Seagate Technology Holdings Plc. (STX) Management Presents at Annual Virtual Wells Fargo TMT Summit (Transcript)

Seagate Technology Holdings Plc. (NASDAQ:STX) Annual Virtual Wells Fargo TMT Summit December 1, 2021 4:00 PM ET

Company Participants

Aaron Rakers - IT Hardware and Semi-Conductor Analyst at Wells Fargo

Conference Call Participants

Gianluca Romano - CFO

John Morris - SVP and CTO

Aaron Rakers

Thank you everybody for joining us this afternoon. I'm Aaron Rakers on the IT Hardware and Semi-Conductor Analyst here at Wells Fargo. Pleased to host a quick discussion with Seagate. We've got Gianluca Romano, CFO and we were lucky enough to have John Morris, the CTO from Seagate join us this afternoon.

So first of all, guys, thank you for taking the time out of your schedule. Really appreciate it.

John Morris

Thank you. Thank you for inviting us today.

Aaron Rakers

Perfect. Maybe.

John Morris

Sorry I'm before we start, let me just remind everyone that we will be making forward-looking statement today, and you can learn more about the risks associated with the statement in our SEC filing on our website.

Aaron Rakers

Great job. Nailed it. So, John, I, don't -- I get to talk to Jean look a lot. I don't -- we've talked, I spoke a few times, but I wanted to start with you because I think the technology curve where we're going from here, the hard drive -- hard disc drive industry is structurally changed dramatically over the last couple of years now. And it's, a significant amount of demand coming from the cloud guys and what's also interesting is that there's a bit of a bifurcation in the technology roadmaps and so I wanted to understand that a little bit more from a Seagate perspective.

You've outlined 50 terabyte capacity points in nearline by 2026. Can you just walk us through the pillars of innovation, the drive towards hammer and how you're thinking about the technology hurdles that take us from where we're at today to that level of capacity.

John Morris

Yeah, sure. It's a great question. First, just as a reminder, we generally see technology transitions every 10, maybe 15 years and we've been able to run perpendicular for a long time as an industry since about 2005. And we've gotten a lot of growth out of perpendicular recording, but we're kind of, we are reaching a point where there's diminishing returns and it's about the right time to introduce a new recording technology, which is what we've been focused on for a long time.

It's kind of laying the groundwork for that new technology to be ready to kind of dovetail in where perpendicular is at, and then provide us another 15 years of growth off the new S curve that we introduced with the technology. So what we're focused on right now is to Reddy hammer or heat assisted magnetic recording to allow us to get that 15 year opportunity with the new Esker from hammer.

And it's a really interesting technology in that. It opens up a completely new design by introducing the laser with the head. We can open up our media design space and that combination of those two things, the laser in the head, a new magnetic outweigh in the media really opens up that opportunity for a really robust and sustainable aerial density growth over the next 10 or 15 years.

And so I generally, I would say the industry is pretty well aligned to hammer is being kind of the next big thing for recording technology and also generally there's pretty good alignment that at capacity's above 30 terabytes is when that technology is really going to make sense. So with that in mind we're deep into product development with a hammer platform.

And so it's in a -- we're in a mode now where we're doing integration of the technology, not unlike what we traditionally typically do for any product and we're progressing very well to our plan with our first major volume platform and we gave some outline on what that would look like a couple of years back actually in our last analyst event as well and I would say we're feeling really good about it. It's achieving our expectations and we've got good customer engagement in the early phases and we're pretty excited about where we're at.

Gianluca Romano

No, we have -- we have proven the technology with a 20 terabyte hammer that is actually in the market today is we have not high volume because it's not optimized from a capacity standpoint. So we will ramp much more on the next product. Most important for us was to prove that the technology was working and also to give the opportunity for our customers to use their drive in their data to, and getting ready for the next product set that we will start planting much more.

Aaron Rakers

That's both guys, that's a great overview. What, I'm kind of starting to see is that it's not the hard cut over right to hammer that maybe some of us, maybe on the investment side, we're a little bit, misaligned on our thoughts on is that it feathers into the product portfolio. And you just mentioned John 30 terabytes and beyond is kind of the real inflection maybe for him, or which is going to take us out still a couple of years, do you see still abilities to drive incremental steps of aerial density per platter, aerial density increases on PMR? Or is it more platter count expansion that takes us from 20 to 30 before we see maybe a real meaningful cut to hammers as needed?

John Morris

Yeah. Great question. Yeah, absolutely. There are ongoing incremental aerial density gain opportunities with perpendicular recording and we and others in the industry expect to be able to make additional gains and deliver additional capacity and do that with higher aerial density than what we're shipping today.

Gianluca Romano

And that's, is that a four months again, where I started off you've got, I'm sure you hear it a lot, energy assist or magnetic, mammary versus hammer, is that, a discussion that should be had, or is that, are you got ways to take DMR if it's not necessarily energy assists, other things to drive before? I guess what I'm trying to get at is the road map from here of the 30. How I think about that?

John Morris

Yeah. There's we, absolutely have capability to increase aerial density with perpendicular with not just an evolution of our designs that were already in volume production on and we are not introducing any major design changes in our perpendicular recording system. It is really just a evolution of what we've done on eighteens and twenties.

Gianluca Romano

That's great. And, gee, you look at, it probably ties back to your comments that you've been making, taking eighteens and twenties and keeping on that common platform that has really been an important narrative to the gross margin profile for the company. So, do we see that common platform approach playing out, well into the mid-twenties or even 34 to 30 terabyte capacity point range, or even beyond that,

John Morris

Well, I would say for sure, it's worked very well for our 16, 18, 20 terabytes is in the market already today. No, I think we can leverage on that platform also for next PMR drive. Now, if we decide to develop more capacity point I would say Emar [ph] is very important also not only for the eye capacity, but because of the high head of density pair disc, we can also then at some point use MR technology at a lower capacity point with a lower bill of materials and of course try to optimize our profitability.

Aaron Rakers

That's a good point. That's a really good point, John, back to you. One of the things I've been interested in as the technologies evolve as the demand from these cloud guys continues to be, easily surpassing that 30% long term or 35% plus long-term kind of growth cater to supply that demand, it's also invoke more platter counts into drives. Is there you've gone, people thought, you went from eight to nine, now there's discussions around 10. Is there an idea that these hard districts go even beyond 10, flatter counts is you know to satisfy the demand that you're seeing out there?

Gianluca Romano

Well, let me start off. It's feasible, there's space to add additional platters in the drive technically. But as John Luca indicated, our objective is to leverage aerial density gains so that we can better facilitate lower cost and a lower overall total cost of ownership. So adding additional heads and platters it generally is favorable for total cost of ownership, but it's not optimal for total cost of ownership. And we've got a really heavy focus to engage with our customer base and understand the major drivers they have in total cost of ownership and incorporate that feedback more directly in our drive architecture and drive design and what it generally leads to is a desire to grow capacity by an aerial density gains or intrinsic transit gains in the recording system. So that we basically have fewer parts in the drive, not more parts than the drive. And so we'll continue to focus on that.

It is one of the big enablers that hammer provides us as a vehicle for capacity is gives us as John Luca highlighted a minute ago. It really does give us an opportunity to hit the capacity per unit that the industry is looking for to achieve their use case solution but do it in the most efficient and lowest cost lowest overall total cost configuration. So we'll continue to work on that, but just circling back at, there's technical capability to add additional heads and disks it, and it is an option that could be exercised if necessary, but our focus is going to be on intrinsic aerial density gains.

Aaron Rakers

That's perfect. And on that same line of discussion, there's this always this battle between SSD cost curve and that a hard district cost curve that remind me again, of what you think you can drive to as far as aerial density gains and how you're thinking about the slope of those curves or for that matter the crossover server is and SSDs relative to drive. So as you see it.

Gianluca Romano

Yeah. So, we highlighted previously that we have technical capability to achieve a 20% CAGR with Ariel with our hammer technology. That's fairly comparable with the kind of cost CAGR that the flash industry is communicating and generally what we would say, there's always a bit of plus minus on those numbers. So generally what we would say is there's a pretty rough equilibrium in the technical capability of both flash and hard disk magnetic recording technology to maintain roughly similar CAGRs.

And because of that an equilibrium that results from it, we actually, we're not seeing a point in time that there's a crossover and the cost per terabyte of the technologies. We do believe there's going to be healthy separation well above the threshold where there'd be a total cost of ownership closure and I would say that's just in general, we don't see a point in time that there is a crossover in total cost of ownership.

Aaron Rakers

Right. Okay. I would say if you look at the NAM business, the major or change in their or from a cost standpoint is when no of the industry moved from planner to Vertica [ph] and then from 32 layers to 64. So they doubled the gigabyte per wafer and then 64 to 96. And that started to decrease the benefit of 96 to 112 or 128. So the benefit from the change in technology name already happen a few years ago. Now you will see less impact now still. The decline low was and what happened in the past.

In RDP is the opposite situation. We are now at the end of the PMR technology that is not providing anymore a lot of cost reduction, but terabytes, but when we moved to haver fairly soon, then you will see that costs a core to decline very rapidly and know much better alliances with the end core.

Gianluca Romano

Yeah, that's a great point. And, at the same time, when I look at the amount of capacity shift in the enterprise market, we haven't really changed over the last handful of years, right? We're still shipping the same amount of flash as relative to hard disc that we ship, several years ago. So it hasn't, definitely supportive of that comment. Before I shift over to UG, and we're going to talk a little bit about the business. one of the things that I don't get many investors ask me about, but I'm curious in is that, the mock two dual actuator solution in your product portfolio, can you just help us understand the importance of that, what that drives and competitive differentiation of that technology in your portfolio.

John Morris

Absolutely. That's a great question. Thanks for asking, one in many use cases, there's this notion of stranded capacity, which is kind of like a portion of the available capacity on a drive that can't be used by the application because the performance is too low to achieve the end user SLA, the end user service level agreement that's desired for that use case.

And in collaboration with a number of our customers, we initiated efforts to architect and the dual actuator drive to address that challenge of stranded capacity and really happy to say that we had great collaboration to that was really focused on solving a very specific challenge and in achieving that performance at lowest total cost of ownership in this use case. And we did that work with the leading cloud service provider, and we're now in volume production with that drive.

And we expect this to be kind of the leading edge. There's more there will be more opportunity and we're broadening the collaborations that we have not just with cloud service providers, but with other parts of the infrastructure community, including areas like content distribution at edge. And, our expectation is over the next several years as drive capacities increase, there's going to be increasingly greater demand for that type of drive architecture so that the SLS can be achieved at a lower total cost of ownership than any alternative would provide.

Gianluca Romano

Yeah. Very interesting. And you're seeing more, you are seeing more of the cloud guys come to you and once you optimize, architecture? Is there any customization that you're actually being asked to work with specific cloud guys on, at the drive level?

Aaron Rakers

Yeah, I think generally that's fairly standard practice in the industry that there's a certain level of customization frequently. It's firmware customization. So think, device features that they can activate through the host interface, but it's a standard practice in our industry to work with the end user in these mass capacity use cases to architect device features that deliver a greater value in their deployments.

Gianluca Romano

That's perfect. So look in a 12 or so minutes we have left, I asked you a few questions and John, to the extent it ties back to what you're involved in, please, please jump in. I'm not going to ask you to w how the current quarter is going, but I am going to ask you just to kind of help us appreciate what you've been saying. What are you seeing any kind of things that you can share with us from a demand profile perspective right now?

John Morris

Yeah, the end demand is really strong and is well aligned to what we discussed at our last earning, really. And so we don't see major differences from what we discuss about a month ago. I would say every quarter is presenting a different challenge as seems like a beginning of calendar '20. So it's about two years now where every quarter, the very something that we need to take care of and of course, I think the company did a very good job every quarter to overcome those challenges from an operational standpoint. And I think the quarter is exactly the same. The supply chain is a bit rapid for sure, but I don't see at this point, any input while to our plan operations in term of volume that we can shape into the market. Maybe…

Aaron Rakers

They, I'm sorry, go ahead.

John Morris

Oh, I will say maybe it's the only financial impact that was not completely planned. He is continuing plays in the freight charges and no, we discussed that for several quarters. As the last time we gave an indication of the impact was in the June quarter that invest was about $30 million about 1% impact while at first margin.

In September, we didn't really report his exact amount, but we said is actually higher than the June amount. And what is a bit of a surprise already at that point? We saw the 30 million was probably a number was going to be fairly stable for at least few quarters and then actually improved from that and decline. But no for several reasons, we see the freight charges actually continuing to increase. So the December quarter, I believe at this point, looking at the volume that we are shifting and they at ACE for the freight, I think it will be even higher than September. So that is a part of that, is that behaving a bit differently from what internally we were expecting, we were expecting to be fairly stable, but actually that is continuing to operational standpoint from in a volume, from a shipment. We are fairly, fairly aligned to our plans

Gianluca Romano

When you talk about supply chain and I can appreciate the freight costs, I'm certain you're not going to exactly quantify what that impact is. I don't think you guys give a guidance on gross margin in the quarter, but on supply chain, is it more about stuff that's outside of your business or are you faced with any supply constraints or labor shortage is impacting your ability to supply relative to demand?

John Morris

Well, I would say we have different challenges. Some are internal, some are external, but we will not -- we will not be finally no impacted in the court for issue in the quarter and we have done in the past. Now we have -- we have auctions in place in order to recover from those challenges and the impacts now able to of course is a little bit more inventory. So we have some strategic inventory to overcome short-term shortages and of course we have lots of safety rules in our own site. So we have tried to avoid as much as possible any impact from the COVID situation. So it's not dependent the prior quarter I think is difficult to manage, but I think we will have the volume that we need.

Gianluca Romano

Yeah. That's perfect. In the last couple of quarters, one of the things, there's two things that I felt that has started to resonate in the hard disc drive industry. Obviously it's a competitively narrow landscape, right which is it's historically good. I've also started to see, and I think we've talked about it today and look is that there seems to be some info, discipline, increased discipline, if you will, around pricing behavior, and maybe that segues into kind of the structural gross margin discussion of the industry, maybe stripping out COVID and freight costs dynamics. So can you unpack that a little work what are you seeing from a pricing perspective? Do you agree with the discipline that we're -- that I'm alluding to in the industry?

John Morris

Yes, you are absolutely right. I think the discipline is mainly on the CapEx side. So in the past also because of the declining, the legacy business, but I worked a lot of capacity that was not utilized and of course now the focus from all the players was to use as much as possible, the capacity and the focus was on volume, more than profitability.

About a year ago, maybe longer, I think the industry is becoming more on how we -- how we spend, how our CapEx and the timing of the timing and, but a much better alignment now between supply and demand. That is why the pricing is always behaving differently is not because of the players is because of the discipline in the CapEx and the diving better alignment between supply and demand that is finally giving a most stable pricing environment. And I would say more, a reasonable return and profitability to be much higher return from the investment in R&D and any money factoring, but now we haven't done in the last seven or eight years.

Gianluca Romano

Yeah. That's helpful and the mix obviously is an important variable to that as you and appreciating the hammer, hammer ramp is a consideration, but if someone were to come to you and say, look there's more again, ex-COVID freight costs aside, there's more of an upward bias to you putting gross margin closer to that high end of the range of 30 to 33, or maybe even we see a scenario where we could move above that. What would you say, hey, wait a minute, there's no way there's certain things to consider, or do you think that discipline first to change that gross margin thought?

Aaron Rakers

Yeah, I think in the last few quarters, we moved from like 26% to 31%, despite COVID. And now the last time we quantify the COVID impact it was already 1%. So I would say no, if you excluded the COVID input, we are already in the upper half of that range of 31% to 50%, but no, we indicated as our long term target model for the next couple of years.

So we actually went faster in that gross margin improvement than what we were thinking maybe a year ago. So I would say when the COVID cost, we start with eight, I think that improvement will stay with Seagate and that will increase our profitability on top of the continuous increase in the mix, going to max capacity the continuing pace on moving demand to the cost of product that we have kind of product that has two terabytes and then of course there is no what is the normal efficiency in our manufacturing that tends to not decline our cost per terabyte? And if pricing remain fairly stable or that will continue to include into the time.

Gianluca Romano

And to the extent that that were to play out with, is there anything that you would structurally think differently around the operating expense management of the company? I think you've been obviously executing above, I think a little bit above this last quarter, your high end of your 20% EBIT operating margin, would you re-invest some of that or would you continue to let that drive you that leveraging the model, just curious?

Aaron Rakers

Well, I would say, but our different items, the first one is we spent a lot in the past on developing the hammer technology, no, the product, but they are technology. And that I think is behind us. So that part is that could eventually be reduced, but at the same time, or we are now focusing a lot on going fast in the product development or for the new Emer product now terabit ability, or the next the following generations. And also very important for us is we have a new business what we call life, right? That business requires some OpEx is that it's not an enormous amount of office, of course, but there is a little bit of a shift in our OpEx between the core business hard disc business and the life business. But in total, I don't see a major change in our OpEx level.

Gianluca Romano

That's, very helpful. And then a couple of minutes we've got left. I think I would be remiss not to ask you about a big part of Seagate stories that you've been a solid free cash flow generator, and you've been very much, shareholder friendly as far as capital return. So I think you've share count by over 15% over the last couple of years. So, as you look at the balance sheet, just free cash flow generation, remind me again of how you're thinking about capital allocation capital return strategy.

Aaron Rakers

Yeah. That would say our strategy is not changed in the last probably almost two years. So what we have done is first of all, we have a now relooked as a CapEx. So we have reduced our CapEx PC is contributing to a higher generation free cash flow. So free cash flow is really strong right now. You've seen the last couple of quarters. We were well above the $10 million and $50 million a quarter last quarter was like CAT. I think no this trend can continue and need to be less than a us all that free cash flow is going directly to our shareholders through dividends. And we want to be very programmatic with dividend, we've unwell dividend increase every time we can. In the last three years, we increased the dividend. We increased by 3%, twice and like 5%, almost 5% last year. So it is a good part of our shareholder return, but share buy back is also very important.

We had a less programmatic and maybe more opportunistic with a share buyback. So I will not displace a fixed amount every quarter. We are a little bit more variable, depending on from the share price, from the other opportunities that we have. The liquidity that we have available at the time, but of course, no we have taken advantage of the lower share price in the last year. We were buying back at $50, $60, $70. So I think so far has worked very well and you see like a big part of our strategy, because even as a level of today, we believe, we strongly believe the company is still well underway.

Gianluca Romano

Yeah. And then those were great share repurchases, in the literally less than one minute I got, on that topic liquidity, right. You've got about a billion of cash on the balance sheet. You've got, obviously, some leverage on the balance sheet is there, reminds us again the liquidity that you feel comfortable running the business with and then I'll let you get on with your day.

Aaron Rakers

Yeah. I know I think we want to have about at least $2 billion in liquidity and no more than $1.7 billion in our level, so we are well above that level. We, already in on forms but, we raised a little bit more debt, so our cash balance also increased right now. We have a repayment coming due in February and $20 million. So we will repay that note that is much will renewing in February, but I mean so far we have ample liquidity to manage our business and continue our share back.

Gianluca Romano

That's fantastic. Great overview guys. I really appreciate you taking the time this afternoon and again, thanks so much.

Aaron Rakers

Thank you. It's always a pleasure to talk to you.

Gianluca Romano

Thank you.

Aaron Rakers

Thank you.

Question-and-Answer Session

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