Thank you for joining us here today at the BofA Global Technology Conference. I'm Wamsi Mohan. I cover IT hardware here for the bank. Delighted to welcome Seagate to our conference today. We have CFO, Gianluca Romano, and EVP as well. He's been CFO since 2021, and he's seen an interesting couple of years with COVID, with supply chain, with demand, inventory. We're looking to get updates from him on a variety of stuff. Welcome, Gianluca. Thanks for joining us today.
Thank you, Wamsi. Before we start with the question, let me remind everyone that I will be making forward-looking statement today, and you can learn more about the risk associated with those statement on our website.
Okay, great. Well, with that out of the way, like, how does the demand backdrop look? What areas are you maybe most confident about a rebound by the end of the year?
I would say, you know, recently, we start to see different trends in different parts of the business, in the different market segments. I would say in China, we start to see a recovery, so we expect a sequential improvement in the revenue. Of course, it's still very far from where it was before the down cycle, like, you know, December 2021. It's starting to recover from, you know, the December level, the March level, so some good signs in that part of the world, and that is impacting a certain number of the segments. In particular, I would say, video and image application. We also see some improvements in enterprise OEM outside China, so mainly U.S. and the rest of the world. Still far from the peak, but at least sequential improvement.
The legacy part and the non-nearline part is probably fairly flat, at least for what we can see at this point in the quarter. As you know, as we discussed, many time between earning release and today, the part that is sequentially declining is the cloud. You know, we discussed what happened recently, especially in the March quarter, what is the situation with the inventory? What is the focus of our customer in the cloud space, especially in the U.S. cloud space? They are trying to increase utilization rate, they are trying to optimize what they put in place in the last two or three years.
We need, you know, we need, of course, to go through this period of time and have the inventory, their inventory to start to decrease, and then we will go through another cycle of growth. In general, especially in that part of the business, but I would say in all the nearline business in general, you have period of growth where customers are focused on putting capacity in place based on their, you know, long-term demand expectation. When you have a macroeconomic situation that require more focus on spending, their focus change for a certain period of time into using more of what they already put in place. Increase utilization, decrease inventory, and, you know, and try to go through that period of time.
When the macro improve, they go back in spending more into the growth and less into the, you know, increased utilization. Cloud is the part that, you know, right now is creating more of a decline in our revenue sequentially, maybe even a little bit more than what we were expecting at the beginning of the quarter. I would say, you know, we still need to go through the second part of June. A lot, a lot of revenue will happen in the last, you know, three, four weeks of the quarter, but we expect maybe cloud is a bit weaker. Maybe our revenue could be more in the lower half of our guidance.
Okay. Okay. Thank you for that update. As you think about your comments first on China, and the VIA market improving, when you think about where your peak levels were to where you were maybe exiting December versus where you're thinking now, like what's the magnitude, roughly, if you could share, of where you're tracking now, roughly?
Oh, yeah, it's still a huge difference. You know, we said, in December 2021, our business in China was about $1 billion and 30% of our overall revenue. Right now is several hundreds of millions of dollars lower, even in the June quarter. I think the good point is, sequentially, it's starting to improve. You know, and we had a fairly good revenue on, you know, from that part of the world. Of course, the U.S. cloud is predominant in term of revenue, and therefore, the decline in U.S. cloud is more than offsetting the good news that is starting to come out from China.
Now, would you say off the bottom, I mean, from the top, you're still several hundred million dollars below. From the bottom, are you several hundred million dollars higher?
I would say a little bit higher.
Okay.
Not several hundred, but-
Yeah
you know, it's not smooth.
Yeah.
It's just, it's a good improvement. Of course, it's not a jump. It's not that we go back close to where we were before, but sequentially, it's starting to be a good improvement. Hopefully, this will continue. I would say after the month of March, we saw a good improvement in that part of the business. Hopefully, it's continuing. Of course, from China, you have different input, different information. Some are showing a good improvement, some are showing a slower improvement. I just saw the on the export number that was just reported. It's not great, but still, I think it will be a sequential and gradual improvement more than, you know, a strong jump back to where it was before.
It will take a certain number of quarters.
As you think about the revenue coming in towards the lower end of the range, how do you think about the rest of the P&L gross margins? Are you changing sort of underutilization impact? Is that increasing? Are you making changes to your production decisions based on how things are tracking?
I'll say the production probably not too much. We know we already cut production. At the beginning of the quarter, production is or the cycle time is fairly long, so we look, you know, two, three quarters away. We think underutilization charges will be around, you know, $50 million-$60 million. That is what we discussed as an earnings release. I would say now it's more, it's more tactical. No, it's not a I don't expect a major changes. I expect a little bit of a change from the midpoint that we guided, so not huge. Tactically, some of the cloud customer could consume a little bit less than what we were discussing at the beginning of the quarter.
Of course, then, whatever is not consumed in this quarter will be consumed in the next, you know, two or three quarters.
Understood. there's also been, some, you know, some of the companies like Micron have faced some recent challenges coming out of China. Do you think Seagate's exposed to those kind of risks?
Well, I think every company could be exposed to those kind of risk. You know, geopolitical risk is not, is not a small risk. I would say I don't see Seagate to be exposed to that specific risk. Again, you know, we have seen rules changing in the last, you know, two or three years, very often, so it can always happen. Hopefully, the world is going in the opposite direction, you know, where it looks like U.S. and China are discussing more and trying to find a different solution that is not what we have seen in the last two years.
That will, of course, help the business in general, not us in particular, but in general, the technology business to, you know, to go back to a more normalized way of doing business with less constraints.
Can you maybe provide us an update on HAMR? It's become a fairly key part of your story as investors think through it. Where's your confidence in sort of launch of product? How is some of the qualification, early qualifications going on that?
Yeah, HAMR is going very well. It's going actually little bit faster than what we were expecting just a few months ago. We are starting to ship already last quarter and this quarter for qualification. Usually a qual takes a certain number of months, we are going through that process, and we still expect to, you know, to increase our revenue sequentially quarter after quarter. Probably, you will see a good volume from HAMR now that can start to impact our P&L, I would say, in three to four quarters from now. Not very far in time. Now, you will see volume growing through, you know, this quarter, next quarter, of course, to impact P&L, you need to have a certain volume. Otherwise, it's not big enough.
I think, you know, three to four quarters, and we start to see that.
Where would you say you could hit, like 1 million drives that you would be shipping?
We didn't give a specific volume, but of course, you need to have, you know, close to that volume to really start to see the impact to the P&L, to the financials.
Can you talk a little bit about margins on HAMR and how you expect progression on that?
I think, you know, HAMR give us, and, you know, the industry in general, because we will not be the only one selling HAMR in the future, gives the opportunity to the industry to improve the profitability. Mainly because you can grow in capacity per unit without increasing the bill of material. With the current technology, you know, PMR, you can increase capacity per unit, but you always need to increase by, you know, one disk and 2 heads. There is a little bit of increase of areal density, but a lot of increase come from more bill of material. Even if you increase the bill of material, you still have a decrease of cost per terabyte. Of course, there is a negative impact of higher bill of material. When you go to HAMR, our 32 TB is based on 10 disk and 20 heads.
Same number of disk and heads of the current 20 TB PMR. The following product will be a 36 TB, and will still be based on 10 disk and 20 heads. All the increases coming through areal density. The following one, 40 TB, still the same, 10 disk and 20 heads, and also the 50 TB. Now, we said at our earning release, in our lab, we are already running individual disk at 5 TB. We can increase capacity by a lot without increasing the cost per unit, because it's the same bill of materials. That will give the industry, and Seagate in particular, because we are now the first adopter, to have a cost reduction and to maybe give some of that cost reduction to our customers, not to improve their TCO. We want them to be successful, but not all.
In the past, the vast majority of the cost was passed to customers. I think HAMR will give us opportunity to still provide a good TCO to customer, but keep a good part of that, cost improvement into Seagate, and therefore improve the gross margin. That is the main focus, the main strategy of the company, and why we spent so much money in developing HAMR in the last more than 10 years.
If you think about the qualifications that are currently underway, can you talk about what all capacity points you guys are trying to qualify?
Oh, it's the first product, so it's basically the 32.
Okay. As you think about the progression of that, by the time you get to mid-next year, what would you say would be all the capacity points that you would have qualified?
Yeah, I'll say with PMR, we were able to have a new product basically every 12 months, 12, 15 months. HAMR maybe take little bit longer, but not much longer, so I would say every, probably every 18, 20 months. A little bit longer, but of course, the increasing capacity is much bigger, and as I said before, the bill of materials is the same. I think if we can execute this plan, we'll be very positive to Seagate in term of financials, but also to the industry in term of technology progression.
What about down the stack? If you were to go to lower capacity points, when would those get qualified?
That is another good advantage of HAMR, you know? If you think 40 TB based on 10 disk and 20 heads, there are, probably only one segment that will use 40 TB at that point.
Sure.
It's only the cloud. The other segments, you know, enterprise OEM, probably will be in the 30 TB. Video and image application will be in the 20 TB, and, you know, other legacy products will be lower. Now you can see, for example, in the video and image application, they could have a 20 TB with 5 -disk and 10 heads. This drive will basically compete to a traditional drive with 10 disk and 20 heads. There is a huge difference in bill of materials, a huge difference in cost. Again, it's not that we need to give all that cost.
Sure.
customer. We give a little bit of that cost benefit to customers, and the rest of the benefit should stay with Seagate, and again, improving our gross margin at very different capacity points using the new technology.
If you look out maybe middle of next year to the middle of the following year, like, how would you say that migration would be, what percentage of your high cap would be HAMR?
We are not developing any PMR after the 24 TB. We have a 24 TB coming out soon, next few months, you will see it. That is the last PMR product. I would say all capacity point above 24 PMR, that is a probably a 28 SMR. All the capacity above that are HAMR. Again, in couple of years, I think all the cloud guys will focus on the high capacity. They will want to have an HAMR, 36 TB compared to a, I don't know, a PMR 24, to me makes a lot of sense.
Sure.
I think the vast majority of our high capacity business will move to HAMR. Of course, depend also from how fast the company can ramp production on HAMR. Longer term, HAMR is a solution, as you were saying before, is a solution for not only for the highest capacity, but also for mid capacity. Probably not for the very low capacity also, because that business is declining, and now in few years, probably will not be there anymore. Again, for the rest, is probably based on HAMR.
As you think about the next 12 months and ramping your production for HAMR, how does that influence your gross margin? Because obviously, you've not sort of achieved the yield or scale that maybe you're still in the process of getting there. How does that play out from a gross margin standpoint?
Well, there is no technical reason why the yield on HAMR should be different than the yield on PMR. said that when you have a new technology, a new product, you need to learn, especially in manufacturing, because you spend a lot of time in R&D to develop the product and, you know, to be sure technically it's working, but you cannot really try to do on a very high volume. That is what you need to learn when you really start to ramp. Now, what we said in the past is, we are not expecting low yield. We are just, don't know what we don't know yet.
We need to go through this period of time where we increase the volume, you know, up to the, you know, level that we were discussing before, and see what is the yield. If it is like the PMR, we just ramp, no problem. If it is lower, we need to slow down, understand, fix the problem, and then ramp. It's something that, you know, everyone will have to do it anyway. You know, we go, we go first, so we are the first one that will have to learn and understand. I would say so far, we have not identified anything in the technology that should create a problem in term of yield. We have not ramped 1 million units yet, so we need to go through that process.
Right. At steady state, like when you think about your longer term gross margin profile, would you just get back to your long-term gross margin profile historic, or Is there opportunity to sort of exceed that or move that range higher with HAMR?
I think we need to, you know, go step by step. The first step is to go back to where we were before the down cycle.
Sure.
Of course, we need to go through this period of time where, you know, we focus on a lot of cost reduction, a lot of optimization, internal optimization, even in our manufacturing. We go through that, and I think as soon as we start coming back, into the upcycle, you will see that level of profitability to come, even at a lower revenue than where we were before. Mainly because we have reduced our cost, so we think we can keep a better cost structure even when volume comes back up. That is step one. Probably, HAMR will be only a part of the yield. Then when we really ramp high volume of HAMR, as we said before, we see an opportunity for further strong reduction in cost per terabyte.
As I said before, you know, we want to give a good TCO to our customers, but we think we can keep a good part of that into Seagate and improve our gross margin further, and higher than, where we were before.
Right up front, you mentioned, you know, maybe we are doing a little better in China and cloud customers tracking a little bit lower. As you look out over the next few quarters, do you think that those trends kind of still persist? Or do you think that what you're seeing from your cloud customers is maybe just a slight delay of purchasing that kind of, you know, recovers back in by the September quarter?
Yeah, I think we will see a similar trend. I think China will continue to improve. I think, legacy, you know, reasonably will stay fairly flat. Usually, you know, that segment is the one that decline. I would say, you know, because we should be, through the end of the down cycle, probably will not decline, but probably will not even increase, but stay fairly flat. Then cloud will have to take, you know, one quarter, two quarters to deplete the inventory. I think this is the right thing to do, instead of trying to, you know, push more and more volume into customers that they don't need right now. We need to go through those few quarters, and then we think through the end of the calendar year, we start to see some improvement also in that segment.
I think calendar 2024 will be a much better year on all the segments. All the segments.
Yeah, let's hope so for that. I do wanna give the opportunity to see if there are any questions in the audience. We do have a mic, so if there are any, just raise your hand and we'll get the mic to you. All right, there's one right here, please.
It's coming.
Sure.
Yeah, great. Thank you very much. Great presentation. You know, very quickly, when we look at the data center, we can see lots of the alternative solutions versus HDD, guess what? PCIe, SSD. What's the management's long-term strategies, how to optimize the mix ratio, HDD versus SSD, which is becoming more a PCIe-based solution? Also, when we look at the AI training area, which is based on the more powerful GPU provided by NVIDIA and others, they are really recommending the very PCIe Gen 5 as well. What is the management strategies on this, or opportunities or risk? Thank you.
Thank you. It's a very good question. I think, two separate question. Maybe let's start from AI. You know, everyone is talking about AI right now. I'll say there are two phases of AI. One is a generative phase. How does this work? Basically, access data that is available mainly in the cloud. There is not much to do for an hard disk. Data is already there, so they access the data, and they do, you know, they generate something new. Let's say they generate a new video. To generate this new video, you don't need hard disk. You need the GPU, and you need the flash, and you need the DRAM, you need many other components. On this phase, hard disk is not really part of the activity.
Once you have the video, what do you do? You save it, and you save on the cloud. This is where the hard disk gets a positive impact from AI. It's saving all the new document, video, songs, everything that is created, gets there to the cloud. It's not one or the other. Two phases. One phase is clearly more oriented to, you know, the GPU and the components we were discussing before, and one is 100% hard disk. When you have the new, the result of what you have created, you save on a hard disk. This increase the database, because then AI has to access the new information or the new data, and create something new again. It's an evolution. It's not that you create that new video, and it's all what you do.
One week later, you access that new video and 10 other new videos that people have created. You try to create something new. That something new gets stored on a hard disk again. There is a huge benefit from hard disk, because you will have more data to get stored. If you create a video and you delete, that's not a huge benefit. When you create a video, maybe you create 10 videos, and then you say, "Oh, I like those two," and I save those two, that is where you get the benefit on the hard disk. There is a lot of benefit from hard disk. In general, now, when you look at NAND versus hard disk, I would say it depends. If you go on a very low capacity, there is, of course, an overlap between the two technology, you know?
When I talk about the legacy, that tends to decline in term of volume year after year, is because the flash is overlapping and taking over on those small applications. Even on a laptop, you need to think a little bit further. You have a laptop and you say, "I can have a hard disk or an SSD." You say, "I want an SSD because it's faster." You say, "Oh, hard disk get displaced by SSD." Once you have the SSD in your laptop and you create your work, your analysis, where do you save it? In the cloud. The data storage is still, even from your laptop, is still favoring hard disk. It's just physically in a different place. When we say NAND displaced hard disk, depends.
Of course, in the tools, yes, but in where the data gets stored, no. It's still getting stored into an HDD. In general, in the cloud, you have both. Now, you have a lot of HDD where you do the storage, and you have the NAND, where that is used to do the analytics and the compute phase. It's not used for storage. They accept the data, they do the analytics, they store on HDD. They access the data. This is the architecture of the cloud. I say if there is something positive through this down cycle, is that NAND is so cheap, that if there was a reason to replace the HDD with NAND, you should have seen it, you know, in the last year, two years.
Ninety percent of the data is still stored on hard disk, exactly as it was before the down cycle. It's just the architecture that doesn't see the benefit of having storage into NAND .
I think we have one more question back there.
Very quickly on the capital structure. you guys yield around 5% dividend yield, which is pretty high for this sector. we got a lot of questions about capital allocation into, you know, if there's two, three more quarters of uncertainty, macro uncertainty, how do you think about capital allocation?
I think Seagate has always been very focused on shareholder return. We have done this through share buyback and through dividends. At the beginning of the down cycle, we decided to stop the share buyback. We generate positive free cash flow. We have generated free positive cash flow every quarter. So far, we don't see any reason why we should suspend the dividends.
Any more questions, audience? Maybe to wrap it up, Gianluca, can you just maybe also talk about your recently renegotiated covenants, where you've given yourself, like, a lot of room, frankly, you could be, you know, negative EBITDA in the quarter, and you could still get to these covenants. Can you help us think through, you know, obviously, and you don't wanna keep going back to the banks to renegotiate these, but is this just a case of, like, a lot of conservatism so that even if the macro deteriorates, you got plenty of room, plenty of leeway, plenty of liquidity? Just, can you just help us think through the process there?
Yeah. I think that's the point. You know, I think was a good discussion, a good support from our banks. Of course, the key is always to start to improve our EBITDA, and this is what we wanna do. No, we created a certain level of leeway, and I think that give us a little bit of flexibility. At the same time, we have reduced, or we are reducing a little bit of our debt. You know, at the end of September, we were $6.3 billion. At the end of June, I think we'll be, like, $5.4 billion, and we can reduce even a little bit more if we have to.
I would say it's a good collaboration, you know, we try to reduce the debt. They give us opportunity and support on the covenants, and, so I think it was a good result.
Okay, great. Unfortunately, we're just about out of time. Thank you so much, Gianluca, for being here today. Thank you for the update. Really appreciate it.
Thank you, Wamsi .