's been lumpy, but is there a different trajectory there in terms of what that can grow?
Yes. First of all, the VIA segment is very important to this industry and to Seagate, in particular. We have strong leadership in VIA market, and we think this will continue to grow. Today, the customers are concentrated in Asia. You will see more and more new customers in different parts of the world, a little bit of the opposite of what happened with cloud that actually started in U.S. with 3 or 4 big customers and then developed in the other part of the world. I think video and image applications [indiscernible] started in China and in Asia and will become an important segment also in other parts of the world. It is very important for smart cities, smart factories, all those applications that will help to automate and to improve many of the future applications, like artificial intelligence, machine learning. All those applications that we required a lot of data storage will be based on video and image application. So I will not say that it's bumpy. I will say this segment is seasonal. That is a bit different. So usually, it's stronger in calendar Q3 and calendar Q4, so the September and December, and then you will see a little bit of seasonality into the March and June. But it is not bumpy in terms of difficult to predict. It's just the nature of the business and know where the budget of those companies is requiring them to get maybe more volume in the second half of the calendar year compared to the first one.
Okay. Helpful. We've touched on the 2 nice growing segments within mass capacity. Let's talk legacy for a second. So could you just remind us that this is a number that you used to give. But let me know if it's something you can hit on now. Just how big of your business is still related to PCs today, just from a percentage basis? And then what's your expectations for that market into next year? You've obviously seen a really strong year on the PC side here. Do you expect that PC market to grow again, just your base case assumption and just the size of that business?
Yes. We don't report PC as a segment. We report legacy in legacy U.S., mission-critical, you have compute and you have consumer. In the past, we also had other subsegments, like DVR or gaming that right now are basically no volume anymore. So it's just 1 of the, let's say, 3 segments that we report in legacy. In the last few years, we have seen the revenue of the legacy segment to declining around 20%, maybe slightly less than 20%. We think at this point that legacy is only 30% and will be a little bit less in the next few quarters than mass capacity -- compared to mass capacity. But we think the revenue for legacy will continue to decline, but probably at a lower pace compared to what has been in the last few years. So you have 2 major trends. One is the mass capacity, where we said the exabyte volume will grow by 35% CAGR, and the price environment is now way more favorable than what it was in the past. And at the same time, we have the legacy segment. That is we estimate it's not going to decline by 20% anymore. It will be a little bit lower than that. And so overall, you can see how or why we are so confident that the revenue for the company will continue to grow in the range that we mentioned or even sometimes even better.
Great. So we've covered the demand drivers. Why don't we move towards some more industry dynamics. So I think in your preamble, you talked about the rationalized spend of the industry. And you've now kind of guided your CapEx spend as a percentage of revenue, which in itself is a handicap for how you're going to look at spending with your business. But can you talk about longer term, do you think that the industry is more rationalized in terms of spend? Do you think that like in other areas of storage, you've seen years in which people go to gain more market share or say when end market gets a little bit weaker, you may see some people go out and try to spend more. What do you think is the right way to think about spend longer term? Is this part of a cycle that we're in now with lower spend? Or is this the new normal?
Well, I think it should be the new normal. It's part of a transition of the industry from a high number of suppliers to a low number of suppliers. When you have a high number of suppliers, now you can see, for example, in the NAND business today, people have to compete on market share if they want to be relevant. And so they need to spend a lot of CapEx and just focusing on volume more than profitability. And then you move to a different kind of industry through consolidation, like, for example, the DRAM industry today, where the focus moved from market share into profitability and the company start to require a certain return from their investment, now fair return from their investments. And we have indicated what is the gross margin range that we expect. We are in that range already. I think, especially in our mass capacity part of the business, we're already in the high part of that range. I think the industry has to focus on profitability and free cash flow. And I don't expect the industry to go back to where it was years ago and just look at volume and installing capacity that is not even utilized, but is expensive and then having a bad pricing environment. It doesn't make sense. In my opinion, it doesn't make sense in the industry today.
Helpful. And then you touched on gross margins. I got to give you a lot of credit in terms of the ramp that you guys have seen over the past several quarters getting into that range so quickly. Other than the fact that you are seeing a more rationalized market and you have some internal structures that have allowed you to kind of get to that range quickly, can you talk about what you're doing longer term that can maybe even take you outside of that range just because [Technical Difficulty]. If you think about it from the picture that you're painting, you have a growing end market, you have rationalized supply. Why can't you turn to your cloud customers and say, "Hey, look I think you need to pay a bit more here." You're doing a big service for them. So why not higher than this historical 30 to 33 range?
Yes. No, we never said that this is a final range. This is I think a step into a , what I call, a fair remuneration of our investment, which is not only the CapEx, but it's a lot of R&D and a lot of other spending. And so it's a good step into that direction. A few quarters ago, we were at about 26%. We went up to the 31% last quarter. So we are still in the, let's say, lower half of that range at the company level. So I think there are still opportunities to go up into that range in the next several quarters, and then we will see. And hopefully, at next Analyst Day, we can give an update on the range. I would say for gross margin, there are, in our case, there are probably 4 main items. The first one is supply-demand alignment, as we discussed before. So keeping that alignment with capacity installing, the capacity that is really needed and nothing more than that will keep a fair pricing environment. Second is the mix of moving more and more into the mass capacity segment out of legacy into mass capacity is, for sure, positive in terms of gross margin. We also have a third category of business, by the way, that is a non-hard disk business. When you look at the individual quarter, you always also need to look at how much of the impact from the non-hard disk part. Historically, they had lower gross margin. But assuming they stay fairly flat as a percentage of total revenue, the big improvement is moving out of legacy into mass capacity in our core business that is hard disk. The third item is a cost-optimized product. So we have a certain number of products at different capacity, not only is there now high capacity, but a different capacity that are based on 2 terabytes per disk. And so pushing more demand into those specific products and out from product at lower capacity. That is also helping our gross margin. And finally, that is more a short-term issue, hopefully, is the COVID cost. And we said in January, our COVID -- additional cost from COVID is at least 1 percentage point. And that was the $30 million. As I said before, we expect that to be much higher. So it will be way more than 1 percentage point in the December quarter. It was more than 1 percentage point in September quarter. So when these extra costs will start to abate, we see the opportunity, we will continue to increase our gross margin.
Thanks, and thank you for walking through all those pieces there. So you hit on 2 topics I wanted to hit on and I want to make sure we get them in here. So the first one is on the spend side. So you talked about a rationalized market. But can you also talk about the other risk there, which is less spend, but also technology risk, right? So you want to stay at the leading end of technology. How do you balance the rationalized spending with still staying at the top of your industry? And can you just remind us of where you sit today in that road map over the next couple of years?
Yes. I would say the lower spend is mainly in CapEx. It's not in R&D. Now R&D, we are fairly consistent with our spending. As you know, we have already proven the technology. We have a 20-terabyte HAMR drive that is in the market. So that part of the development for us has been done. So we are actually moving the resources from the technology development to the product development. So now all the focus is to move from a 20-terabyte HAMR drive that is a small capacity for a HAMR drive into the next product, the 30 terabytes and then the following one, 36 terabytes and 40 terabytes and 50 terabytes. We discussed at our Analyst Day how we see now the 50 terabytes, even 100 terabytes in just a few years from now. I think the 100 terabyte is in 2030. So 8 years from now, you will have something in the market that is 100 terabytes when today we are selling, let's say, 18 terabyte. So it's a major, major change and major improvement for the industry, not only for Seagate. And so it's important that we keep those resources, but they are now focused more on product development and a little bit less in technology development. We spent a lot in technology development in the last, at least, 10 years. So I will not say that we are spending less in this part. But as I said before, in terms of CapEx, we changed our target range from 6% to 8% of revenue to something that is substantially lower, and it is now 4% to 6%. And right now, we are probably more in the lower part of the 4% to 6%. And this is, again, to keep a good alignment between supply and demand.
Helpful. And then I want to sneak in the other one that you brought up earlier, but just the impact of the non-HDD business on gross margins. So let's just focus on that business for a second because you spend a lot of time at it at your Analyst Day, talking about the Lyve and the Lyve Cloud business. So can you talk about how that's trending? I mean you obviously launched it. You gave additional color at the Analyst Day, but you talked about how big that opportunity could be. How is that taking off? Are you seeing success early days here? And what do you kind of expect from a contribution perspective here in the next kind of year or so?
Yes. In the non-HDD business we basically include system solutions, SSD and Lyve. And talking about Lyve, we said at the Analyst Day, it will take a little bit of time to really see revenue and impact in our financials. So it's a new business. We want to develop that right way. And so we take the time to do. It is obviously based on our core business, that is hard disk. So we have a major advantage in developing a new business that is still based on our core activity. We also have a partner Equinix that is basically helping us with all the infrastructure, physical infrastructure and the network. So I think it's a very good partner because they help us on the path that we are less familiar with. We provide hard risk. We provide our software. And then together, we have a go-to-market strategy. So I would say in terms of development, you need to consider a little bit of time. I think at the Analyst Day, we said for the entire Non-Hard Disk business, we expect revenue to double in the next 4 or 5 years. So the plan -- that is a plan we are, of course, executing on the plan. I would say, especially for the cloud part of this business, you will see an increase probably in the second part of that time frame.
Helpful. Last one I wanted to get in, just to get in my CFO question here. But you've done some pretty good jobs with the buybacks over the course of the last year. You've got the stock at a good price. Could you talk about where you're kind of seeing the market today? Would you consider buying back more stock here? You obviously did a lot more in the December quarter. That's tailed off a little bit, but I mean, it ticked up again in September. Just talk about what you're looking at when you're looking at buying back stock and just your capital return policy, and I think that should do it.
Yes. I would say our capital allocation strategy has not changed probably in the last 2 or 3 years. Our first focus, of course, is the business and develop the business. And then with the free cash flow, we focus on first of all, dividend. We want to be very programmatic on dividend. We have raised our dividend in the last 3 years. In October, actually, we just announced the new increase in dividend by almost 5%. And then with the other part of the free cash flow, we focus on share buyback. And at our Analyst Day, we said actually in the next couple of years, probably, we will spend more than the free cash flow. And in fiscal '21, we spent about $2 billion in share buyback as you said, at a very attractive price. We were active again in the September quarter. This is our strategy. Every quarter, we look at the need of cash in different parts of the business. And then we decide how much we dedicate to share buyback. Share price, of course, much better than a year ago or 2 years ago. But we feel very comfortable even at this level of share because we believe the company is still highly undervalue.
Great. Well, with that, I believe we're out of time. Thank you again for joining us today. It was a pleasure to thank you for all the detail. Good luck in this coming year and once again, thanks for attending.
Thank you very much.
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