Seagate Technology Holdings plc (NASDAQ:STX) Q2 2024 Earnings Call Transcript
Seagate Technology Holdings plc (NASDAQ:STX) Q2 2024 Earnings Call Transcript January 24, 2024
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Operator: Welcome to the Seagate Technology Fiscal Second Quarter 2024 Conference Call. [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 posted our earnings press release and the detailed supplemental information for our December quarter 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. We have 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 the 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 in the Investors section of our website.
As always, following our prepared remarks, we'll open the call for questions. I'll now turn the call over to Dave for his opening remarks.
Dave Mosley: Thanks, Shanye and hello, everyone. I am going to focus on 2 key topics in my remarks today. First, we delivered solid fiscal second quarter results with revenue at the midpoint of our guidance and non-GAAP earnings of $0.12 per share, exceeding the upper end of our guided range. And second, last week, we marked a major inflection point in mass capacity storage with the launch of our ground-breaking Mozaic platform. Mozaic is intentionally named to describe the fusion of innovative technologies including Seagate's unique implementation of HAMR that collectively enable us to extend our areal density leadership. As we shared in the past, growing areal density is the most efficient way to enable data center operators to scale mass capacity storage to lower their TCO and to advance their sustainability targets.
I'll discuss the platform in more detail shortly and also share progress towards qualification and volume ramp of our first HAMR-based Mozaic product which lays the foundation for products boasting 5 terabytes per disc and beyond. Let me start by highlighting our fiscal Q2 performance. Revenue of $1.56 billion was led by sequentially improving cloud nearline demand and a seasonal uptick in consumer drives, offset partially by the decline in VIA sales that we anticipated. Strong cost discipline and execution on pricing adjustments resulted in non-GAAP operating income tripling quarter-over-quarter and increasing roughly 17% year-over-year despite lower revenue levels. These performance and demand trends affirm our expectation for the September quarter to be the bottom of this prolonged down cycle.
The enhanced discipline we've built into the business, including strict cost controls, management of supply and the strengthening of our balance sheet gives us an excellent foundation to build on as we move into a broader recovery. Additionally, execution of our product roadmap is expected to structurally improve profitability and return us to our targeted financial model which supports healthier industry economics. We enter calendar 2024 with increased confidence in our non-GAAP gross margin trajectory, including our ability to reclaim 30% minimum benchmark level at quarterly revenues that are at least 20% below our prior cyclical peak. From a demand standpoint, gradual recovery within the U.S. cloud market has started to take shape, reflecting solid progress in consuming excess inventory, along with more stable end market behavior.
Enterprise OEM demand trends have also stabilized within the U.S. markets. Customer feedback still points to macro-related concerns, although IT hardware budgets are projected to modestly improve in calendar 2024 and traditional server growth is expected to resume, trends that support incremental HDD demand growth in the calendar year. We were also encouraged to see incremental demand among certain non-U.S. cloud and enterprise customers in the December quarter. Across the broader China markets, we project a relatively slower pace of recovery given the ongoing economic challenges within the region. However, some local governments announced further steps to support the region's economy which our customers believe will bolster local demand across mass capacity markets in China in the second half of the calendar year.
These efforts support our view for demand in the VIA markets to pick up sometime after the Lunar New Year. Against the dynamic market environment, Seagate has continued to execute on a mass capacity product portfolio that further advances our technology leadership and serves the breadth of our customers' unique workload requirements while also supporting our objective of improving profitability. I'll outline the execution path for our latest product launches and the relevance of the new platform and then share how we believe our mass capacity solutions deliver economic value both to our customers and to Seagate. Our product qualification and ramp plans are on track with what we've been articulating over the past several quarters. We began shipping initial volumes of our 24 terabyte PMR, 28-terabyte SMR drives in the December quarter.
Customer reception has been positive, as illustrated by the numerous active qualifications underway across multiple cloud and enterprise customers. Our 3-plus terabyte per disk product is the first major release of the HAMR-based Mozaic platform and we are rapidly nearing qual completion with our initial hyperscale launch partner. The qual has gone very well and we are working with this customer at their request to fully transition future Seagate demand to the 3-plus terabyte per disk platform. Volume ramp is starting in the March quarter according to plan with a goal to ship about 1 million units in the first half of this calendar year. We then expect to continue to ramp through the balance of the calendar year and we are currently broadening our customer engagements.
Based on their planned timelines we expect to complete qualifications with a majority of U.S. hyperscalers and a couple of global cloud customers during calendar 2024. Starting at 3 terabytes per disk, Mozaic delivers a quantum leap forward in areal density innovation with a well-defined path that extends to 5 terabytes per disc and beyond. This transformative platform is the culmination of decades of development and numerous technologies pioneered by Seagate, including our Super lattice platinum alloy media that enables higher bit density. The revolutionary plasmonic writer with integrated laser capable of reliably writing each bit and an advanced reader technology that boast one of the world's smallest reading sensors. While Mozaic represents ground-breaking technology, the platform is fully plug-and-play with existing conventional drives and addresses the breadth of our customers' mass capacity workloads.
These drives can also be deployed with SMR technologies for the few customers able to integrate SMR to take advantage of the additional capacity gains. As I noted earlier, areal density gains are the most efficient way to scale storage capacity. Let me offer a few clear examples. First, as we execute our product road map we can deliver increasingly higher capacity drives with minimal changes to the bill-of-materials. This results in a better TCO value proposition for our customers and attractive economics for Seagate. Second, as we scale areal density to 4 terabytes per disk, this enables extremely cost-effective product offerings in the low to midrange capacity points used by a majority of our enterprise VIA NAS customers. With 4 terabytes per disk, we use half the number of heads and disks to produce a 20-terabyte drive.
Prototypes are already working in our labs with revenue planned for the second half of calendar 2025. As we ramp production to expand to other end markets, we gained tremendous manufacturing efficiencies, adding to the attractive margin opportunities that I just described. We continue to build on our technology and operational innovations with each successive product generation. For example, we are executing plans to vertically integrate the laser manufacturing process which enhances supply flexibility, provides greater control of the technology and provides opportunities to lower production costs. Collectively, we believe these actions underpin our mass capacity cost reduction road map while also providing a very strong TCO story for a broad range of customers.
While TCO remains a key driver for mass capacity storage, data center operators are also focused on power and space consumption, particularly as investments in compute-intensive infrastructure proliferates to support generative AI applications. For context, the latest AI GPUs consume up to 700 watts which is roughly 100x more power intensive than a hard drive operating at maximum performance. Our products can help data center operators store more exabytes using less power and space. To quantify this, a single 32-terabyte Mozaic drive can replace three 10 terabyte drives storing more capacity at 1/3 of the power and footprint. TCO and sustainability gains of this magnitude are decision altering when architecting a new data center and offer a highly economical path to modernizing existing infrastructure.
We believe that this dynamic can potentially accelerate the replacement cycle. As we move into the early stages of demand recovery, Seagate's strong focus on maintaining our product and technology roadmap through this past down cycle position us to return to profitable growth and address data center operators most important challenges: cost, power and space. We believe we've got the right product at the right time, heading into a gradual recovering mass capacity market. With that, Gianluca will now cover details on our financial performance and outlook.
Gianluca Romano: Thank you, Dave. Seagate's December quarter financial results reflect solid operational execution. Revenue was $1.56 billion, up 7% quarter-over-quarter. Non-GAAP operating income more than tripled sequentially to $127 million, leading to non-GAAP operating margin expanding to 8.2% of revenue up 540 basis points quarter-over-quarter. And non-GAAP EPS was $0.12, improving $0.34 sequentially and exceeding the high end of our original guidance range, reflecting both improving demand trends and our focus on profitability. As these trends continue, we expect our results to improve and reach the target financial model over time. Within our hard disk drive business, exabyte shipments grew 6% sequentially to 95, with revenue growing 7% to $1.4 billion.
Revenue performance was mainly driven by an expected improvement in cloud customer demand, along with seasonal improvement in the consumer market. Within the mass capacity market, revenue increased 4% sequentially to $1.1 billion, driven mainly by strong nearline cloud demand, offsetting the expected decline in the VIA market. Mass capacity shipments totaled 83 exabytes compared with 79 exabytes in the September quarter. Mass capacity shipments as a percent of total HDD exabyte was 87% which is comparable to the prior quarter 88%. For nearline products, shipment of 65 exabytes were up quarter-over-quarter from 56 exabytes. Average capacity per nearline drive continue to increase sequentially, reflecting modest demand improvement among both U.S. cloud customer and China cloud customers.
We believe that inventory among many CSP customers is reaching more normalized levels and anticipate continued nearline demand improvement in the March quarter and beyond. VIA market revenue was down sequentially in the December quarter, consistent with our expectations. Looking ahead, we expect VIA to reflect more typical seasonal patterns through calendar 2024, with the March quarter representing the low point. Legacy product revenue was $324 million, up from $278 million in the prior quarter, driven by higher seasonal demand in the consumer market. We expect the legacy market to be sequentially lower in the March quarter following typical consumer demand trends post-holiday season. Finally, revenue for our non-HDD business increased to $171 million compared with $159 million last quarter, primarily driven by improved SSD demand.
Moving on to the rest of the income statement. Non-GAAP gross profit increased sequentially by roughly $80 million in the December quarter to $367 million, ahead of our original expectations. Non-GAAP gross margin of 23.6% expanded nearly 400 basis points compared to the previous quarter, due in part to pricing adjustment and cost savings from earlier restructuring activities as well as lower amortization costs which were about $40 million consistent with our view for ongoing demand recovery. However, we expect underutilization cost to marginally increase for the next couple of quarters as we transition some of our production line to Mozaic. Accounting for this headwind, we still expect to see margin expansion every quarter –[Indiscernible] 2024 as nearline demand continues to improve gradually and we ramp our latest products along with continued execution of price adjustment across the entire portfolio.
Non-GAAP operating expenses totaled $240 million, down from $248 million in the September quarter and reflecting ongoing spending optimization. With the benefit of diligent expense management and higher margins, adjusted EBITDA improved more than 50% sequentially to $216 million. Non-GAAP net income turned positive in the December quarter, resulting in non-GAAP EPS of $0.12 per share based on diluted share count of approximately 211 million shares and tax expense of $17 million. Moving on to cash flow and the balance sheet. In the December quarter, we had inventory flat at just below $1.1 billion. Capital expenditure were also flat sequentially at $70 million. A majority of planned capital expenditure were completed in the first half of fiscal '24.
Consistent with prior commentary, we still expect fiscal '24 CapEx to be down significantly compared with fiscal '23, also still sufficient to support our innovation-driven product roadmap. We generated about $100 million in free cash flow and returned $146 million to shareholders through the quarterly dividend exiting the quarter with 210 million shares outstanding. We closed the December quarter with $2.3 billion in available liquidity, including our undrawn revolving credit facility. Our debt balance was $5.7 billion at the end of December quarter, with more than 90% of our long-term debt obligation beyond 3 years. Non-GAAP interest expense were flat quarter-over-quarter at $84 million and we project similar expense levels in the March quarter.
Turning to our outlook. We expect incremental improvements in mass capacity demand from both cloud and enterprise customers to more than offset seasonal related decline in VIA and the legacy markets. With [Indiscernible] context, March quarter revenue is expected to be in the range of $1.65 billion, plus or minus $150 million,. an increase of 6% sequentially at the midpoint. We are planning for non-GAAP operating expenses of approximately $260 million as our temporary pay reduction ended late in the December quarter. At the midpoint of our revenue guidance, we expect non-GAAP operating margin to expand to the low double-digit percentage range including underutilization cost of approximately $50 million. We expect our non-GAAP EPS to be $0.25 plus or minus $0.20 based on a diluted share count of approximately 212 million shares and a non-GAAP tax expense of $27 million.
I will now turn the call back to Dave for final comments.
Dave Mosley: Thanks, Gianluca. Heading into calendar 2024, we have increased confidence in a gradual nearline demand recovery that coincides with the launch of Mozaic. We believe this platform delivers sustainable areal density leadership with compelling TCO advantages, enabling data center operators to satisfy their increasing workload demands while conserving both power and space. This combination of capabilities is significant and our timing is fortuitous. We've navigated the last 7 quarters with discipline and focus while maintaining our product and technology execution plans. As a result, we emerge well positioned to drive optimized financial performance to support our capital return commitments and return to our targeted profitability levels over time.
Our strong execution is only possible through the tremendous efforts of our global team and I would like to thank them for their resiliency and dedication through this dynamic period. I would also like to thank our suppliers, customers and shareholders for your ongoing support of Seagate. Operator, let's open up the call for questions.
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