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

All right. Good morning, everyone. My name is Krish Sankar. I'm the TD Cowen semi equipment hardware storage analyst, and we're fortunate enough to have Seagate, one of the leader in hard drives. And it's Gianluca Romano, the CFO. Thank you very much, Gianluca, I really appreciate your time. I do have a few questions. And if anyone has any questions, feel free to raise your hand. So maybe let me start out, kind of if you look over hard-drives over the last couple of years, we kind of went through a cyclical downturn. Things seem to Have bottomed in the September quarter of last year And is slowly improving. And during the time also I think Seagate has taken some additional steps in Improving our cost structure, taking some capacity off-line. So can you just talk about how things are trending since that cyclical bottom? And like how to think about pricing from here going forward, capacity expansion. Eventually what that means to margins?

Perfect. Thank you. And before I start, I want you to know that I will be making forward-looking statements today, and you can learn more about the risk associated with those statements on our website. Yes, so we bottomed. Our industry bottomed in the September quarter, start to improve December, March, June. Now as we guided, the improvement is coming mainly from the cloud segment. That is probably the most important segment We have. But I expect a second step in the recovery coming from the other segments, enterprise OEM, [indiscernible] image application in general, China, but is still lagging the recovery. So I see this upcycle that now started after the September quarter to possibly have no different steps. And we are just going through the fourth step of the cloud report. The cost structure is now very different than what it was 2 years ago. Through the down cycle, of course, we took the opportunity to change a lot of things in our manufacturing, in our R&D, in our OpEx in general. And this is why a couple of quarters ago, we started to say we can achieve a much higher gross margin, and then operating margin, it's actually a lower level of revenue compared to where we were 2 years ago. And we are seeing it right now. We already improved a lot, our gross margin, in the last few quarters. And we already discussed about our estimate of what will happen in the future quarter, in term of continuing tracing revenue and continue improvement in the profitability. But I think as part of that improvement in profitability, we started to raise price about a year ago despite we are possibly at the worst part of the down cycle. The industry is very consolidated. I see the industry also as a strategy and a need to improve profitability and therefore, was not only Seagate but the entire industry, decide to focus more on improving the bottom line than fighting for market share. And this had a lot of benefit to, I would say, the entire industry, not only to us.

That's interesting because if you look at many cyclical industries, you were very disciplined in cutting the cost on the way down. The worry is that when things start rebounding, maybe on the COGs side, capacity starts coming back online. On the OpEx side, variable cost starts increasing. So how do you think about that on the way up? How do you manage that?

I'll say, we have 2 different strategies. One is in the manufacturing cost and one is on the OpEx. On the manufacturing, during the down cycle, we reduced a lot of our headcount in both direct and indirect labor. The direct labor, we will have to increase again, it's very related to the volume that you produce. So that part will come back. But we will not need to rehire the indirect labor that we took out from the company. So that is a permanent benefit to the company. OpEx, we focused a lot, especially on the R&D side. In the past, we had to develop 2 different technologies, what we call PMR and HAMR. Starting about a year ago, we stopped doing any development on PMR. We just Focused on HAMR. And therefore, we have the opportunity to reduce the team. Now instead of having 2 teams, now we just need one team, maybe a little bit bigger team, but just one team. So even for the R&D side, we don't expect to increase head count in the future. So we are now going through this qualification of the first big product on HAMR, and we think all our future products will be HAMR-based. We are qualifying, and we actually have qualified with many customers, our lot product in the PMR technology. That is a 28-terabyte SMR, 24-terabyte CMR. We don't think we will need any new PMR-based products. So all our development will be on HAMR.

Got it. And before I get into HAMR, I kind of had like a few more questions on the non-HAMR, the core business. You mentioned how large part of the Cyclical upturn has so far, has been driven by cloud. When do you expect the enterprise segment to start picking up and the VR segment video imaging, which is largely China. When do you expect that to start recovering?

So the [indiscernible] image application is improving already a little bit. So June will be better than March. At least this is our current expectation. So We already start to see a little bit of an upside. We think September and December will be a sequential improvement. So I would say through the end of the calendar year I think, especially if the overall China business is recovering and the government support is really going through the local projects and the local companies. Then, of course, they will Focus more on the storage part of their business. So I think through the end of the calendar year, we could see both [ video ] and image application and the Enterprise OEM starting to do what the cloud is already doing. Just with probably couple of quarters of delay of lag.

And then historically, on the nearline side, the split used to be roughly 60% cloud, 40% enterprise. Do you think it's going to be any different this cycle? Or do you think it's probably still the same ratio?

Well, if you look at 2 years ago, before the down cycle, it was probably -- revenue was still probably close to 50-50. And then the down cycle of core pending from the quarter, everything was very different. Right now, with the cloud recovering, we see, of course, a bigger cloud compared to enterprise OEM. Right now, we are probably in that 60-40. Cloud will continue to grow faster than enterprise OEM. Enterprise, of course, will grow also. But between the 2 segments, cloud is expected to go faster. So probably in another year, you will see median of 65 and this time, we go to 70. Now because enterprise OEM is not going to grow but because cloud is expected to grow much faster. Now AI could be a little bit of a variable, right? Because AI is not clear if it will impact only the cloud or a lot of the on-prem data center. So we could see a period of time where also the on-prem data center are growing faster than they usually grow. So that ratio could change a little bit, but we still expect cloud to go faster.

Yes, there is going to be a next question because It's kind of interesting. When you look at many of The cloud spending, many of it is going for AI versus general purpose HPC, at least, so as of now. But do you have -- you probably have the level of visibility. Or do you have That where your customers tell you what workloads These are being used for?

Well, in general, they don't need to tell us because they don't need a special hard disk. They buy a normal Storage hard risk and then they utilize in their data center and possibly, they utilize for different application. Some can be AI, some can be non-AI. Of course, now when you see this improvement from the cloud business because their business is Improving because of AI, we expect that part of this Improvement is actually coming from AI. We had a lot of conversation with customers. So of course, they are telling us now the storage is becoming more and more focus for them because of AI. They are very focused also on other component, but they still need to build the infrastructure, and that is good to us. Now they need to build the infrastructure so they can develop AI application and they can store the data from AI into our desk. So it's a matter of time. I think that time is coming. It's probably already right now happening. But will be even bigger in the next few quarters.

Got it. And then maybe switching gears a little bit to HAMR. In the last call, you kind of mentioned about how you expect to be qualified with one large hyper-scaler and start shipping like probably a few hundred thousand units by June kind of time frame. So curious how that qual is going on. Is the time line still the same?

So the call is still ongoing. All the data we have until now demonstrate that the component issue that we had in March has been solved. So that will not be in our way anymore. During this time, we also has the opportunity to improve many of our manufacturing processes, and we also changed the firmware of the drive. So this will have a positive impact to the product in term of yield for us and product stability for the customer. So to me, those are all good improvement and good news. Of course, they have to be qualified also. So possibly, the qualification will extend into the September quarter and not be finalized in this quarter.

Because my understanding was that if you're going to be shipping a few hundred thousand units it means are already qualified. In the past, you said by June, so that might happen more in calendar Q3, in the September quarter?

So we are -- well, whatever we don't ship on HAMR this quarter, we will ship on PMR drive. So we don't expect any change to our revenue forecast. Actually pricing is also a little bit better than what we expect. So possibly, no EPS could be better, and we will be more precise later in the quarter. But I don't see any negative impact from this change. We have volume in PMR drive that we can use to replace any shortage on EMR.

Got it. And just on that point, because in April, I think you'd already identified the component issue. You went to the other supplier to like supply this big customer. And at that time, the expectation was you'll be qualified by June. Now it's kind of pushed out to by 3 more months. What is the reason? Is it just because getting the component took a while or like the qual time frame is getting longer?

I would say the component was, of course, the reason for the delay in March. Now through that time, we found opportunity to improve our own processes, manufacturing processes and working with our partner, we also decided to change our firmware. So are all positive changes are all things that will reduce our cost will increase the stability of the product or better quality. Longer term, this means better gross margin, better result for us. The only negative is that instead of qualifying in June, we'll take a little bit longer. This is a long game. And 2 or 3 months is not changing anything. We have so much advantage on this technology that the important here that we have the best product with the best quality and also the best cost for us, that means better yield.

Got you. Is it kind of like a catch-22 situation because that customer's demand can be met by PMR because HAMR isn't qualified. And the longer this goes, does the HAMR qual gets pushed out and the opportunity, the TAM opportunity for HAMR comes down because PMR is meeting the demand?

I would say in term of units, now PMR can meet the demand until a certain level and I think the industry is a bit supply constrained, but possibly not this quarter. But in the next few quarters, we could be in a situation where in the cloud space, a very high capacity. Now the industry could be constrained. But what PMR cannot do is to provide the same benefit of a much higher capacity drive. So as soon as the drive is ready, for this customer and other customers, of course, they wouldn't want to have a [ bad ] product. We are very confident actually in the product. And actually, we decided to start the vast majority of the cloud customer qualification in the September quarter. So we will not wait any longer. So next quarter, we'll start qualifying almost all the [ CSP ] in U.S. and outside the U.S. So we're seeing the product is actually very ready.

And is there a chance the current customer who has been kind of your -- hopefully, the first one to qualify is still, you think, the first to qualify. I think another hyper-scaler could qualify?

No, no. They will be first for sure because they are through the end of the call. The other guys will start the call in September. Based on this experience, I would say, the call could take about 3 quarters for the new CSPs that are starting the call in September quarter. So the big -- I think the big volume ramp will be, let's say, mid of 2025.

Got you. And that assumes you already have a few cloud customers qualified. And at that point, are we talking about like a couple of million units a quarter run rate kind of a thing or?