Seagate Technology plc (STX) Management Presents at Bank of America Merrill Lynch 2021 Global Technology Conference (Transcript)

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Seagate Technology plc (NASDAQ:STX) Bank of America Merrill Lynch 2021 Global Technology Conference Call June 8, 2021 11:30 AM ET

Company Participants

Gianluca Romano - Chief Financial Officer

Conference Call Participants

Wamsi Mohan - Bank of America

Wamsi Mohan

Hi, good morning, and welcome again to our next session at the BFA Tech Conference. We're delighted you could -- that we could -- you could join us today. You know, it's -- it's been amazing to see the participation levels, virtual creep up last year, and this year again, these sessions are hitting record levels of interest; so delighted that you could all join us today. Today we're welcoming Seagate Technology, CFO, Gianluca Romano. Gianluca, thank you so much for joining us today. We really appreciate your time. We are excited to have you, particularly because you shared some great news this morning. So, maybe to kick it off, Gianluca, can you can you talk about what the pre-announcement -- what drove sort of the pre-announcement?

Gianluca Romano

Thank you, Wamsi, for inviting us here today. Before I start, let me briefly remind that I will be making forward-looking statements today. And you can learn more about the risk associated with those statements on our SEC filings that are posted on our website. So, talking about our pre-announcement, of course, very good news. We discussed at our last earnings release that entering into the quarter we were expecting a very strong near line market demand, both on the cloud and enterprise OEM side, and we see that happening; so really good. We also discussed about a decrease in demand in the VIA market, and surveillance, in particular. And this is also happening; so very, very good.

On the legacy side, I would say mission critical consumer are also performing well. And on top of all this, we added something that we actually were not fully expecting that was an increase in the crypto farming demand. This is helping us in utilizing some of the capacity now that we're discussing in the last six to nine months, but was not fully utilized. We had -- the industry added too much capacity for a few years. And this increase in demand is actually helping a better -- to achieve a better alignment between supply and demand. And as you know, when you have a better alignment in supply and demand, you go into a much better pricing environment. So, this is happening a little bit before what we were expecting. We discussed at our Analyst Day that we were expecting that equilibrium to be achieved around as Q4 2022; so in the June quarter, next year.

Now, because of this new demand, now we see a strong acceleration. We don't know if this will last for a long time or not but it's important for us to be in a situation where we can use that capacity, and much older than what we were expecting. We are now changing our CapEx plan; so we are still aligning our core business marker capacity between supply and demand as we were thinking before. And if the crypto currency demand stay with us for long, growth is all upside, this is all an opportunity to that -- of course, we want to take benefit of in the next few quarters or longer if it will stay longer.

Wamsi Mohan

Okay, that's great context.

Gianluca Romano

Yes. So we really expect a strong calendar '21 at this point. As I said, we are accelerating through achieving the target we discussed in our long-term model. We will discuss even more about the calendar '21 and more importantly, the fiscal year '22 at our next earnings release.

Wamsi Mohan

Okay, now that's great context, Gianluca. I appreciate that. So, if we can dig in a little bit, I mean, if we -- if we look at just sort of your updated guide, right from our prior guide; on that $100 million of incremental revenues there's very strong conversion margins. I mean, this is coming down to EPS pretty heftily and nicely. So, when we think about that it usually means that you're tracking very well both on gross margins, which I guess makes sense given your utilization comment and basically, better pricing. So, are you seeing that better pricing across the board? Are you seeing that better pricing in certain pockets, like how should we think about that?

Gianluca Romano

I would say in general, in both, the mass capacity segment, though we have a good or a better pricing environment. I will not say -- it's still where we think it should be, but it's going in the right direction. And as you said now, a big part of the increase in revenue is flowing through EPS. So this is helping our gross margin, is increasing our operating income. And is going the direction that we discussed few months ago with the Analyst Day, we are still not there but we are getting close. And we think we can accelerate through the achievement of those objectives few quarters before what we were expecting before.

Wamsi Mohan

Okay. Few quarters is quite material, given that there were just a few quarters because it looked [ph]. Okay, well, that's great. So when you think about, you know, this demand that -- that incremental demand driver that you saw around the crypto market; part -- you said you're not changing CapEx plans, but when we look at externally whatever we can track like, like GIexplorer.com, look at NetSpace [ph], it -- I looked this morning, I think it's exceeded like 23 petabytes. I don't even know where they are getting exabytes, sorry, not that. Yes, 23 exabytes. So, I don't even know where that could be getting that level of capacity. So, what do you think is sort of happening in that market? Do you see any inventory build or was there a prior inventory build that's being utilized? How would you characterize that?

Gianluca Romano

I think they are using a lot the distribution channel market. So, they take from there, so I expect at quarter end to see a very low inventory level at the stick [ph]. That's good, we don't change our CapEx plan, first of all, because it's not a small plan; you know, we always said our new target is before -- between 4% and 6% of revenue. So, it's not a small number here, it's a big number. We want to see if this increase in the crypto demand is going to stay and how much it will be. So, I do not disclose that in the future. We could upsize the CapEx but for the time being, we don't see the need. And again, our revenue is going to grow; so our CapEx as a percent, as a revenue in dollars is going to grow. So is that -- I think is a good way to realign supply and demand faster than what we were expecting, and then we need to be good enough in keeping better alignment for the future.

Wamsi Mohan

Would you say Gianluca that the pricing environment for the entire industry is getting better? Are there some Seagate specific actions that you're taking versus what maybe the industry is doing?

Gianluca Romano

No, I think it's more an industry situation. So, again, is not Seagate supply demand, I think it's more an industry supply demand. So, we see no pricing going into that direction, not for the segment, not for the Seagate. So, I think is a good news, an improvement for the full industry.

Wamsi Mohan

So Gianluca, when we look at sort of what is happening in the channel, right, like -- I mean HDDs are essentially sold out at mass capacity, different capacity points and the pricing has spiked in some significant fashion. So, given that are you making any active choices to reorient like, you know, drives from -- like place A to place B, is there -- are there -- are you being very tactical about that or is that something that you know, is not possible given the demand that exists from your overall committed customers, large hyperscalers, for instance?

Gianluca Romano

Yes. The demand in the nearline space is strong. So, of course, we have a lot of volume that is linked to that segment, but of course, we want to continue to serve. As you know, we have LTAs with some of our big customers, and of course, we are respecting all our commitments and agreements, but opportunities for some tactical improvement, and of course, when we can we do it. But again, our first focus is customer partnership and be sure that we work with our customers in the mutual interest and create a win-win situation for both. And then, when we have additional volume available, of course, we try to sell where we can get the best financial return.

Wamsi Mohan

Okay, that makes sense. So, when you think about this market and the lead times that are associated with nearline drives. I mean, obviously, these drives are getting larger and larger, testing time is taking longer and longer. Cloud demand looks like it's here to stay, you said VIA market is recovering. So, if let's say crypto demand exists strong for another quarter, is that the point where you would say, we need to, like, go back and relook at capacity? Or does it make it be like two quarters or three quarters? Like what's going to make your decision around, like -- making or understanding whether you need more capacity or not because this might be structural, not just sort of a cyclical thing?

Gianluca Romano

Yes, it will take a little bit of time, of course. And when you look at the volume, for example, note, we were discussing just before starting in the conference room, but it's one specific crypto currency that is now around 20x. So 20x is a big volume, but when you look at the overall exabyte, that we ship in a quarter, or in a year as an industry, not just as a Seagate, it's still a fairly small percentage. It's very important because if consumed at additional capacity, but otherwise was going to stay underutilized; so that last 10% is very important. But if not -- now is not the volume that you see in the cloud or in other segments. So, let's see -- let's see how that new market will develop. And of course, we will try to take all the benefit for the new opportunities. We see that as an upside to our plan. So if it stays, we have opportunity, we will take benefit; if it doesn't, we still have a plan. We are not utilizing that capacity for hopefully, at least two or three quarters, so that we will be fully aligned by FQ3, FQ4, as we were discussing before and if it happens even earlier, it's good.

Wamsi Mohan

So Gianluca, when you guys reported results here for the June quarter, are we going to see this upside in the systems business as well?

Gianluca Romano

Yes. So -- yes, the short answer is yes. But if part of the system [indiscernible] is actually supporting the grid [ph]. So, already owns the last quarter -- the last quarter that we reported, we show an increase, especially in the system business volume. And I think it's going in the same direction with the current quarter, and hopefully in the next two or three quarters.

Wamsi Mohan

Yes, no, that's great. So, the way I understood that your comment was, look, if crypto demand remains strong, use the upside to sort of what your prior targets were. If crypto demand wanes, then you still have a plan to make at least your existing targets.

Gianluca Romano

Yes. So it's basically -- you know, this new demand is basically helping us to improve for sure in the short-term, and bridge from a situation of underutilized capacity to a situation of almost fully utilized capacity. And then, in two or three quarters we see where we are, and if it's still a great opportunity, we can upsize and increase the volume or staying as we were planning before, still in a very good situation.

Wamsi Mohan

Can you also may be address, Gianluca, just some of the linearity in the quarter? I mean, it feels as though, this crypto thing sort of took off in a matter of weeks. And so, if you -- and the persistence of that seems to be indicating that you're -- there is incremental sort of tightness as you're going through the course of the quarter, which means you're probably going to exit the quarter with some real-like demand backlog as it pertains to this. So feels as though you should be able to sustain this for longer is not the right way to think about it?

Gianluca Romano

I'll say, linearity was fairly good in the quarter, so we started fairly well, we are continuing to ship fairly well, good linearity. As you said, we expect a fairly good backlog at the end of the quarter, and this is giving us confidence for the second part of the calendar year.

Wamsi Mohan

Okay, that's great. Can you maybe address some of these supply chain issues that also seem quite topical, particularly as it pertains to the manufacturing ability to sort of not have disruptions in manufacturing, especially given that Malaysia and some other places where there are significant footprint have announced some lockdowns; is that impacting you right now or are you able to win everything at full capacity?

Gianluca Romano

Well, no, right now it's not impacting us. So, we still both were bid [ph] by the same number of employees that we had, let's say, a month ago or two months ago. So the factory is continuing to work very well. Of course, we are not yet 100% utilization, and nobody said that to improve and being responsible [ph] outside for the next couple of quarters. But nothing different than what was a couple of months ago; so we have enough to cover all the demand, but we can serve in the current quarter and given the next quarter.

Wamsi Mohan

Okay, that's great. Are you seeing any impact, sort of not maybe directly, and I know it's hard to measure, but indirectly, given that your customers might be having issues with supplies or whether it be on the server side or on the PC side? I mean, everyone's talking about the supply constraints impacting their own products and their own productions, as well as the secondary impact of that. Are you seeing anything material in terms of auto rates changing or anything that you can comment on?

Gianluca Romano

Well, right now we just see upside. No, we have not seen any downside in demand. So, I don't think our major customer are experiencing any material problem for what we are concerned. So, we have not seen any reduction in volume or any push out in time, actually, eventually it's the other way around, I would say.

Wamsi Mohan

Gianluca, can you talk a little bit about sort of -- you know, within the nearline context, is there specific, like, you know, recovery in demand; you called out the VIA market earlier in your comments. How sustainable do you see the trajectory of that? I mean, cloud feels like it's quite sustainable, VIA has sort of had more cyclicality. But as you think about where we're coming off of, does it feel like for the next several quarters, the visibility is pretty good in the VIA market?

Gianluca Romano

Yes, no. For the visibility we have today, we continue to believe that nearline is going to be strong and very solid. We are coming out from several quarters of record volume in that specific segment. And no, we think it's a trajectory where we stay with us, for sure, for a few more quarter. And I don't want to anticipate too much of what we will discuss at next earnings release. But again, it's a very strongest segment; it's where the industry is focusing because it's a business that will continue to grow, not only this year, but for the next several years. On surveillance in the VIA market, as you said a little bit more seasonal, usually is strong in calendar, Q3 and calendar Q4, and little bit less strong in the first two quarters of the calendar year. So, it's normal for us to see an increase in demand right now. And now we expect that to continue for the next six months, and -- and then we see what's happening in calendar Q1 next year.

Wamsi Mohan

Okay, that's helpful. And then, what about on the cloud side; are you seeing continued sort of strong demand in cloud? I mean, there is a lot of concern with some folks thinking that cloud had sort of -- obviously, during COVID there was a big shift of cloud that might have changed some of the demand trajectory and tougher comps for a lot of companies. How do you think about it?

Gianluca Romano

I think -- but it was an acceleration and -- but doesn't mean that we'll slow down right now. I think it was just accelerated but will continue because that is where the business is going, where the development is continuing to improve. So, the cloud is the space that we focus as a major business; it's not the only business but, of course, is probably the -- at individual segment is the one that will grow the most in the next few years. And so, we don't see any slowdown actually, we just see -- there's just been an acceleration and we believe that it will actually be a good reason to continue in that direction, not a slowdown, but it's not really a cycle but is a trend, it's a different situation.

Wamsi Mohan

Okay, that's helpful. So Gianluca, when pre-announced this morning, I got some feedback from investors, and there's some concern, and I think this has been a concern for some time; it's just around hitting peaks in EPS. Hitting a peak in EPS close to $2, quarterly peak; I think, you know, when -- you look at a lot of companies that sort of have seen very strong demand, there is this perception that the demand is going to fall off. I mean, we've seen this with Apple, with HP, with a lot of companies like where the quarters are amazing and yet the stocks don't perform because people are worried about this peak pieces. How would you respond to sort of peak pieces in the context of Seagate?

Gianluca Romano

Well, what we are -- now we are trying to do is, is to give confidence that we are not there. And the only way we can give confidence is talking a little bit about the future. So, in the last earning release -- so in April, we did talk about calendar '21; so a fairly long visibility. And we said -- we have said calendar '21 to be at least 10% higher than calendar '20; so it's a major improvement. Right now, you know, I can confirm that we are even more confident that we can be at least 10%, even probably higher, but we will discuss this as the next earnings release. So, better how we gave confidence? Again, I believe right now we are in a situation where especially in the mass capacity we are not talking about cycles; we are talking about a very large increase in demand because data is growing so fast. But there is no reason where the cycle will just be a trend, it then will be always in that direction of facing demand, increasing storage capacity, increasing cloud efficiencies; and we are there to serve that business that is growing, and is growing faster.

Wamsi Mohan

So, given those statements about your confidence and this visibility; can you give us any insight as for these long-term contract agreements that you have with these customers? Like, how -- what's the structure of it? What is it that investors should take confidence that -- that yes, the margins can improve in this business?

Gianluca Romano

Yes. We have different structures, of course, with different customers. I will say the constant part of the agreement is volume. So, I would say our customer interest is, first of all, be sure to get a certain level of volume for each quarter. And this is good for us, because we need to plan our production; and again, we want where that alignment between supply and demand and knowing what is the demand that is sure whether they will have to consume is a big help for us. With some customers, we also have a pricing agreement and with others it's just volume and then we discuss the pricing on a quarterly basis or on a six month basis which is different from -- for the different customer. But I will say the important part is, the customers are now interested in fixing the volume because they see but it's not infinite capacity in this business anymore.

Wamsi Mohan

Yes. So Gianluca, just a follow-up on that comment. And I mean, if you have that sort of -- those sort of agreements, would it be fair to say that the upside in the quarter was largely channel driven or I mean that -- because it seems as though, although the aggregate pricing environment could be improving, you're yet to really see the material part of that given the structure of these contracts?

Gianluca Romano

I would say we see that as usually staffed, thus for no distribution channel, and then move into the other segment. I think this is a good way to look at the situation.

Wamsi Mohan

Okay, great. So I'm going to ask you this question, I don't know how much of a liberty you are to answer it. But we've been receiving a lot of questions around a particular customer of yours where there are some restrictions in place for shipments, and I was wondering if you could comment at all on that?

Gianluca Romano

Who's is the customer?

Wamsi Mohan

Huawei.

Gianluca Romano

Well, we have -- no, we always answer to this specific questions the same way because that is the truth now, we comply with all the rules and regulations, and based on that we ship for all our customers following those rules and regulations. We don't comment on specific customers as we don't comment on specific suppliers or investors. But in general, nor is part of our job to ensure that we know -- we understand, and then, we follow all their rules and regulations at all of trade.

Wamsi Mohan

Okay. No, I appreciate it. That's helpful. So Gianluca, maybe shifting gears just a little bit talking about capital structure. How do you think about the right levels of depth for the company? And given where the stock is, it -- in some ways, yes, it's about historical valuation. But historically, Seagate has had some headwinds, particularly in legacy markets that did not allow it to grow. So, we're sort of going through this valuation re-rating almost for the company. And you pointed out all these things about 10% growth this year, and just -- the market getting better around pricing, your gross margin targets are a lot higher than what you're operating at. So, it feels like there are a lot of levers for upside. So given that context, how do you think about that the state of the balance sheet, the willingness to lever up more and buy back more stock?

Gianluca Romano

Yes. As you know, in terms of capital allocation, we have -- maybe two different methodologies; one is applied to dividend, where we want to be very programmatic. And every year we look at the dividend yield, we look at know our liquidity situation, and in generally, as you have seen, we try to have an increase of our dividend and to remunerate our shareholders through dividend as a stable way of remuneration. The share buyback is more opportunistic; we have done a lot in the December quarter. We have done a lot in the March quarter. I think now the average share price that we repurchased in those two quarters was note in the 60s. So, we are now way higher than that. So, I think it was a good strategy. We believe the share price is still very attractive. As you said, we should not look at the past, we should look at the future; and we think that based on our future plans, based on how the industry is growing, how demand is growing, this industry will see good upside. So for sure, we have more than $4 billion, probably $4.4 billion, at the beginning of the quarter as outstanding authorization for share buyback. We will use it -- we will use it in over a certain period of time, and of course, we will not be very, very short, but depends from the opportunity, from where the share price will be, from where the liquidity will be. And the debt level is part of this discussion. If we have -- now if we see an opportunity there, of course, we can access the market, and then use the proceeds from the debt for an accelerated share buyback or we can wait and end with late.

We generate a very strong free cash flow, now it's one of our priority. Now, we look at all our financial metrics, the revenue growth, the gross margin as we discussed at Analyst Day. But our first priority is always free cash flow, and we want to give a stable fairly predictable free cash flow. And every year we try to improve that free cash flow, and increase the level of free cash flow. So we will discuss this at our next earnings release but continue to generate a strong free cash flow and possibly increase that level of free cash flow, give us also opportunity for more share buyback.

Wamsi Mohan

I think, Gianluca, when I hosted a call with Dave last week, he expressed similar confidence about free cash flow and Seagate's ability to maybe drive more free cash flow in the next 10 years versus the past 10 years. And if I -- if I was to think about that, that would average around $1.6 billion each year, and I'm not saying that that sort of the trajectory necessarily is linear. But when you think about sort of those levels of free cash flow, at the same time, think about this quarter itself, you're -- you're basically exiting at a close to $8 run rate on earnings. And if you do $2.50 which in one of the next couple of quarters, which doesn't seem unreasonable, you would be operating at almost $10 in run rate EPS with the stock at $100; that's 10 times PE. So really no re-rating on the stock when you look at it in that context and the confidence in free cash flow. So doesn't it -- doesn't it feel like this is still a very good time to deploy more capital towards buybacks?

Gianluca Romano

Absolutely. Now, we -- you know, I said before, we still believe the share price today is very attractive. And you know, Dave is a person that many years ago said we will have a 20 terabyte MR [ph] sold before the end of calendar 2020, and we did it. So I have full confidence that if he has spared to have a free cash flow higher in the next 10 years and what we generate in the last 10 years, we will do it.

Wamsi Mohan

So, Dave -- I'm sorry, Gianluca, I wanted to ask you; when investors think about it some of the -- some of your largest holders that have recently sold some stock. You know, would you say this is just a rebalancing within portfolio? I mean, obviously, they have been tremendously successful in their investment, I mean, sort of tripled their investment, and it's sort of bit -- you know, we have to put that in the context. But anything that -- you know, discussions that you can share with us or is that something that's out of purview in some ways?

Gianluca Romano

Well, you know, they are our shareholders, so they have -- of course, their rules for their portfolio management, now I think is not eventually better to discuss directly with them. From what I have seen, we have full support from those shareholders, and -- and I don't see a change in this strategy. But of course, it's better to talk to them, and again, I think it's mainly linked to their internal roles on portfolio management.

Gianluca Romano

Okay, that's helpful color. Gianluca, I also wanted to ask you around OpEx levels, right. So, you know, you expressed this confidence in growth, and in pricing, and margins; we saw in this quarter obviously it translated very strongly from an operating leverage standpoint down into EPS and incremental margins. How should we think about OpEx more on a sustained basis as you're driving at this level -- very strong levels of growth?

Gianluca Romano

Well, in the next few quarters, I think the level will not change too much from what it is today. Maybe a little bit of increase, because we are restarting traveling, that is good news, but of course, at some cost. So we will also discuss some of the marketing activities little bit; financing that will materially deviate from the [indiscernible] per quarter. And then, now let's see maybe in two quarters from now, how the situation is and if we need to update the estimate. But for the time being, I don't see a reason for a change.

Gianluca Romano

And if you do have to change that estimate Gianluca, what would you say would be the main driver of that?

Wamsi Mohan

It's basically just the full restart of the activity after COVID, so main is a marketing activity.

Wamsi Mohan

Okay. Okay, that's helpful. I know we're coming up at the end of our allotted time. So I wanted to ask you two more quick questions. So, one, is there any color you can give us on sort of -- you know, the margin structure for legacy versus mass capacity as investors try to think about the relative growth of these like what -- how would you say those margin structures look like?

Gianluca Romano

Well, mass capacity has a little bit higher gross margin level compared to the legacy. I would say, right now they are both enjoying it a bit better pricing environment; so they are both improving. But the difference between the two is still there, I think it will always be there; mainly because the legacy part that is not huge anymore, but is declining a little bit year-over-year. So there is always a bit of capacity available on that part of the business. The mass capacity is going through a different situation where it gets so much better aligned to demand. And so, we've set the pricing to be -- eventually to be stronger in the mass capacity segments and in the legacy. So maybe there was a gap for the gross margin, we'll open it a little bit between the two segments. But the overall company is growing towards the target that we discussed just a few months ago at the Analyst Day.

Wamsi Mohan

Okay, that's great. Gianluca, I think we're just about getting to a bit out of time here. So maybe I'll give you an opportunity to just address all the investors on the call about why you are excited, and why they should be excited about investment in Seagate.

Gianluca Romano

Well, I would say the most important thing to run a good business is to drive it's alignment between supply-demand, and to be the leader in terms of products. Right now we are going into that direction. In terms of alignment, we are the leader with our product, we will be the leader in the future with our new technology, HAMR; that we are by the way, already selling one on 20 terabyte but it has the right time when we will have a drive with 30 terabytes or higher based on HAMR technology, that will be another, a new major change for the industry…

[Call ends abruptly]

Question-and-Answer Session

End of Q&A

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