Seagate Technology Holdings plc (STX) Management Presents at Citi 2021 Global Technology Virtual Conference (Transcript)

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Seagate Technology Holdings plc (NASDAQ:STX) Citi 2021 Global Technology Virtual Conference Call September 14, 2021 1:00 PM ET

Company Participants

Gianluca Romano - Chief Financial Officer

Conference Call Participants

Jim Suva - Citi

Jim Suva

Hello, everyone. It’s so great to virtually see you. My name is Jim Suva. I am the IT hardware and tech supply chain analyst here at Citigroup Investment Research. We are very pleased to host our Annual Global Technology Conference, where we have over 200 companies. This fireside chat is with Seagate, stock ticker, STX. I want to go over a few housekeeping items first. First is, no media or press are allowed on this conference call or this video connect. If you are media or press, please disconnect immediately. We also note, if you are an investor that’s subject to MiFID II, please ensure you have that research agreement into place. We also note there are disclosures associated with this available at the Citigroup log in as well as the velocity site and have been sent out. We do note if you want to ask questions, please press the little area on your screen and submit a question. I will then get to e-mail and assuming that there is time left, I will try to aggregate those questions under the same topic or question. I will not mention who asked the question, so it will be through me. This will help us maintain the strong audio and video quality associated with this.

I do want to mention that joining us from Seagate I am very delighted to have Gianluca. He is the Chief Financial Officer. And as CFO, he has a first – a couple of commentary opening questions about Safe Harbor to mention then we will get into our questions. Gianluca?

Gianluca Romano

Thank you, Jim, for inviting me here today. Before we go into the Q&A session, a quick reminder that I will be making forward-looking statements and you can learn more about the risk associated with those statements in our SEC filings posted on our website.

Question-and-Answer Session

Q - Jim Suva

Well, that was easy and quick. So, why don’t we go ahead and talk about kind of the current state of the HDD storage industry kind of your perspective and what’s changed over the past few years?

Gianluca Romano

Yes. I would say that the demand is very strong in the current period. We had a very strong quarter in June. We actually guided the current quarter even stronger, higher revenue, higher EPS. At an open forum last week, our CEO, they mostly actually confirm that the revenue is coming at the level that we guided at the midpoint of the guidance. He also mentioned that we expect profitability to be stronger than what we guided. So, we guided $2.20 at the midpoint. And he said, we now expect EPS to be at the high end of the range. So for the time being, I would say, very good news, the better EPS is coming from several factors, I would say part is the mix. The mix is a little bit better than what we had in our original plan for the quarter. The pricing environment is still very favorable. And we are also executing well on our internal cost reduction. And all this is, of course, driving better margins, better profitability and finally, better EPS. When we look at the longer term, we are very confident that the mass capacity part of the business will continue to grow very strongly. We said in the past we expect volume to grow about 35% CAGR for the next several years.

Inside mass capacity, we see cloud and video and image applications as the segment that are growing the most. On the other part of the business, the legacy part, so the part which is including laptop, desktop gaming, consumer, mission-critical. This is the part that in the last few years has declined and we expect this to continue to decline, even if in the last few quarters, we, for sure, saw a slowdown on that decline. But in our long-term view, we expect that to continue to decline for – well, probably another couple of years and then maybe stabilize on a certain volume. In terms of percentage of our business will be less and less relevant. Last quarter, legacy was about 30% of our hard disk drive revenue. So, we think in the next couple of years we will probably go down to below 20%, this mainly because mass capacity as I said before, is growing very, very rapidly and we expect continuous strength in that part of the business.

Jim Suva

Gianluca, you actually published a financial model earlier this year. I think if my memory is right, you kind of targeted revenue growth of 3% to 6%, I maybe off on that. Can you talk to us about that financial model? The industry actually has seen revenues decline in – for several years and you are talking about revenue growth. So, kind of what gives you the confidence or how should we think about your financial model?

Gianluca Romano

Yes. First of all, we are very confident. Actually, at our last earnings release, we guided fiscal year ‘22, so, the current fiscal year revenue to grow high single-digits so way higher than the 3% to 6%. I would say in the last 3 years, revenue has been slightly growing. This is the last couple of years, but you are right, before that, but it was a fairly long period of time of decline. The reason was legacy part of the business or the segment I mentioned before, we are representing 80% of the revenue and mass capacity was fairly small. During fiscal year 2020, we had mass capacity becoming a little bit bigger than legacy. And last year, and as I said, especially in the last quarter of last year, we have a major increase in mass capacity now representing almost 70% of our hard disk revenue. So, the fact that mass capacity is now so much relevant in our revenue and the third which is growing very rapidly, as I said 35% volume CAGR. And the decline in legacy is becoming less important to the overall performance of the company. So in February, during the Analyst Day, we indicated that range for revenue growth, but in the current year, we see a much higher growth already and we will review that forecast maybe next earnings release and during the full fiscal year, but – no, but we are very confident and it’s good to start with a strong year to give confidence to everyone that this industry revenue is going to grow for the next several years.

Jim Suva

One thing that’s changed is I never thought we would be talking about cryptocurrency or Chia. So, can you talk to us a little bit about cryptocurrency and Chia and kind of how it’s consuming some storage and what your view is on that, because at least here in the U.S., we – it’s kind of a newer phenomenon about Chia?

Gianluca Romano

Yes, we had a lot of discussion, especially in the last quarter about Chia and cryptocurrency and blockchain storage. We don’t think it was a very high volume in our June quarter. We indicated at our earnings release, no more or less what level of volume we are thinking about. It’s not huge, but it’s for sure, important to continue to realign supply and demand. What I think was a major problem of the hard disk industry in the last few years with the legacy segment declining in terms of volume and revenue and mass capacity growing. But with mass capacity, we were also installing a lot of CapEx. We had a situation for certain period of time where supply was above demand. And about a year ago, we review the situation for Seagate. We review the situation for whatnot we believe the industry is. And we decided to slowdown a little bit our CapEx. We still invest a lot, but let’s say less than what we were planning before. And this is driving the industry in a much better situation in terms of supply and demand. I believe there is still some overcapacity but it’s not huge anymore. It’s fairly small. So when you have items like Chia or other items that suddenly consume 4 or 5 exabytes for a company that is driving a good realignment of supply and demand and a good utilization of the factories. So I – we don’t know exactly how this will evolve in the future. I would say in our planning we don’t consider a lot of volume from cryptocurrency. If this will become a real trend and a real strong demand for hard disk consumption will be, for sure, an upside to our current plan. So no, we welcome for sure the new segment. But I would say, for the time being, we are a little bit prudent on how we plan for that volume.

Jim Suva

Yes. I was doing some research on Chia. And I’m like, well, what if all of this doesn’t sustain long-term. And I learned that the disk drives really gets scrubbed or abused really bad, and you simply just can’t take them and put them into an enterprise or a secondary use. I see you nodding your head, so it sounds like that, that’s accurate.

Gianluca Romano

Well, I would say, first of all, a big part of the exabyte that went to Chia and other cryptocurrency we don’t believe are coming from new hard disk drive. So there could be refurbish drive, old drive or drive at were purchased for a different application than decided to be used for Chia because of the return in the short-term. So I don’t think that really brought a lot of new demand. Well, let’s say, in future, we see opportunities on other applications like the Filecoin, IPFS. So the more the blockchain decentralized storage that could be a good new demand vector for hard disk?

Jim Suva

If I remember right, you recently introduced a financial model of gross margins of 30% to 33%, if I’m correct. And it seems like you’re already getting to the lower end of that. What’s the biggest factors that could influence that? Is it mix? Is it ASPs? Is it volumes? What are the variables that investors should be aware of?

Gianluca Romano

Yes, that is a range of total 33%. In the June quarter, we were almost at 20%. I think we were actually running up at 20%. And as you know, we actually guided the current quarter or the September quarter, higher in revenue, higher in earnings per share. And as adjusted, we actually expect that earnings per share to be at the high end of the range, which is, of course, implying a better profitability, a better gross margin, better operating margin. So we think we will be well into the range as we said at our prior earnings release already in the current quarter. Everything is helping. I would say, the continuous mix moving to mass capacity is a help for the gross margin. The pricing environment is very favorable. And as I said before, we are always focused on our cost reduction, on our utilization of the factory. This is a big element of the cost reduction. And with a much better alignment between supply and demand, now our factories are working fairly full. And this is driving the cost per terabyte of our hard disk down significantly. So we are happy with the execution of our plans. We are happy with how we are progressing on the gross margin. Our focus is mainly free cash flow, as I said several times in the past. So for us, it’s all important, the revenue growth, the improved in profitability, the increase in earnings per share. But if you ask what is the main focus of the management team is, for sure, free cash flow. And we had a very good quarter in June, above $350 million. And we want to continue to improve our free cash flow.

Jim Suva

One thing that wasn’t a future – our focus a few years ago was COVID and now for the past 2 years, it has been a full focus. Can you talk a little bit about are you facing any supply constraints or bottlenecks or production issues or government curtailment of manufacturing locations or work hours?

Gianluca Romano

Yes. Unfortunately, it’s very complicated. The supply chain in the hard disk business is very complex, as you know there are so many components inside a hard disk. So I would say almost every quarter, we had some issues due to COVID disruption in different parts of the supply chain, sometimes in our factories, sometimes our suppliers. But the good news is we were always very quick to react and to solve the problem so that we didn’t really have any material impact to our volume. So part of the improvement is coming from the higher level of vaccination. We try to support all our employees and their families, try to provide access to the vaccine as much as possible. We also always need to thank our suppliers because they did a fantastic job until now they really step up every time they had a problem as we did internally and be able to at least reduce that problem at a level that was not materially impacting our volume. You never know what can happen tomorrow and probably still there, for sure, but is a high cost related to COVID, and we were disclosing that cost in the prior quarter. We said we will not do anymore because I would say this is kind of a new normal, unfortunately, but it’s still there and especially on the freight charges, all the action that we take for making – to make our factories as safe as possible. A lot of costs, probably for another few quarters, I would say, in our plan, we have this cost probably until the end of the current fiscal year, but hopefully, it will start to abate a little bit soon.

Jim Suva

Yes. I hope it does abate also because I look forward to us being in person at some point.

Gianluca Romano

Hopefully, yes.

Jim Suva

Can you talk about your progress on 20-terabyte qualifications and ramping?

Gianluca Romano

Yes. We said recently that we are actually shipping already the 20-terabyte in the current quarter. The volume is, of course, not very high. So I don’t expect a lot of financial benefit in the current quarter for the 20-terabyte. I think in the short-term, the story for high capacity is more renting the 18-terabyte. We had already a very good volume in the last quarter. We are still ramping. I think for the next couple of quarters, two or three quarters, the majority of the increase in exabyte will come from renting the 18-terabyte. But in the meantime, we will proceed with our 20-terabyte and getting our big customer qualified and continue to ramp probably in the second half of the fiscal year. We have different kind of 20-terabyte actually. Now we have the PMR that is the one that I was just discussing. We have a 20-terabyte HAMR that we actually started to sell December last year. That is a small capacity drive for that new technology. So we are now ramping in volume. We are just producing enough quantity that we can sell to our main customers so that they get familiar with the new drive, with the new technology. In the meantime, we are developing our second-generation HAMR drive that will be probably around 30-terabyte. That is the driver that we want to ramp in volume. And of course, we expect after the 30-terabyte to continue to progress with that technology. And we discussed at our Analyst Day we expect 50-terabyte in just a few years from now in fiscal ‘25. The technology can really scale up a lot in capacity. So we have a road map in the long-term road map, we already had 100-terabyte at least by 2030. We believe HAMR is the right technology for hard disk to continue to scale up in capacity, so to be used for cloud applications. But a certain point because really, this increase in capacity is coming from aerial density, it’s not coming from our additional media and additional ads. You can also see different application for HAMR not only in the cloud, but also for mid-cap drive just with a lower bond and a better TCO for our customer and a better profitability for Seagate.

Jim Suva

And Gianluca, regarding 20 terabytes or, I guess, more of the flavors of it, PMR versus HAMR. What are the – just so investors understand what applications would use one versus another or end product or why would somebody choose one versus the other?

Gianluca Romano

Well, I would say today, they will – the high volume will go to the PMR, the 20-terabyte PMR. For HAMR, I think the best solution is to wait for next generation when another drive will be a 30-terabyte drive, that will be at the beginning, focused only on cloud applications, while PMR will be used for our enterprise OEM, for video image application and some of the legacy applications. But as I said before, in the future, we see HAMR technology also has a good solution for many other segments, not only for cloud but also for mid-cap drive. And will be a good technology with good areal density will reduce a little bit the bond for the mid-cap drive and as I said before, providing good results for both our customers and the company.

Jim Suva

Can you spend a couple of minutes talking about Live and Live Cloud, explain to investors what that is, why it’s important.

Gianluca Romano

Yes. Live and Live Cloud, in particular, is a diversification of our business. It’s still based on our core business and core know-how with this hard disk. So it’s a different way of use our core technology and core know-how. So, it’s still based on producing the best product possible in terms of hard disk. But instead of selling the hard disk not to several customers and several applications we have. We can also use our own hard disk to have a cloud that is not competing with our customers. It’s a very different kind of cloud. It’s not based on high performance in terms of compute or analytics, is more a cloud based on backup storage, disaster recovery and also for storage those data that they are not needed immediately to be analyzed or to be used in a high compute application. So, some customers can store their data in live cloud and then transfer the data to a bigger data center where they can have the level of performance that eventually they need. We have a very good, very important partnership with Equinix. So basically, we provide our know-how in terms of hard disk and some of the software applications. They provide their infrastructure, they provide the network. They also provide a good part of the go-to-market. So, I think there are a lot of synergies between the two companies, how we can work well together. And so we think we have chosen the right partner to start with new business for us. It will take a certain number of years to really develop in high revenue, but we think will be good for Seagate in the future. Even the P&L structure of cloud business is a bit different from the hard disk business. So, I think it will be a good way to complement our core business with something new and something that is not absolutely competing with our current customers.

Jim Suva

Earlier in our discussion, you spoke about the focus of free cash flow, as Chief Financial Officer, you are in-charge of the capital allocation framework of the company. You pay a strong dividend. You have been buying back stock. Can you talk about your capital returns program?

Gianluca Romano

Yes. So first of all, you are right, our focus is cash flow, free cash flow, in particular. With our cash flow, we always give priority to our business, our CapEx, our OpEx, so that we can continue to develop new products, and we can install the right capacity level in order to continue to have a good alignment between supply and demand. But with the free cash flow, we are really, really focused on shareholder return. As you said, we have a strong dividend in the last few years. After the Board meeting in October, we have announced dividend increases. So, we will have a discussion with our Board again in October. And of course, we will communicate any decision coming out from the meeting. We want to be fairly programmatic with our dividend, so we want to give confidence but we continue to have dividend as an important part of our shareholder return. The other part is share buyback. We have more than $4 billion of share repurchase already authorized from our Board. We have done a lot in the last few quarters, especially in the December quarter and March quarter last year. We want to be a little bit more opportunistic with our share buyback compared to what we do with our dividend. So, depending from the level of cash that we generate, the possible alternative utilization of that cash and the share price we will do more or less in different quarters, but it is an important part of our shareholder return. And at the Analyst Day, we said for the current fiscal year, for fiscal year ‘22, we expect to return more than 100% of free cash flow to our shareholders. And then in the longer term, we think not to be at least at 70% of free cash.

Jim Suva

You said 70, seven, zero, right?

Gianluca Romano

Seven, zero.

Jim Suva

Okay. And over 100% in fiscal ‘22, I think.

Gianluca Romano

Exactly right.

Jim Suva

Okay. It’s interesting because you have actually bought back significantly more shares than what has been granted through management stock options and compensations, investing and such. In fact, your share count has actually materially decreased. Should we think about that maybe the rate changing a little bit, but you are actually looking at decreasing your share count as opposed to just recouping or retiring the shares that are newly issued to management?

Gianluca Romano

I would say, yes, if you look at the projection for free cash flow. And if you assume more than 100% for the current year and more than 70% in the longer term, that is in excess and what the company is granting to their management team for sure.

Jim Suva

Okay. Gianluca, the second half of this year versus the first half of the year, is there anything we should be aware of as far as positives or negatives in the second half of this calendar year versus the first half?

Gianluca Romano

Well, we are very confident that we will have a strong fiscal ‘22 in general. We are starting particularly strong in the current quarter. Of course, we will discuss more about the December quarter as the next earnings release. We gave an indication of what we have said for fiscal ‘22. That is implying some seasonality in the March and June quarter. Seasonality is fairly normal in this business, especially for some of the segments like desktop, laptop gaming, some of the consumer applications, mission-critical even in the mass capacity part of the business, surveillance is actually fairly seasonal. So, it’s not unusual. It should be expected to see some seasonality coming out from the December quarter. We will give an update for the fiscal ‘22 at next earnings release when the current quarter is done, and we have a good – we will give a good guidance for the December quarter. Part of our business is based on LTAs. So, we will have also some big customers that will give us a light visibility for these six months. So, I am very confident and also stay tuned for an update in just a few weeks from now.

Jim Suva

And then I would also like to focus a minute on pricing. It seems like pricing for the industry has really been more favorable. Is there something that caused that pricing to be more favorable? And what I am trying to get at is, is it sustainable to be strong pricing compared to past historical pricing?

Gianluca Romano

Yes. I would say pricing finally it always depends from the level of alignment between supply and demand. And in the past several years, supply was higher than demand. And I think the industry made some mistakes there, continued to install capacity a little bit in advance of when demand was materializing. Demand was strong, was actually growing faster, but capacity was always call bit too early. So, about a year ago, we decided to slowdown a little bit and still investing a lot because every quarter, we invest more than $100 million. So, it’s not that we are not investing. We are still spending a lot, but we are spending less than what we were thinking it was necessary about a year ago. And this has brought a much better alignment between supply and demand. And you have seen immediately how the pricing environment has become more favorable. And we think this is fair, it’s correct and assuming the industry is keeping with equilibrium between supply and demand, I don’t see any reason why pricing should start to behave differently from what it’s doing today.

Jim Suva

And Gianluca, you have been in many investor one-on-one meetings today and the rest of today and you get asked a lot of questions. Can you take this opportunity in front of the large audience we have now to maybe clarify the couple of questions you get asked the most to help educate investors?

Gianluca Romano

I would say the capital allocation for sure, is a question we receive very often gross margin also how we see the gross margin trending during the fiscal ‘22 and free cash flow. I would say those are the main focus from investors and not probably what they need to know to fairly evaluate their investment in Seagate. And no, I would say the gross margin we have already demonstrated in the last few quarters a sequential improvement, strong improvement, I think we were around 26% gross margin just two quarters ago. And in June quarter, we were close to the 30%, and we said we will be in the range already in the September quarter. And we are doing well as our CEO said last week, free cash flow, always our top priority and for many reasons, but one of the reason is shareholder return. We want to have a strong program for shareholder return and to do that we need to generate strong free cash flow. So, those are the main questions that we usually see on top of, of course, the COVID situation.

Jim Suva

And Gianluca, to wrap it up as Chief Financial Officer, what’s the one or two reasons that you think investors should be buying Seagate stock and owning it in their portfolios?

Gianluca Romano

Well, I believe, first of all, the investors that trust in Seagate a year ago, they have generated a very strong return. So, this is important. We are happy for those investors between dividends and the appreciation of the share price. I think the return was extremely good. But my opinion, this is at the beginning. We believe share price is still well under value when you look, for example, the PE is well below the median of the S&P 500. Our earnings per share is really strong, is improving. Our profitability is improving. So, all those things, all those metrics are pointing to an improvement in the performance that usually brings an improvement and increase in the market cap of the company and share value. So, this is also why we want to be active in the share buyback because we think it’s still a very good time to buyback our own shares.

Jim Suva

Well, I personally want to thank Seagate for allowing us to have this interactive discussion with their Chief Financial Officer, Gianluca and Gianluca, thank you so much for your time today. I know you just have a very long lineup of meetings with investors today. So, thank you so much.

Gianluca Romano

Thank you very much. Thank you everyone.

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