Seagate Technology Holdings plc (NASDAQ:STX) Q4 2023 Earnings Call Transcript

Seagate Technology Holdings plc (NASDAQ:STX) Q4 2023 Earnings Call Transcript July 26, 2023

Seagate Technology Holdings plc beats earnings expectations. Reported EPS is $1.41, expectations were $-0.25.

Operator: Good day, and welcome to the Seagate Technology’s Fourth Quarter and Fiscal Year 2023 Conference Call. All participants will be in a 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. Good afternoon, 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 posted our earnings press release and detailed supplemental information for our June quarter and fiscal year 2023 results on the Investors section of our website. During today’s call, we’ll 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 that was filed with the SEC. 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 efforts. 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’re 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.

As always, following our prepared remarks, we’ll open the call for questions. I’ll now hand the call over to Dave for opening remarks.

Dave Mosley: Thank you, Shanye, and hello, everyone. We appreciate you being here with us on today’s call. Amid a tough business environment, Seagate delivered fourth quarter revenue of $1.6 billion, while holding non-GAAP operating margin at 3.5% to narrow our non-GAAP loss per share to $0.18. These results demonstrate financial leverage and our focus on returning to profitability. Importantly, we continue to generate positive free cash flow, achieving $168 million for the quarter and $626 million for the fiscal year, reinforcing Seagate’s solid operational and financial execution amid the business backdrop we have seen in fiscal 2023. This past fiscal year has been shaped by macro and end market conditions that have tested our resilience in addition to our financial performance.

I’m proud of our team’s perseverance and execution. As a result of our proactive actions, we’ve lowered our cost structure by more than $350 million on an annualized basis. We’ve enhanced balance sheet flexibility taking out nearly $800 million of debt funded largely by monetizing non-manufacturing facility assets. We reduced production output by approximately 25% compared with peak volume in order to drive better supply/demand dynamics and enhance profitability as the markets recover. And all of these accomplishments were made while delivering on our 30-plus terabyte HAMR product development and qualification milestones with volume ramp on track to begin in early calendar 2024. Looking ahead, we expect the macro end-to-end market conditions that we have flagged throughout fiscal 2023 to continue weighing on demand through at least December.

Consistent with our track record of managing what is within our control, we are taking additional measures to weather the near-term business environment. First, we are adjusting pricing, which we believe will help to ensure a healthy industry supply chain for our customers over the long term. And second, we are carefully managing our manufacturing capacity through a build-to-order approach for certain areas of the business to align our future production output with customer qualification and demand plans. It will take time to bring production capacity and associated support resources back online. Therefore, it is crucial that we balance lead times for mass capacity products with our ability to reramp production. We expect these efforts will enable Seagate to efficiently manage supply for our customers as demand improves.

I’ll now share some perspectives on near-term demand factors, in particular in the mass capacity markets, starting with our business in China. As expected, sales in China improved sequentially off of the March quarter lows, driven by increased demand in the VIA markets and certain regional cloud and enterprise OEM customers. While these trends are pointing in the right direction, sales are still well below historical levels. Since the strict COVID protocols were eased last December, the pace of economic recovery in China has been uneven. For now, we are forecasting sales into China to remain relatively stable for the balance of the calendar year. We are encouraged to see Chinese authorities begin to inject more stimulus to reaccelerate economic growth.

Based on customer input, economic improvement is expected to catalyze e-commerce, drive cloud-related ad revenue and spur new smart city projects. Seagate’s VIA and nearline products are positioned to benefit from these anticipated improvements in the end market demand. Outside of China, nearline demand from enterprise OEM customers has remained soft. CIOs continue to operate under tighter budgets in response to near-term macroeconomic uncertainties. Ongoing efforts to optimize existing workloads, both on-prem and in the cloud, are helping enterprise customers defer mass storage deployments. These trends have slowed the pace of inventory absorption among most of our U.S. cloud customers. We have significantly reduced shipments to several large cloud customers in order to accelerate inventory absorption and protect our financial returns.

We project it will take another couple of quarters for inventory levels to normalize. We also believe the timing for demand recovery could be affected by spending priorities focused on accelerating the build-out of compute-intensive AI infrastructure. While AI and ML have been around for quite some time, generative AI has quickly emerged as the next megatrend. This megatrend makes us as excited as ever about the long-term growth drivers for Seagate. In addition to the ongoing migration of workloads to the cloud, which we believe is far from over, gen AI is expected to be a catalyst for data creation, underpinning future demand for mass capacity storage. In today’s earliest stages of gen AI development, you’re seeing the necessary first steps of building and training of AI models.

These efforts require significant investment in compute architectures, and we’re seeing that investment ramp today. The next stage of development will yield enterprise-specific use cases that leverage trained AI models to convert data into value-enhancing applications. As this phase plays out, cost-effective mass storage will be critical and we see HDD as a long-term beneficiary. We are already seeing examples of content creators generating high-definition images from text, which is growing in use as evidenced by four of the top services selling 20 million images each day. Development is well underway to create data-intensive videos and animations simply from voice commands. The adoption of AI-generated video bodes well for mass capacity storage.

For context, today, nearly four million videos are uploaded daily to YouTube and their file sizes can be thousands of times larger than a single image. Additionally, we believe that predictive AI will lead to advances in many fields, including science and health care. For example, predictive AI can be used to analyze large collection of medical images, many created by Gen AI to provide insight for early detection, prevent disease progressions and develop patient-specific treatments. Mass capacity data storage will remain both an enabler and beneficiary of these trends working in harmony with flash and DRAM memories to bring AI applications to bear. While flash will continue to feed high-performance compute engines, mass capacity HDDs will remain the most cost-efficient storage media to house the enormous volumes of data being generated and used for predictive analytics.

Even in today’s unsustainably low NAND pricing environment, HDDs are still roughly five times more cost-efficient than comparable flash solutions on a per bit basis, and we do not project that gap to close in the next decade. This level of conviction is due in large part to our leading technology road map. Seagate is leveraging magnetic recording technology innovations such as HAMR across our mature 10 disc [ph] HDD platform, positioning us very well to meet increasing demand, including from data-intensive AI applications. Given the current business climate, Seagate is focused on product development and execution and helping our customers qualify next-generation drive capacities. We are executing well on both fronts. We continue to deliver aerial density and TCO advancements through our conventional PMR hard disk drive products.

Development efforts on what may be our last PMR product are nearing completion and will extend drive capacities into the mid- to upper 20 terabyte range. As mentioned earlier, our 30-plus terabyte product launch plan is fully intact and initial customer qualifications are progressing well. We are on track to begin volume ramp in early calendar 2024. We are also preparing qualifications with a broader number of customers, including testing for lower capacity drives targeting VIA and enterprise OEM workloads. While there is always work to do, I am pleased with the progress the product development teams have made during fiscal year 2023. Overall, Seagate has consistently demonstrated the ability to quickly adjust and execute at a high level on every factor within our control.

We remain diligent in managing through near-term business conditions. At the same time, I am excited by the tremendous long-term opportunities ahead brought about by existing and emerging megatrends underpinned by data. Cost-effective mass capacity storage is a critical enabler and Seagate is poised to deliver with strong technology road maps and improving financial leverage. I’ll stop there and hand it over to Gianluca.

Gianluca Romano: Thank you, Dave. Amidst the current industry down cycle, we delivered results that demonstrate our ability to maintain disciplined production output and strong cost control measures. For the June quarter, we reported revenue of $1.6 billion, in line with our recent public commentary and non-GAAP loss of $0.18 per share, slightly better than the midpoint of our guided range. Total hard disk drive revenue declined 14% sequentially to $1.4 billion, with shipment of 91 exabytes. Mass capacity revenue declined 20% sequentially to $1 billion, reflecting softer demand in the cloud nearline market, partially offset by an improvement in the VIA business. Shipment into the mass capacity markets totaled 75 exabytes compared with 104 exabytes in the March quarter.

Mass capacity shipments as a percentage of total HDD exabyte was roughly 82% compared to the March quarter 88%. The expected slowdown in our cloud business led to nearline shipments of 55 exabytes, down 37% sequentially. As Dave outlined earlier, we anticipate that it will take a couple more quarters for CSPs to consume inventory and demand to improve. Specific to the VIA market, revenue was up sequentially from what we believe was a demand drop in the March quarter. We expect a relatively stable VIA demand environment in the second half of the calendar year, although still below the run rate before the downturn. Within the legacy market, revenue was $401 million, up 8% sequentially, reflecting higher demand for mission-critical products. The client and consumer markets were down slightly quarter-over-quarter, typical for a June quarter.

Finally, revenue for non-HDD business decreased 15% sequentially to $218 million. As anticipated, current IT spending behavior in light of economic uncertainties impacted our enterprise system business. We expect this headwind and the purchase timing for a couple of large customers to result in a meaningful decline in our system revenue in the September quarter. Importantly, we shipped our first HAMR-based CORVAULT system for revenue as planned during the June quarter. We expect broader availability of these CORVAULT systems by the end of calendar 2023. Moving to our operational performance. Non-GAAP gross profit in the June quarter was $313 million, down 10% sequentially, reflecting lower revenue and a less favorable mix partially offset by lower underutilization costs.

Non-GAAP gross margin expanded 80 basis points sequentially, approaching 20%. Underutilization cost decreased to approximately $40 million in the June quarter as we temporarily increased production to build long lead time components. Based on the current business outlook that Dave outlined, we expect higher underutilization costs in the September quarter. However, we expect gross margin to modestly increase as our cost structure improvements are fully realized and we implement pricing adjustments in certain markets during the second half of calendar 2023. We reduced non-GAAP operating expenses to $258 million, down $91 million year-over-year and $24 million sequentially. The year-over-year decline reflects our cost structure improvement actions to-date, lower variable compensation as well as disciplined cost management.

We expect non-GAAP OpEx in the September quarter to be similar to the June quarter, reflecting nearly full realization of cost savings from restructuring efforts announced in April, offsetting an increase related to the recent sales and leaseback of three nonmanufacturing sites. Moving on to the balance sheet and cash flow. We ended the June quarter with liquidity level of approximately $2.3 billion, including our revolving credit facilities of $1.5 billion, which was lowered by $250 million as previously disclosed in the credit agreement amendment. Inventory was down $60 million quarter-over-quarter at $1.14 billion and we will continue to focus on reducing our own inventory in the coming quarters. Capital expenditure totaled $50 million in the June quarter, down 7% sequentially.

Fiscal year 2023 CapEx was $316 million or roughly 4% of revenue. We target lower CapEx in fiscal year 2024 as we maintain our focus on shifting to a build-to-order factory loading, balancing supply to demand and still supporting our innovation-driven product road map. Free cash flow generation was $168 million for the quarter and $626 million for the fiscal year, reflecting solid operational execution and efficiency in working capital management. We expect free cash flow to be lower in the September quarter as we incur a majority of the cash payments associated with the restructuring charges announced in April. We used $145 million for the quarterly dividend and exited the quarter with 207 million shares outstanding. There were no share repurchases during the quarter.

Our debt balance exiting the quarter was $5.5 billion down $507 million quarter-over-quarter, primarily reflecting the 2023 notes retirement. This debt reduction was mostly funded through the sales and leaseback of the three facilities noted earlier. Additionally, we raised $1 billion in new notes and user proceeds to prepay $450 million of existing term loans and retire the March 2024 notes of $500 million. As a result of these actions, we now have less than 12% of total debt coming due over the next two fiscal years. Interest expense in the June quarter was $84 million and is expected to increase lightly for the September quarter, reflecting a full quarter of the debt restructuring actions that I just described. Adjusted EBITDA for the last 12 months totaled $974 million resulting in a net debt leverage ratio of 4.8 times well below our amended credit agreement terms.

According to our September quarter outlook, for the hard drive business, we expect incremental improvements in mass capacity to offset declines in the legacy markets. For non-HDD revenue for the system business is expected to decrease sequentially during part to demand timing among a couple of our large system customers as noted earlier. With vetted context, we expect September quarter revenue to be in a range of $1.55 billion plus or minus $150 million. As a mid-point of our revenue guidance, we expect non-GAAP operating margin to be in the low to mid-single digit range, which includes the proactive measure we discussed today partially offset by higher under-utilization cost in the range of $70 million. And we expect a non-GAAP loss per share in the range of $0.16 plus or minus $0.20.

I will now turn the call back to Dave for final comments.

Dave Mosley: Thanks, Gianluca. I’m proud of the perseverance and agility as we continue to proactively respond to the market environment we have faced over this past year. Entering fiscal 2024, we are leaner. Our balance sheet is healthier and our product roadmap is stronger. All of these factors enhance our ability to weather near-term market conditions, deliver financial leverage and position the company to capture attractive long-term opportunities for mass capacity storage. As we conclude our prepared remarks, I would like to thank our employees, suppliers, customers, and shareholders once again for their support. Thanks for joining us and let’s open up the call for questions.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Krish Sankar with TD Cowen. Please go ahead.

Eddy Orabi: Hey guys, this is Eddy for Krish from TD Cowen. I understand you want guide for December, but curious to know your thoughts on December nearline exabyte shipments. Like do you see them growing sequentially from September or more like flat or maybe slightly down? I’m asking is in case we remain at current revenue of $1.6 billion per quarter into next year, I’m wondering if there would be a risk to the dividend that in case especially you guys continue to invest in the business. Thank you.

Dave Mosley: Yes. Thanks, Eddy. So we aren’t guiding for December. I think we expect at this point to hold the line on overbuilding and so that’s one of the reasons we’re being very cautious, but there will be some – there’s an indication of some natural flow through at the cloud service providers, for example. So we expect it to slowly start trending back up from here. I don’t expect a big hockey stick rebound. I mean I could be wrong on that, but we do expect it to be – to slowly go back up because – mainly because we’re not pushing it a bunch of our own inventory. And relative to the dividend, we’re planning for all this in all of our plans right now, and I think we execute this plan, we should be just fine. And we want to continue to be the person for all of our stakeholders that we’ve always been before. We’ve got a laser focus on that right now.

Eddy Orabi: Got it. Thank you.

Operator: The next question comes from Wamsi Mohan with Bank of America. Please go ahead.

Wamsi Mohan: Yes. Thank you so much. I was wondering, Dave, if you could flush out a little bit two of the points that, that you made in your purported marks. One on adjusting pricing strategy in certain markets. What specifically are you doing in these markets? And then secondarily, the reduced production output through this bill to order and lower CapEx comments that you made. How exactly will this bill to order work? Is this specifically for mass capacity? What kind of lead times would you require and are your customers and what do you expect your follow through from customers and also from a competitive standpoint? Thank you so much.

Dave Mosley: Thanks, Wamsi. Yes, it is complicated, because there’s a number of different markets in play here. So for example, a distribution channel or some of the classic markets we have consumer client server. You just don’t move things very quickly, but some places it’s relatively easier to raise prices and have that flow through into the system. On mass capacity drives, generally speaking, we do the price increases through transitions of products. So we’ll say this is the changing economics. We need to make sure that we get paid for that. So as we go through the next product generation, there’s still a TCO benefit to the end customer to drive through that product transition. But the economics have to change largely.

So we can go back and pay our suppliers and keep everybody healthy. There’s been such a profound downturn in demand that we have to make sure that the entire supply chain is treated properly. But exactly what you said, different markets are behaving very differently and accept things very differently. And this is the direction we’re pushing at this point.

Gianluca Romano: Yes, on the cost side, Wamsi, and on the production, that is of course driving under-utilization. Now, we had a little bit higher production in the June quarter, mainly on the wafer side and little bit on the media, but I would say more on the wafer, we will no need to do that level of production right now. So general utilization charges that declined in the June quarter from almost $80 million to $40 million, it’s probably going up a little bit in September. We estimated about $70 million, but of course through the quarter, that could change a little bit.