Seagate Technology Holdings plc (NASDAQ:STX) Q3 2024 Earnings Call Transcript

Seagate Technology Holdings plc (NASDAQ:STX) Q3 2024 Earnings Call Transcript April 23, 2024

Seagate Technology Holdings plc beats earnings expectations. Reported EPS is $0.33, expectations were $0.27. STX isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the Seagate Technology Fiscal Third Quarter 2024 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Shanye Hudson, Senior Vice President, Investor Relations. Please go ahead.

Shanye Hudson: Thank you. Hello, everyone, and welcome to today’s call. Joining me are Dave Mosley, Seagate’s Chief Executive Officer, and Gianluca Romano, our Chief Financial Officer. We’ve posted our earnings press release and the detailed supplemental information for our March quarter results on the Investors section of our website. During today’s call, we will refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and included in our Form 8-K. We’ve not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control and/or cannot be reasonably predicted. Therefore, a reconciliation to the corresponding GAAP measures is not available without unreasonable effort.

Before we begin, I’d like to remind you that today’s call contains forward-looking statements that reflect management’s current views and assumptions based on information available to us as of today and should not be relied upon as of any subsequent date. Actual results may differ materially from those contained in or implied by these forward-looking statements as they are subject to risks and uncertainties associated with our business. To learn more about the risks, uncertainties, and other factors that may affect our future business results, please refer to the press release issued today and our SEC filings, including our most recent annual report on Form 10-K and quarterly report on Form 10-Q, as well as the supplemental information, all of which may be found on the Investors section of our website.

Following our prepared remarks, we’ll open the call up for questions. In order to provide all analysts with the opportunity to participate, we thank you in advance for asking one primary question and then re-entering the queue. I’ll now hand the call over to you, Dave.

Dave Mosley: Thank you, Shanye, and hello, everyone. Seagate is delivering solid financial results in an improving demand environment. In the March quarter, we grew revenue 6%, expanded non-GAAP gross profit 18%, and more than doubled non-GAAP earnings per share compared with the prior quarter. Our performance is a function of both improving end-market demand and the decisive actions we implemented throughout the downturn to strengthen our financial profile heading into the recovery. Nearline cloud demand trends are increasingly positive across both US and China customers, and we also saw a sequential improvement in the enterprise OEM markets in the March quarter. On the execution side, the quarter-on-quarter margin expansion reflects our pricing initiatives taking hold as well as favorable mix, resulting in revenue growth in the quarter outpacing exabyte growth.

Pricing strategy is just one key piece of our broader focus on profitability, which also includes maintaining a healthy supply-demand balance, introducing new technologies to enhance value for our customers, and maintaining tight expense controls with an emphasis on generating cash. Looking at the near-term end-market dynamics, cloud continues to lead the demand recovery. For a second consecutive quarter, we realized strong double-digit revenue growth from sales to cloud customers, with improvement across both US and global cloud names. We believe the long-running cloud customer inventory correction is mostly complete and their end demand is also improving. Based on our customer interactions, we currently expect healthy nearline demand growth to continue through the rest of calendar 2024.

Within the enterprise OEM markets, demand stabilized in the second half of calendar 2023 and we observed incremental improvement in the March quarter. Historically, enterprise nearline demand has correlated well with traditional server growth, which is projected to modestly increase in calendar 2024. As a result, we expect enterprise OEM revenue to improve as server growth resumes. In the VIA markets, revenue was seasonally lower in the March quarter and we expect demand to trend higher through the calendar year. Smart cities remain the largest end-market opportunity for VIA products. However, new applications continue to emerge that use AI analytics to form actionable insights from data at the edge, where an estimated 80% of data resides. One such use case centers on smart energy and utility management that aims to use imaging data to drive energy efficiency and conservation.

Analysts place this among the fastest-growing sectors for VIA applications worldwide. Within China, the pace and magnitude of demand improvement in VIA and other HDD markets will be shaped by economic recovery in the region. We continue to monitor the government’s efforts to spur economic growth, including stimulus plans aimed at digital transformation and infrastructure spend. Recent economic indicators show signs of progress. However, it will take time for the benefits of these programs to take hold. Overall, we believe these constructive market trends support steady revenue growth throughout the calendar year. Our ability to deliver that growth is enhanced by our build-to-order initiative that is now in place with the majority of large mass capacity customers.

These plans support Seagate better demand visibility and greater predictability for capacity planning, while our customers find value in the assurance of supply that meets their volume and timing needs. Importantly, the improving overall outlook for HDD demand is unfolding as we execute on our product and technology roadmap. Today, we are simultaneously driving qualification and ramp plans for two high-capacity product families. Our last PMR product delivering up to 28 terabytes per drive, as well as our first HAMR-based Mozaic product on 3-plus terabytes per disk. This is rare for our industry, and I want to acknowledge our product teams at Seagate, who are doing a phenomenal job supporting customers as we work together to advance our industry-leading products and technologies through the various customer qualifications.

These two product families share about 95% commonality in components and leverage the same assembly processes and test processes. This enables efficiencies across areas such as procurement, manufacturing, capital investments, and customer qualifications. The 24-terabyte, 28-terabyte PMR drives are in qualification at most of our global cloud and enterprise customers. We have already completed qualification with one major enterprise customer, some global Tier 2 customers, and with our enterprise systems business. We currently expect to begin shipping significant volumes in the first half of fiscal 2025. Relative to HAMR technology, we continue to progress towards completing our first large CSP customer qualification, though we experienced a temporary slowdown in recent weeks.

We determined a mechanical component unrelated to the HAMR recording subsystem and some of our drives was not performing as expected. We identified and rapidly implemented the solution with full support from our customer. Verification tests are underway and these tests should be completed in the June quarter. Every other aspect of the qualification process has gone as expected. With this shift in timing, we now expect to ship a few hundred thousand HAMR-based Mozaic drives in the June quarter and meet the remainder of our customer’s exabyte demand through other already qualified products. As we gradually ramp HAMR products with our lead hyperscale customer in the second half of the calendar year, we remain focused on broadening the number of customers qualified on Mozaic products.

Customer feedback reaffirms strong interest in HAMR technology and that is further reflected in the successful completion of our first qualification with a top non-cloud customer a few weeks ago. We’ve laid out a Mozaic roadmap with a clear path to at least 50 terabyte drives that offers customers TCO and sustainability benefits, including lower power consumption and less required floor space on a per terabyte basis. We are scaling drive capacity through aerial density gains rather than adding heads and disks. As we execute on our product roadmap to 50 terabytes and beyond, we expect to incur minimal changes to our bill of material costs and maintain low capital intensity of between 4% and 6% of revenue. As a result, we believe HAMR provides the path for achieving margin performance beyond our current target range as production scales and also positions Seagate well to continue capitalizing on megatrends like AI and machine-learning, which drive long-term demand for cost-efficient mass storage.

As we’ve discussed in the past, the initial phase of GenAI has focused on building out the compute-intensive infrastructure required to develop and train large language models. As development shifts to the deployment phase, enterprises will begin to leverage these trained AI models to transform data with value-enhancing applications and generate data-rich content. Customers expect HDD demand to increase as this phase takes hold. Over the next several years, the volume of AI-generated content is expected to increase and also shift towards more imagery and videos, which can be up to 1,000 times larger than text. These trends bode well for HDD demand over the long-term, as HDDs remain the most cost-effective means to house and subsequently use mass capacity data.

To summarize, the combination of more favorable demand trends, strong operating discipline, and product and technology leadership, provide the foundation for driving further financial performance gains. This combination reinforces our confidence in returning to our long-term target margin ranges and potentially exceed those ranges over time as HAMR-based products proliferate in the marketplace. With that, Gianluca will now cover our financial performance and outlook.

Gianluca Romano: Thank you, Dave. Seagate delivered solid financial performance in the March quarter with sequential improvement across every key financial metric. Revenue was $1.66 billion, up 6% quarter-over-quarter. Non-GAAP operating income was up 44% sequentially to $183 million, leading to a non-GAAP operating margin of 11% of revenue, expanding nearly 300 basis points quarter-over-quarter, and our non-GAAP EPS was $0.33, increasing $0.21 sequentially and above the midpoint of our guidance range, reflecting the improving demand trends and continued cost discipline. Within our Hard Disk Drive business, exabyte shipments grew 4% sequentially to 99-exabyte, while revenue increased 7% to $1.5 billion. Revenue performance was mainly driven by the expected improvement in the nearline cloud market as well as favorable pricing actions.

Within the mass capacity market, revenue outpaced exabyte growth, increasing 11% sequentially to $1.2 billion with nearline cloud demand more than offsetting the slight decline in the VIA market. Mass capacity shipment totaled 89-exabyte compared with 83-exabyte in the December quarter. Mass capacity shipment as a percentage of total HDD exabyte was 89%, reflecting the continued long-term secular growth for mass capacity demand. For nearline products, shipment of 72 exabytes were up quarter-over-quarter from 65 exabytes. We believe that inventory among most CSP customers has decreased and anticipate continued nearline demand improvement in the June quarter and beyond. In the VIA market, we believe the March quarter will prove to be a low point of the calendar year with demand returning to more typical seasonal patterns moving forward.

Legacy product revenue was $297 million, down from $324 million in the prior quarter, primarily driven by lower seasonal demand in the consumer market. Finally, revenue for our non-HDD business was $178 million, essentially flat quarter-over-quarter. We expect both the legacy and non-HDD market to remain at similar level in the June quarter. Moving on to the rest of the income statement. Non-GAAP gross profit increased sequentially by $65 million in the March quarter to $432 million. Non-GAAP gross margin improved for a fourth consecutive quarter to 26.1% and expanded approximately 250 basis points compared to the previous quarter. Continued pricing adjustment and favorable mix shift toward mass capacity products offset margin headwinds from underutilization costs, which were about $43 million.

Non-GAAP gross margin for the HDD business expanded much faster than overall company gross margin. Looking ahead, we expect underutilization cost to decrease in the June quarter and abate in the second half of the calendar year as our overall build volume improves to support incremental demand in the nearline market. We believe these factors along with ongoing expense discipline and product execution support the return to the 30% minimum margin benchmark in the current calendar year. Non-GAAP operating expenses totaled $249 million, up 4% quarter-over-quarter, but slightly better than our guidance, reflecting the timing of certain R&D spending and continued cost control efforts. Adjusted EBITDA continues to improve and was up 29% sequentially in the March quarter to $278 million.

Non-GAAP net income was $71 million, nearly tripling quarter-over-quarter, resulting in non-GAAP EPS of $0.33 per share based on diluted share count of approximately 212 million shares and a tax expense of $27 million. Moving on to cash flow and the balance sheet. In the March quarter, we increased free cash flow generation to $128 million. Capital expenditures were down sequentially to $60 million as the majority of planned capital expenditures were completed in the first half of fiscal ’24. We expect fiscal ’24 CapEx to be at or below the low end of our long-term target range of 4% to 6% of revenue. We returned $147 million to shareholders through the quarterly dividend, exiting the quarter with 210 million shares outstanding. We closed the March quarter with $2.3 billion in available liquidity, including our undrawn revolver credit facilities.

Today, we announced that Broadcom has acquired our [ASIC] (ph) assets, including development engineering and related IP for $600 million in cash. The cash inlay will be reflected on our balance sheet in the June quarter and Seagate expects to use a portion of the net proceeds to support our supply chain as we begin to ramp new product builds, as well as pay down debt over time. Additionally, we expect to realize annualized OpEx savings of approximately $40 million starting in fiscal 2025, but there is no expected impact to revenue. Inventory increased to $1.2 billion as we staged material to support the continuous mass capacity demand recovery, along with our concurrent ramp of our last PMR-based product and the initial Mozaic-based product ramp.

Our debt balance was $5.7 billion at the end of March quarter, with more than 90% of our long-term debt obligation maturing beyond three years. Interest expense were $82 million and we project interest expense to be between $83 million and $85 million in the June quarter. Turning to our outlook, we expect continued improvement in our mass capacity markets, led by ongoing demand for our nearline cloud products as well as modest improvement in both the nearline enterprise and VIA markets. Legacy and non-HDD revenue are expected to remain relatively flat sequentially. With better context, June quarter revenue is expected to be in the range of $1.85 billion, plus or minus $150 million, an increase of 12% sequentially and 16% year-on-year at the midpoint.

We are planning non-GAAP operating expenses of approximately $260 million. At the midpoint of our revenue guidance, we expect non-GAAP operating margin to improve into the low-teens percentage range, including underutilization cost of approximately $20 million. We expect our non-GAAP EPS to be $0.70 plus or minus $0.20, based on a diluted share count of approximately 212 million shares and a non-GAAP tax expense of $25 million. Our strong expense management and supply discipline are contributing to the year-over-year profitability expansion that you are seeing in our results and outlook. Our balance sheet and healthy free cash flow generation position us well to continue supporting our capital return commitments. I will now turn the call back to Dave for final comments.

Dave Mosley: Thanks, Gianluca. Seagate is demonstrating strong operational execution and supply discipline amid an improving demand environment, which sets us up well to grow revenue and further expand margins throughout calendar year 2024. Our product portfolio, anchored by industry-leading HAMR technology, offers compelling economics for our customers and for Seagate. As we proliferate these new products, we expect to drive further financial leverage over time. I’m confident that our product strategy offers customers the most compelling TCO proposition and positions Seagate well to capitalize on long-term demand for cost-effective mass capacity storage. We believe that the Mozaic platform delivers TCO advantages for datacenter operators and supports their increasing focus on conserving power and space.

This week, Seagate published our 18th Annual ESG Report outlining the progress we’ve made towards our own sustainability goals, including our product circularity program. We are collaborating with customers and recovering drives from our own operations to extend these products’ life cycles and conserve the planet’s limited resources. Since launching this program in 2020, we’ve recovered and shipped nearly 4 million drives back into the market. Finally, I want to thank our global team members for their hard work and dedication and recognize our suppliers, customers, and shareholders for your ongoing support of Seagate. Gary, we’re ready to open up the call for questions.

Operator: [Operator Instructions] Our first question today is from Erik Woodring with Morgan Stanley. Please go ahead.

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Q&A Session

Erik Woodring: Great. Thank you so much for taking my question. I’ll make it — I’ll combine this into a two-part question. So, Dave, I appreciate your comments on HAMR in the prepared remarks, really just wanted to get clarification on two points, if I may. First is, have you replaced the mechanical component that was giving you an issue and then proceeded to do testing such that you won’t have any further delays on HAMR and now you’re just going through kind of the final testing phase with your lead CSP customer? And then second, I believe you’ve talked in the past about a goal of onboarding the remaining large CSPs by the end of calendar year ’24. Does this hiccup impact that timing at all, or have you started the call process with these customers? Just any clarification on those two points would be super helpful. And that’s it from me. Thank you.

Dave Mosley: Thanks, Erik. Yeah, appreciate the question. So, relative to the mechanical component in question, we do have other sources and we had those other sources running in parallel, so we were able to segregate the material and then get the test beds back up with the right material, I’ll say it that way, and repopulate all those test beds and we recovered the schedule quite quickly because of that. So we’re not happy that we had this issue, but obviously, I think we can move on from here and that’s why we’re expressing the confidence that we did in the script about completing the qualification this quarter and shipping the units. Relative to big picture of the program and these kinds of things happen when you start to integrate high-volume from all your suppliers, sometimes you see interactions that you didn’t use and foresee, and long-term, this isn’t going to slow us down at all and it shouldn’t impact the other qualifications either.

We are — to the second point of your question, we are always re-evaluating exactly where we are involved but we want to also ramp HAMR as fast as we possibly can and get not only the 3 terabytes per platter but 4 terabytes per platter as well. So, still very optimistic on that front.

Erik Woodring: Great. Thank you so much.

Operator: The next question is from Amit Daryanani with Evercore ISI. Please go ahead.

Amit Daryanani: Good afternoon. Thanks for taking my question. I guess, Dave, in the — I just want to focus on the cloud recovery part. In the past, I think you’ve talked about this being potentially a bit more gradual in nature, but certainly looking at your March numbers and the June guide, it would suggest perhaps the recovery is a bit more steeper. So I’m hoping when you talk to — to get a sense of when you talk to these cloud customers, how do you think about the pace and the durability of demand recovery on the cloud side? And related to that, I think you folks shipped close to 100 exabytes of capacity this quarter, what is the total available capacity that you have right now? And what triggered the decision to potentially add more capacity down the road? Thank you.

Dave Mosley: Yeah, thanks, Amit. It’s been a remarkable journey, I think over the last year and a half, two years because the demand was so low relative to the supply that we had, that the industry had and we all took, I think, some supply offline, and we started this build-to-order in earnest at least nine-months ago, telling people that, hey, in order for us to actually trigger the builds, we’re going to — we need some predictability out of the business and we’re quite happy with how that’s proceeded. What’s different in the next nine — in the last 90 days is that the demand really is coming back. And so when we see the exabyte growth last quarter being outstripped by the revenue growth and then we see even more exabyte growth now, then we’re fairly optimistic about it.

We are still not full though to your point. We still have underutilization charges, if you will, costs, and we also have factory capacity that’s not fully utilized yet. So we’re going to stick to the plan I think. The main point for us is we don’t want to overbuild or build product based on speculation. We really want predictability long-term financial health and so on. We’re happy with the improvements that have been made, but we’re not quite there yet, and so we’ll continue to drive this.

Gianluca Romano: Yeah, let me add on the underutilization charges, we said in the prepared remarks we do not expect underutilization charges in the fiscal year ’25, so fairly soon we will not have that additional cost.

Dave Mosley: Thanks, Amit.

Operator: The next question is from Aaron Rakers with Wells Fargo. Please go ahead.

Aaron Rakers: Yeah, thanks for taking the question. I know, Gianluca, you just kind of highlighted the underutilization costs, but I guess as we think about the model and you think about the recovery that you’re seeing, I’m curious if we adjust for underutilization, it looks to me like you’re guiding maybe a 70 basis point, again ex-underutilization gross margin expansion this quarter at the midpoint of the guidance. How would you characterize the company’s ability to price up in this environment, especially looking at the results, it looks like your mass capacity dollar per terabyte was up about 5% sequentially. Where are you at in that journey and how much more do you think pricing could turn favorably for the company? And really what I’m getting at is the continued driver from pricing to gross margin.

Gianluca Romano: Yes. Well, I would say in the last several quarters, now we had some success in improving our pricing and we are continuing to do that, so part of this increase in gross margin that you are estimating for the June quarter is, of course coming from pricing. As you know, we are — in the March quarter, we were very high in mix for the mass capacity, then when we go through the rest of the calendar year, you have other parts of the business that will grow. So the mix will not be maybe as good as we had in March, but pricing is going up, and our cost, of course, is always trending in the right direction. Of course, we have a ramp of new products, but overall, we are very happy with the pricing action and where the mix is today. So we see further improvement through the calendar year.