Earnings Call Transcript
Seagate Technology Holdings plc (STX)
Earnings Call Transcript - STX Q1 2023
Operator, Operator
Good morning, and welcome to the Seagate Technology Fiscal First Quarter 2023 Earnings Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Shanye Hudson, Senior Vice President, Investor Relations and Treasury. Please go ahead.
Shayne Hudson, Senior Vice President, Investor Relations and Treasury
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've posted our earnings press release and detailed supplemental information for our fiscal first quarter 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. 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 and uncertainties and other factors that may affect our future business results, including expectations regarding any regulatory, legal, logistical, or other factors, 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. Seagate also filed an 8-K today disclosing that on August 29, we received a proposed charging letter from the U.S. Department of Commerce's Bureau of Industry and Security, or BIS, alleging violations of the U.S. export administration's regulations. We have responded to the letter and believe that we've complied with all relevant export control laws and regulations. We've been cooperating with BIS, and we intend to continue engaging with them to seek a resolution. During the Q&A portion of this call, we won't be commenting further on this matter, and we'll provide additional updates as appropriate, moving forward. With that, I'll now turn the call over to you, Dave.
Dave Mosley, CEO
Thanks, Shanye, and hello, everyone. In our remarks today, we will discuss the September quarter performance in the context of an intensely challenging macro environment and outline the aggressive actions we are taking to manage the company during this tough period. Despite these near-term challenges, the underlying data demand drivers remain strong, as does the opportunity for mass capacity storage solutions. I will outline why we're confident that as current conditions improve, Seagate is in an outstanding longer-term position. For the September quarter, revenue came in at $2.04 billion, which was inside the revised guidance range that we provided at the end of August. Non-GAAP EPS of $0.48 was well below our expectations, impacted by multiple gross margin headwinds that I'll touch upon shortly. As we shared in late August, three main factors were influencing our outlook: the impact of COVID lockdowns and the related economic slowdown in China, broad-based customer inventory adjustments, and weakening global consumer spending. Since the August timeframe, macro sentiment has further deteriorated, which has led to a more cautious spending environment and more significant inventory adjustments as we move through the final weeks of the September quarter. These factors incrementally impacted sales volumes in the economically sensitive consumer markets and certain U.S. cloud customers. We currently expect customer inventory drawdowns will remain a factor through at least the December quarter. We reacted quickly to adjust our production levels to the current demand environment, and our gross margin performance reflects the resulting factory underutilization costs that increased markedly through the month of September. It's important to note that, consistent with some of the U.S. CSP comments, end-user demand for core data and analytics applications remains solid, which supports our view that the business will improve as elevated inventory levels are consumed. In the meantime, we continued to respond to the changing market conditions and further reduced production output across all product lines, with the exception of our 20-plus terabyte products, where demand has held firm and pricing relatively stable. Our actions underscore our focus on maintaining strong supply discipline, and we believe this will enable us to quickly return to a more favorable pricing environment across mid- to lower-capacity products as conditions normalize. Stepping back, today's highly uncertain macro environment stems from multiple factors outside of our control, such as rising interest rates, inflationary pressures, and geopolitical dynamics. With that in mind, we are focused on managing what we can control and taking aggressive actions to appropriately respond to the near-term market environment and enhance profitability over the long term. In addition to adjusting our production output to drive supply discipline and pricing stability, we are implementing a restructuring plan to sustainably lower costs, including a reduction in our global workforce. These are very difficult decisions to make and ones that we do not take lightly. However, we believe they are necessary to align our cost structures with the realities of the near-term market while still enabling us to support future mass capacity storage opportunities as demand recovers over the longer term. We are improving working capital by reducing our inventory levels over the next couple of quarters, and we are significantly lowering our fiscal '23 capital expenditures while maintaining investments that support the launch and ramp of the 30-plus terabyte product family based on HAMR technology. These cost-saving actions, together with our supply discipline, enable us to drive increased leverage to earnings as conditions improve over the near term. Longer term, we remain confident in the secular growth of mass capacity storage and believe our technology leadership positions us to capture the significant future growth opportunities. Consistent with our focus on enhancing longer-term shareholder value, we are maintaining our quarterly dividend. However, we are temporarily pausing our share repurchase program to ensure we can continue to make necessary investments to support our current business and underpin our longer-term strategic plans. Let me now share some perspectives on the end markets, starting with VIA. The global economic slowdown has continued to impact VIA-related project budgets and installation timelines, which has led to a buildup of customer inventory. These trends have dampened the typically strong seasonality in the back half of the calendar year, particularly in the China market. Stimulus programs to help boost the local economy have been announced. However, timing for economic recovery is not yet apparent, while COVID lockdown restrictions remain in place. Our long-term expectations for VIA demand have not changed. While we have significant direct customer exposure in China, end-market demand is global and continues to expand, as smart video applications are adopted to address real-world challenges. For example, reducing traffic congestion is one area of focus for smart cities, which cost U.S. drivers alone an estimated $53 billion in 2021. These savings can only be realized after capturing and storing large volumes of data and applications best served by HDDs. In the nearline markets, we saw a double-digit percentage sequential revenue decline across both cloud and enterprise OEM customers, reflecting the broad-based inventory adjustments that I described earlier. Recall we had been anticipating the customer inventory correction to be largely complete in the December quarter. However, amid intensifying macro uncertainties, customers have grown more cautious with their spending plans, which we believe will extend the recovery into calendar year '23. U.S. cloud customers are still reporting healthy demand tied to digital transformation, artificial intelligence, and other applications that unlock data value and continue to rank among CIO's highest investment priorities. While enterprise CIOs continue to move workloads to the public cloud, according to a recent study, 80% of cloud users also have a hybrid cloud strategy, illustrating the desire to operate seamlessly across a network of public and private clouds. We believe these trends support our view for mass capacity exabyte growth to return to the upper 20% range as the broader markets recover. These same trends underscore the positive market momentum we are seeing in our enterprise systems business, which recorded revenue growth of over 45% sequentially. While we expect sequential sales levels to reflect some lingering supply challenges in the December quarter, our systems results illustrate how customers are still allocating budget dollars toward areas that drive business value. The data trends that rely on cost-efficient, higher-capacity storage solutions remain intact. As a leader in HDD technology, Seagate is well-equipped to address demand by continuing to execute our strong product roadmap. We are leveraging the current production slowdown to double down on our development actions and accelerate cycles of learning to continue delivering TCO value to customers. Sales of our 20-plus terabyte product family grew meaningfully quarter-over-quarter, supported by strong demand from cloud customers. 20-plus terabyte drives now rank as our highest volume revenue platform, surpassing 18 terabytes as expected. We are extending this product family using conventional CMR technology into the mid-20 terabyte range, which also offers SMR capabilities into the upper 20 terabyte range. Development of our 30-plus terabyte platform based on HAMR technology remains firmly on track. In addition to HAMR, these drives incorporate many new technology innovations to reflect the years of development, design, and integration know-how that form the backbone of our future product portfolio. We continue to execute our development plans, meeting key milestones, including reliability metrics and aerial density gains that also position us to extend drive capacities well beyond 30 terabytes. As I shared in our July earnings call, customer revenue shipments are expected to begin around mid-calendar 2023. I could not be more pleased with our great progress this quarter. In closing, we are navigating through the macro challenges that are impacting our business over the near term. However, the long-term growth trajectory for mass capacity storage remains solid, driven by the fundamental demand for data and the need for businesses to harness its value. We believe that the actions we have undertaken will ultimately strengthen our position over the long term. Looking ahead, as we incessantly push the technology innovation roadmap, we believe our customers will continue to value Seagate as their primary storage solutions provider. Gianluca will now cover the financial results in more detail.
Gianluca Romano, CFO
Thank you, Dave. Revenue came in at $2.04 billion, reflecting the evolving macro landscape that Dave described in his remarks. Non-GAAP operating margin for the quarter was 9%, below our expectation at the end of August due to lower revenue, a less favorable market mix, and higher underutilization charges, as we continue to lower our production output as we gain visibility into December quarter demand. We are taking decisive actions to reduce expenses, reserve cash, and improve long-term profitability, which include reducing production output to enable rapid inventory correction at our customers and on our own balance sheet, significantly lowering capital expenditures for the rest of the fiscal year, resulting in CapEx as a percentage of revenue to be below the long-term target range of 4% to 6% of revenue, and executing a restructuring plan to sustainably reduce our cost by approximately $110 million annualized. We believe this action will put the company in a strong financial position when the global macro business environment begins to recover and expand operating profit faster than revenue growth. Moving to our end markets, as we have mentioned, intensifying macroeconomic pressure and more reserved customer buying behavior impacted our results across both mass capacity and legacy markets. In the September quarter, total hard disk drives capacity shipments were 118 exabytes, down 24% sequentially and 26% year-on-year. Mass capacity market made up 88% of the total with shipments of 104 exabytes, down 25% sequentially and 21% year-over-year. Average capacity per drive increased 3 percentage points sequentially to 11.8 terabytes, reflecting continued growth demand for our 20-plus terabyte product family, which represents over 40% of total mass capacity exabytes shipped in the September quarter. Nearline shipments totaled 85 exabytes, down 28% sequentially, reflecting the ongoing inventory adjustment at both cloud and enterprise OEM customers, which are expected to last through the calendar year-end. On a revenue basis, mass capacity represented 78% of total HDD revenue at $1.4 billion in the September quarter. As a percentage of HDD revenue, mass capacity was down 2 percentage points sequentially and up 7 percentage points year-on-year. Consistent with our view at the end of August, VIA revenue was down quarter-over-quarter, due mainly to the prolonged economic slowdown in China. Specific to our mass capacity market, we expect the prevailing macroeconomic challenges will extend through the December quarter, negating the traditional seasonal uptick usually seen in the VIA market. That said, we remain confident in the long-term growth of the mass capacity markets in both the cloud and at the edge. Within the legacy markets, revenue was $391 million, down 20% sequentially. Quarter-over-quarter, the pace of decline was more pronounced in the mission-critical market due to soft enterprise spending, particularly in China, and deteriorating consumer spending. Similar to the VIA market, we do not expect to see a typical seasonal uptick in overall demand for legacy markets in the December quarter. Finally, revenue for our non-HDD business was $263 million, up 21% sequentially. The increase quarter-over-quarter reflects the improving component supply for our petabyte scale solution in our enterprise system business. Moving to our operational performance. Non-GAAP gross profit in the September quarter was $498 million, corresponding to non-GAAP gross margin of 24.5%, down more than expected quarter-over-quarter. Underutilization cost represented a 250 basis point headwind to gross margin impacted by the adjustment we made to lower production output throughout the quarter in response to market conditions. These impacts were compounded by a less favorable market mix, driven by a lower percentage of revenue derived from margin-rich mass capacity markets and an increase in the non-hard disk drives business. Non-GAAP operating expenses were at $314 million, down $35 million quarter-over-quarter due to lower variable compensation and proactive expense management, which included strong control over discretionary spending and the pause in hiring. In the December quarter, we expect OpEx to further decline by about $10 million, including savings associated with our restructuring plans starting later in the quarter. Based on diluted share count of approximately 210 million shares, non-GAAP EPS for the September quarter was $0.48. Moving on to balance sheet and cash flow. We ended the September quarter with a total liquidity position of approximately $2.5 billion, including our revolving credit facilities, which is sufficient to support our strategic plans and meet customer demand. Despite lower than expected revenue for the September quarter, inventory ended fairly flat at just over $1.6 billion. We expect inventory to decline significantly over the course of fiscal 2023 as we align our supply chain and finished good levels to the prevailing demand environment. Reflecting the payment of the previously committed amount, capital expenditures were $133 million for the September quarter. Free cash flow generation was $112 million, essentially flat with the prior quarter as the improvement in cash from operations was offset by higher capital expenditures. We used $147 million for the quarterly dividend and $408 million for the purchase of 5.4 million ordinary shares, exiting the quarter with 206 million shares outstanding and approximately $1.9 billion remaining in our authorization. In light of current near-term priorities, we are temporarily pausing our share repurchase program, but we remain flexible and opportunistic as conditions develop. In August, we raised $600 million in capital through a new term loan due in fiscal 2028, resulting in total debt balance of $6.2 billion at the end of the quarter. Adjusted EBITDA was $2.1 billion for the last 12 months with a total debt leverage ratio just below three times. We expect interest expense for the December quarter to be approximately $74 million. Looking ahead, we continue to face a challenging business environment, shared by macroeconomic and geopolitical themes. Seagate, like our customers, is diligently managing cash and investment amid the disrupted demand environment. We expect these factors and ongoing customer inventory corrections to weigh on revenue in the December quarter. Please bear in mind our financial outlook for the December quarter is as follows: We expect revenue to be in a range of $1.85 billion, plus or minus $150 million. At the midpoint of our revenue guidance, non-GAAP operating margin is expected to be in the mid-single digit range, reflecting the impact from higher underutilization cost. And we expect non-GAAP EPS to be in the range of $0.15 to minus $0.20. I will now turn the call back to Dave for final comments.
Dave Mosley, CEO
Thanks, Gianluca. Seagate's team is acting with determination and agility to rapidly adjust to a highly uncertain environment. I'm incredibly proud of their unwavering focus. Throughout our 40-plus year history, Seagate has successfully operated through many adverse conditions, and we are putting that experience to work. We're taking the right actions to strengthen our near-term financial position and optimize liquidity through this period. We're driving forward on our technology roadmap which makes us poised to quickly recover as market conditions improve, as well as capture the significant future opportunities ahead. Finally, we continue to operate with a deep sense of commitment to all of our stakeholders—our people, our customers, the communities in which we operate, and, of course, to our shareholders. Gianluca and I would like to now take your questions.
Operator, Operator
We will now begin the question-and-answer session. And our first question today will come from Wamsi Mohan with Bank of America. Please go ahead.
Wamsi Mohan, Analyst
Yes. Thank you. Good morning. As you look into the December quarter, you've not reported a sub-$2 billion revenue quarter. I went back and checked all the way since back in 2005. What is your view on the inventory levels? And how much below-demand levels are you currently shipping? And do you expect to exit the December quarter with a lower inventory level? If I could also ask just are you expecting higher underutilization charges in December? Or should we expect the same magnitude? Thanks.
Dave Mosley, CEO
Thanks, Wamsi. I'll let Gianluca quantify the underutilization charges. I think the blunt answer to your question is, yes, we're expecting to get the inventory levels of our owned inventory and then of the customer inventories down this quarter. We'll watch the customers, what they have at the builders, and what's that flow-through hopefully. We would have hoped that it would have happened by now, but I think macroeconomic conditions are weighing on everybody a little bit that way. And we believe that by controlling our own build plan, which results in higher underutilization charges, we can actually get our owned inventory down as well.
Gianluca Romano, CFO
Yes. During the September quarter, we reduced production twice at the beginning of the quarter and then again during September. We actually increased even more through the end of September. So we had more than $50 million of underutilization charges in the September quarter. December will be higher. So we start already with a lower production than the beginning of the prior quarter in October and November. Then in the month of December, we will, of course, look at the demand for the March quarter and see if we can start to ramp back production or we need to keep it lower. And I think Dave wants to add something.
Dave Mosley, CEO
Yes, I agree that the current situation is historically low. There are still macro challenges ahead. In the second fiscal quarter, consumer demand is quite weak. While channel inventory isn't high in absolute units, it is elevated on a run-rate basis. Additionally, this year we are not seeing any seasonal impacts in the first or second fiscal quarters. We do not anticipate a recovery in the cloud sector during the second quarter and are closely monitoring inventory levels. The recovery in China will also be gradual. We have been expecting some recovery for about three quarters now. There is some optimism that conditions will improve, but we need to see tangible purchase orders to feel confident. Ultimately, the recovery will depend on how quickly customers can address their inventory levels.
Wamsi Mohan, Analyst
Thank you for the information, Dave. I know you mentioned that you can't discuss the export regulation area in too much detail, but could you provide investors with some insight into why you believe the shipments are not subject to export regulations? Is it related to the intellectual property for the products and where it is located, or any other details that could help us understand your confidence in your position? You clearly stated that you are confident, so understanding the reasoning behind this is important from an investor's perspective. Thank you.
Dave Mosley, CEO
Yeah, Wamsi, I think like Shanye said, we don't really think it's appropriate for us to be commenting on it at all at this time. I mean, we'll cooperate transparently, and we believe we have a really good compliance program in place with all the policies and procedures. So that's what builds our confidence. But like I said, we'll communicate transparently. I just don't think it's appropriate for us to be commenting.
Wamsi Mohan, Analyst
Okay, thank you so much.
Operator, Operator
And our next question will come from Krish Sankar with Cowen and Company. Please go ahead.
Krish Sankar, Analyst
Yeah, hi. Thanks for taking my question. Hi. The first one for Dave. I'm just kind of curious heading into 2023, how should we think about the pricing environment? Is there a way to quantify it or qualitatively see relative to the last downturn in 2019? And if we extrapolate how to think about revenue growth for FY23 or calendar '23? And then I had a follow-up.
Dave Mosley, CEO
It's still a little too hard to call revenue growth. I'll let Gianluca quantify some of the pricing environment discussions. But I would say at the high cap, the 20-plus terabyte family, pricing was relatively benign. I think there was really competitive space, especially in legacy and the low-capacity nearline, because those markets are so depressed right now. So it was fairly competitive. I think this is just a sign of the times in the industry when factories aren't full, people want to get as much demand as they can to keep running their factories. We're all mindful of that right now. So I think we need to see supply and demand come back in the balance to see a better environment.
Gianluca Romano, CFO
In the legacy market, we saw some pricing pressure, so the low capacity drives, maybe also coming from the very low price of the NAND right now. On the high-capacity drive, as Dave said, the price environment is still very favorable and say fairly stable. So I would say different from what we have seen in prior down cycles.
Krish Sankar, Analyst
Got it. Got it. Very helpful. And then just as a follow-up, clearly, your cloud customers, there's obviously very high levels of inventory digestion. There's pricing pressure. Have you seen any market share shifts in this environment, either in your favor or against you, especially among the U.S. hyperscalers?
Dave Mosley, CEO
We're not really trying for market share, I'd say at this point in time. We're watching all these inventories levels. And we're saying, let's make sure we build the right absolute right stuff. So I think there are various challenges that I can articulate at various hyperscalers. They have different business models, different dynamics within them. Some have multiple business models. So there's macro implications as you're hearing from some of their comments. There are also architectural transitions and there are still supply chain shortages. In some cases, some of the supply chain shortages led to situations where people bought too much of the wrong stuff, and then there's even overages in the supply chain. So I think it's really complicated as to how this inventory built. Fundamentally, the creation vectors for data and the consumption of mass capacity drives have not changed. There is an aging of the fleet going on. There's replacement of old mass capacity drives with the new ones which have TCO propositions. Higher capacity drives are just better that way. And so all of the relevant trends still exist. We believe that the drives that are in the data centers today are being used. They're more full than ever. The data keeps coming at them because of all the hyperscaler product offerings that are incentivizing people to move to the cloud. So we think this is just a temporary environment.
Gianluca Romano, CFO
In a downturn, focusing on market share should not be the priority; instead, the key is to concentrate on maintaining positive free cash flow. Ensuring positive free cash flow also requires keeping the pricing environment stable, which may necessitate reducing production to maintain a good balance between supply and demand. Additionally, we are preparing for long-term demand, which we believe will remain very robust.
Krish Sankar, Analyst
Got it. Thanks, Gianluca. Thanks, Dave.
Operator, Operator
And our next question will come from Karl Ackerman with BNP Paribas. Please go ahead.
Karl Ackerman, Analyst
Yes. Good morning, Dave and Gianluca. Two questions for me as well, please. The first one is on HAMR. And so I guess as you think about ways to reach demand equilibrium, how are you thinking about transitioning capacity to HAMR during this softer period? I guess, does the transition to HAMR create the need for retooling head and possibly media production? And I guess as you address that question, could you also discuss the buy-in on HAMR from your cloud customers and some of the progress you referenced in your prepared remarks. Thanks.
Dave Mosley, CEO
Yeah. Thanks, Karl. What I would say is that in the current environment where you have free capacity in your fabs, you use that to run more and more experiments to accelerate things. I mean, that's one lesson from numerous downturns in the past that I have. So we're definitely taking advantage of that to do all we can to accelerate not only HAMR, but get the yields up and the scrap down and get to better cost platforms and things like that. We're gaining so much confidence on HAMR that not only are we talking about the dates, but we're also talking about the ability to move capacity up beyond just the introductory, say, 30-terabyte platform up to higher capacity points. That also allows us then to take componentry out of 20-terabyte drives, for example, so that we can address the market that way. So all of that is going on right now inside Seagate. And I would say it's not just about one small piece of technology HAMR. It's also about readers and certain mechanical subsystems and electronics and everything else is really being brought together. We're in full stage product development right now, and like I said in the prepared remarks, very happy with the progress.
Karl Ackerman, Analyst
That's very helpful. If I may squeeze one more in. Given the strength of your systems business this quarter, are there still match set challenges for you in that business? And are you still facing long lead times for other hard drive input components, or have those challenges loosened and I guess, maybe back to what you would consider normal? Thank you.
Dave Mosley, CEO
Yeah. I think from a hard drive perspective, it's an easy answer. We have plenty of inventory right now. So we need to bleed that off. Relative to the drive side, or sorry, to the system side, we have had shortages, and I think the broader industry has had shortages. And sometimes just individual $1 component, sometimes assemblies like power supplies or NICs or things like that. What I would say is that most of that is breaking free. It's not completely done yet. One of the reasons for the success of our systems business is the complexity is not very high. And so people are used to very bespoke solutions in that world, but they'll take what they can get, and they're aggregating on less complex, simpler to achieve from a supply chain perspective designs. We see some smaller competitors really struggling for that, and that may even mean they have to exit the market. So I think we've had quite a bit of success in our channel business as well. So I think all of these trends are really supply chain trends. We believe by building very, very few SKUs and building them well, that we'll have a market advantage.
Operator, Operator
And our next question will come from Timothy Arcuri with UBS. Please go ahead.
Timothy Arcuri, Analyst
Hi, thanks. I seem to recall that the term loan, I think, has some covenants, maybe 4x, is the covenant on the term loan. And it seems like you might be breaching this over the next few quarters. So I guess, the question is sort of how comfortable can we be with the dividend? Can you sort of talk through that?
Gianluca Romano, CFO
We are pleased with the liquidity we currently have. In fact, our cash balance has increased compared to the previous quarter. As you may have noticed, we raised our debt during the September quarter. We are monitoring our covenants and debt structure closely. If necessary, we will take appropriate actions. However, as mentioned in our prepared remarks, we are comfortable with our dividend level, but we are temporarily pausing our share buyback.
Timothy Arcuri, Analyst
Following up on that, is the dividend the top priority in your capital commitments? In other words, are you willing to do whatever it takes to avoid cutting the dividend? Is that an accurate statement?
Gianluca Romano, CFO
Yes. We want to protect the dividend. As you know, one of our priorities is shareholder return. And the dividend is an important part of that. We know that and we want to protect the dividend.
Dave Mosley, CEO
And we'll continue to invest in ourselves and all the other things that make us Seagate through these periods of time. We have to come up with a plan and execute the plan relative to all those things, and that's what we're out to do. It's one of the reasons why we're dipping into our inventory, getting working capital flowing a little bit more right now, not just to pause on the share buybacks, but we definitely want to execute this plan as aggressively as we can, as early as we can to make sure that we're safe.
Timothy Arcuri, Analyst
Great. As a follow-up, I had a question regarding the letter from BIS. Can you assist us in estimating what the appropriate normalized revenue might be if there are implications from this letter? I'm trying to gauge what the right normalized revenue would be.
Shayne Hudson, Senior Vice President, Investor Relations and Treasury
Hey, Tim. This is Shanye. As I mentioned earlier, we believe that we have complied with all relevant export control laws, and we are continuing to cooperate with BIS regarding this matter, but we will not provide any further comments on this call.
Timothy Arcuri, Analyst
Okay, okay. Shanye, thank you so much.
Operator, Operator
And our next question will come from Erik Woodring with Morgan Stanley. Please go ahead.
Erik Woodring, Analyst
Hey, good morning, guys. Thanks for taking my questions. I have two, if I may. Maybe, Dave, just first for you. Can you maybe marry the comments you had in your preannounced text today with what you talked about at the beginning of September, meaning at the beginning of September, you mentioned for the first time that certain U.S. hyperscaler terminology, that's the cautious buying terminology. And then today talked about uncertainty worsening in the latter part of September. Does that imply that demand or purchasing habits from U.S. hyperscalers has incrementally deteriorated since the preannouncement, or are the trends that you saw in September still relatively in line with what you spoke about back in early September? And then I have a follow-up.
Dave Mosley, CEO
I believe conditions have shifted over the summer. We are continuously negotiating long-term agreements to ensure predictability, which is essential for operating our factories and coordinating with our supply chain partners to achieve efficiency and reduce costs. Typically, our customers have been purchasing above those agreements. However, throughout the summer, we observed a market change. I can't pinpoint exactly when this occurred as we have numerous long-term agreements with varying durations, and they expire at different times, leading to some complexity. As we approach the end of an agreement within a quarter, we negotiate the next one and assess the inventory and data center development activities, which is what significantly changed this summer.
Erik Woodring, Analyst
Okay, that's helpful. Thanks, Dave. Gianluca, I'd like to ask you about the impact of your restructuring plan. Do you believe that your quarterly run-rate operational expenses could be around $290 million starting in the March 2023 quarter after the restructuring? Or is your current operational expense base already reflecting some of the early stages of your restructuring efforts, not just from September but also December? Thanks.
Gianluca Romano, CFO
Yeah. We are executing the restructuring plan in November so you will see already some impact in the December quarter. I would say $290 million is very aggressive. It's probably in the $300 million range for the next few quarters.
Operator, Operator
And our next question will come from Aaron Rakers with Wells Fargo. Please go ahead.
Aaron Rakers, Analyst
Thank you for the questions. I have two as well. Regarding the long-term agreements and the goal of improving predictability in the business, I’m interested in how your conversations with cloud vendors have evolved over the past few months. Specifically, what insights have you gained about their inventory levels? I believe you mentioned in the call that the demand drivers for your business have remained unchanged. How much visibility do you have into the inventory that these cloud vendors are managing, understanding that their situations may vary?
Dave Mosley, CEO
Right, Aaron, they are in a fairly complex space. However, if we examine what's being phased out, the amount of data being removed is quite small compared to the substantial increase in new data being added. We believe the growth in data usage is significant, but we also think there is a bit too much inventory. I won't attempt to quantify how much that is. There are other factors contributing to the pauses in data center expansions. Depending on the specific customer, issues related to their supply chain can be a factor, rather than their business models causing the problem. It is a complicated global market with various types of long-term agreements. As some of these agreements run their course, we are seeing that the visibility into future demand is significantly lower. Consequently, we are moving towards a more realistic perspective on our building plans while ensuring we remain disciplined during this period.
Aaron Rakers, Analyst
And then I believe in the comments in the call, you had suggested that the expectation was we return to kind of a high 20% growth rate in nearline capacity shipments at some point as we work through this, and we see recovery start to materialize. Correct me if I'm wrong, I think in the past, we've talked about north of 30% or even mid-30% growth. Is there something that's changed in your mind structurally as far as the growth underpinning the nearline business going forward?
Dave Mosley, CEO
So there's a difference between mass capacity and nearline. Mass capacity typically would run a little bit higher or lower. Nearline would grow a little bit higher. So that's the reason for the difference. But I think our fiscal '23 will be an anomalous year for sure. What kind of new trajectory we get into is, obviously, as we continue to build exabytes in the cloud, the growth rate will come down over the next 10 years. But I do think that we believe the fundamental drivers are still there for data. We're pretty excited about answering that with more and more efficient drives as well, so which is why we're using this period to kind of get those drives into the factories to come out as aggressively as we can afterwards.
Aaron Rakers, Analyst
Yeah, thank you.
Operator, Operator
And our next question will come from C.J. Muse with Evercore. Please go ahead.
C.J. Muse, Analyst
Yeah. Good morning. Thank you for taking the question. I guess first question, I was hoping to dig a little bit deeper into gross margins. You talked about further utilization cuts. Is there any math you could kind of provide how to think about fixed versus variable COGS? And also as part of the restructuring, what kind of impact will that have on gross margins and on what time frame?
Dave Mosley, CEO
I'll let Gianluca provide the quantitative details. What I can say is that the key principle here is to avoid building anything speculatively while managing our cash. Our focus is not on achieving a specific gross margin, but rather on ensuring that any initiatives we undertake are financially sound and that we have cash available to cover our expenses. We aim to reduce our inventory significantly, taking into account the effects on factory workers and the supply chain. It's essential for us to right-size the business for the future at this moment. Gianluca, would you like to respond?
Gianluca Romano, CFO
Well, on the utilization charges, as I said before, we had a little bit more than $50 million in the September quarter. When we go into the December quarter, we expect that to be higher and the revenue actually you expect to be a little bit lower. So the impact to gross margin percentage is, of course, higher. On top of that, you need to look at the mix. In the September quarter, we had a lower mass capacity percentage compared to the total HDD revenue, compared to the prior quarter. And we also had a higher system. And system actually has a little bit lower gross margin than hard disk in general. So it depends also how the mix will be exactly in December. But probably as you have seen from the guidance, we expect a further decrease in gross margin in the short term. But we are very comfortable with the long term, as soon as the microeconomic situation will improve, especially in Asia and then in China, and this inventory correction will be over, and we go back to our more normalized revenue level. We actually expect to have a strong gross margin, as we were doing just three quarters ago, and there is no reason why we should not be in that range again.
C.J. Muse, Analyst
Very helpful. As a follow-up question, I guess, specific to the VIA market and thinking around surveillance in China, and totally separate question from the BIS issues you referred to earlier. But curious if you're worried at all about increased regulations coming out of the BOC and BIS as it relates to further entities in China being placed on the entity list or unverified list. Is that something that you're contemplating as a potential risk to that part of your business?
Dave Mosley, CEO
We continue to monitor all regulations that emerge and assess their potential impact not only on our products but also on the broader market. It's important to consider that it's not only about demand; there are other aspects of the market to keep an eye on. We have observed some effects over time across all markets. Overall, there is a robust diversity of customers fulfilling end demand. I believe that demand will eventually shift, as the need for smart city applications remains strong. This includes areas such as traffic management, healthcare, and global video surveillance aimed at enhancing safety. We perceive this market has been somewhat neglected over the past year, and we anticipate it will return. Currently, we are not increasing production or stockpiling products because we need to ensure we see actual purchase orders first.
C.J. Muse, Analyst
Thank you.
Operator, Operator
And our next question will come from Shannon Cross with Credit Suisse. Please go ahead.
Shannon Cross, Analyst
Thank you very much. Gianluca, maybe could you talk a bit about beyond inventory and lower CapEx, any other levers you see that you could pull within working capital or other areas to drive incremental cash flow? And then I have a follow-up. Thank you.
Gianluca Romano, CFO
Well, we focus on all we can manage in working capital. But for sure, the inventory level is the main driver that we can use right now. Our inventory has grown from $1.1 billion before the start of COVID to almost $1.6 billion in the September quarter. So we have opportunities right now to reduce our inventory. It of course will not happen all in one quarter, but we will diligently reduce our inventory in the next couple of quarters.
Dave Mosley, CEO
It's not as big, Shannon, but we can go with yields and scrap. And these are still material numbers that the team can use, the time, the excess capacity, and so on to do the right experiments to drive those on the right products.
Shannon Cross, Analyst
Okay, thank you. And then, Dave, I don't know if you can talk a little bit about this, but it seems like this restructuring is very obviously headcount focused. But are there other areas where you're reducing costs? Because it seems like this is kind of a flex down given the macro environment and obviously, the challenges with inventory and that, more than maybe a structural restructuring, if I can say that? Or am I off on that?
Dave Mosley, CEO
Yeah. I would say we'll still have the ability to flex up. Obviously, people impacts are the toughest parts of the job, and we're really sensitive to not only the people but the communities and the supply chain. There are big impacts happening right now. We are lowering output of some of the legacy products and completing product transitions to future products, which are more efficient products as well, just from a support perspective. So the complexity of the product line is coming down and resetting the factory footprint a little bit. We haven't talked about that very much. But there are demand realities out there what line we have, where it may actually impact the factory footprint. So there's OpEx support around that as well. That will all help as we restructure and then come out. We're very mindful of the fact that we do need to accelerate into the future with the right products as well because that's been the nature of this business. I don't think there's a massive structural change in mass capacity data that we're planning at this point in time. We're just dealing with the reality of the current environment.
Shannon Cross, Analyst
Okay, thank you.
Operator, Operator
And our next question will come from Jim Suva with Citigroup. Please go ahead.
Jim Suva, Analyst
Thank you very much. You've been very clear about the restructuring that's going on in the December quarter. And given the September quarter, which just ended, and in your December outlook, do you think that's actually sufficient to right-size equilibrium supply and demand? Or do you think it's going to be a bit more prolonged as you look at these ELAs and all the demand characteristics inputs from your customers? Do you think it would be a little bit longer prolonged recovery? Or do you think after the December quarter, we're going to be pretty free and clear then?
Gianluca Romano, CFO
Well, it's a bit difficult to say right now. So what we are doing is keeping the level of production down for the month of October and November for sure. And then at the end of November, we will look at more tangible demand for the quarter of March and also June and see if it's the right time to ramp it back or if we need to keep it down for a few more weeks.
Dave Mosley, CEO
Yeah, I think, Jim, maybe this ties back to Shannon's question as well. Mass capacity was up almost 60% in fiscal calendar '20, mid-30s in '21. FY23 is likely going to be negative. That's the first time that's ever happened before. It's not that data is not growing. It's certainly growing in all the application space. I just think that we've got to make sure we reduce our manufacturing build plans to maintain this healthy supply discipline. We may see a pop back to some of those big spikes again. It may be a more muted growth. We don't know, but we're really confident in the long-term drivers. So we'll take this reset right now and then deal with the future as it comes.
Jim Suva, Analyst
Great. Thank you so much.
Operator, Operator
And our next question will come from Sidney Ho with Deutsche Bank. Please go ahead.
Sidney Ho, Analyst
Great. Thanks for taking my question. My first question is on gross margin. So it sounds like your gross margin will be down quarter-over-quarter in December based on your answer to a previous question. But more importantly, how much are you under earning your gross margin versus normalized level? Maybe help us break down by the various components between underutilization charges, COVID costs, logistics costs, maybe revenue mix? Anything there would be helpful. And I have a follow-up question.
Gianluca Romano, CFO
Based on our current production levels, underutilization charges will be significantly higher than in the September quarter since we will maintain low production for at least two months, and possibly longer. This is the primary reason for the decline in gross margin. Additionally, with lower top-line revenue, the percentage impact is exacerbated. In terms of COVID-related costs, they have remained relatively stable from quarter to quarter and we do not anticipate any deterioration in that area. On the logistics front, we are actually spending less as we are shipping fewer units. These are the main factors affecting our situation. Looking ahead to the March quarter, the restructuring efforts are expected to begin positively influencing our profit and loss statement.
Sidney Ho, Analyst
Okay, that's helpful. My follow-up question is, you talked about customers' inventory drawdown through at least the December quarter. Are you suggesting that revenue will grow in the March quarter? And then, to follow up to that, how do you see this cycle playing out for the nearline market compared to the previous cycles in 2020, 2018, 2016? Those cycles usually fix by dropping two to three quarters, and then it comes back on maybe a quarter or two quarters later. Do you think that will be comparable this time?
Dave Mosley, CEO
I think 2016 was kind of a double dip. So it was a real oddball. I don't expect that's going to happen here. I think what we have is a phasing up of a confluence of factors between macroeconomics and architectural transitions like we talked about, some supply chain issues that people still have. I do think we'll see some people start to come out of it sooner rather than later and other people may be more conservative. So it's too early to call exactly when it's going to happen, but we're going to be watching it very carefully and then making sure that we use our cash to only build what's absolutely necessary for the market through that period.
Sidney Ho, Analyst
Thank you.
Operator, Operator
And our next question will come from Ananda Baruah with Loop Capital. Please go ahead.
Ananda Baruah, Analyst
Thank you for the question. I have two quick ones. First, regarding gross margin, are you making any adjustments to your production capacity, or are you maintaining it and absorbing the restructuring charges for now? Additionally, does this imply that any future improvements in gross margin will be solely related to production? I have a quick follow-up as well. Thank you.
Gianluca Romano, CFO
Well, I said this before, of course, the level of production will have the majority of the impact on our gross margin in the future, but also the restructuring. We are restructuring the company. This will give us some benefit and some financial benefit in the future. A part of this restructuring, a significant part of this restructuring is actually in manufacturing. So when production level goes back up to where it was before, and our top line will start to improve. As I said before, we expect gross margin to go back to where it was, and even better.
Ananda Baruah, Analyst
Got it. So the restructuring also involves production? Is it production capacity as well, Gianluca? I guess, could you give us any sense of how to think about the split of the restructuring program between that?
Dave Mosley, CEO
I think, Ananda, as you know, there's many different types of factories that we have. So some are dramatically underutilized. Others will keep running relatively heavy because we're doing experiments to make sure that we can do product transitions and get the yields up on the products that are going to bring us out of this period. Some of those products are way more efficient as well. So we can use that not only the investments that we're making from an OpEx perspective but to guide ourselves toward what restructuring we need to do of our manufacturing footprint through this period. I think they go hand in glove.
Gianluca Romano, CFO
But longer term, Ananda, longer term, we will also have the benefit of our new technology. So with a 30-terabyte HAMR and future products based on that technology, we also expect that to be accretive to our gross margin. So there are many things that you need to consider when you start to model longer term.
Ananda Baruah, Analyst
And Gianluca, when do you think you're at run rate for the OpEx portion of the restructuring program, like what do you think is the run rate?
Gianluca Romano, CFO
Yes. So if we execute the restructuring, as we had planned in November, I would say the March quarter will include the full benefit.
Operator, Operator
And our next question will come from Thomas O'Malley with Barclays. Please go ahead.
Thomas O'Malley, Analyst
Hey, guys. I just wanted to ask kind of an overarching question on the recovery here. Obviously, there's pretty limited visibility right now. Clearly, you're working through new negotiations with your customers, but could you just help give us a picture of how long and how deep this recovery may last? Obviously, you're guiding substantially down for December. As you look into the March quarter, obviously, customers are acting differently, but would you expect the total company revenue to be down again? Or do you think that you could see a recovery starting at the beginning of the calendar year?
Gianluca Romano, CFO
Well, of course, it's difficult to predict the future, and we have been a little bit surprised recently, but I can tell you in our internal plan, we see an improvement in the March quarter compared to what we carry in December.
Dave Mosley, CEO
We plan to reduce our expenses to ensure that our inventory is properly adjusted. We've mentioned this in our previous quarter as well. We're closely monitoring the inventory across the entire market, but we believe that at some point, overall capacity will begin to increase again. Our goal is to arrive at that point with the right products while effectively managing our expenses.
Gianluca Romano, CFO
Especially if the situation in China will start to improve compared to what has been in the last six months. That will be a major benefit to our business.
Thomas O'Malley, Analyst
Got it. And then my second one is just on the right mass capacity exabyte growth rate for the long term. So I think, Dave, you talked about conversations with U.S. hyperscalers right now. Most of them are coming in kind of below what the long-term agreement was. They were pulling above that previously. But you're really only taking the mass capacity growth rate down from like 30 to like the upper 20s range. Obviously, nearline has been running above that. But with all these LTAs or these conversations that you have with these cloud guys coming in below, like how do you get comfortable with the fact that that mass capacity is still at that high 20s rate? Like shouldn't it be normalized a little bit lower than that, given that these guys look to be ordering at a slower rate coming out of this higher growth period of time?
Dave Mosley, CEO
Yeah, that's good. This year it will be so far down, that the question is does it snap back or like I made reference earlier in the call here to I think calendar '20, where it was 60%. So I don't expect that, just to be blunt, but this is exactly why we go work those LTAs, give people predictability, our sales predictability on what exactly the demands are for our factories, and then give the customers the predictability so that they can understand the pricing environment and so on and the number of exabytes we are going to need to pull. We are still having those conversations very seriously with everyone. I think what changed through the course of the summer was the fact that they were telling us about what's going on this fall. And we got this phase-up of all these different macroeconomic business, architectural transitions that were happening that are affecting us.
Thomas O'Malley, Analyst
Thank you.
Operator, Operator
Our next question will come from Toshiya Hari with Goldman Sachs. Please go ahead.
Toshiya Hari, Analyst
Hi, thanks so much for taking the question. I joined late, so apologies if you've already addressed these questions. First one on pricing on a per-exabyte basis for your mass capacity business. I think in the quarter, that number was down kind of mid-single digits on a sequential basis, down kind of low teens year-over-year. I think there was a 12-month stretch from mid-'21 through early '22, where pricing per exabyte was down in the single digits. Pre-COVID, it was down 15%, plus or minus. So should we expect pricing in your mass capacity business on an exabyte basis to be down low to mid-teens going forward? And kind of the benign conditions last year were kind of one-time, if you will? Or should we expect pricing to improve as you come out of this inventory digestion phase?
Gianluca Romano, CFO
No, I think the pricing will improve. Of course, in the September quarter, the mix is also very important. We shifted a lot of our 20 terabyte. So it's difficult to just look at the price in total. You really need to look at the price on the like-for-like for the same product. What I said before that maybe, no, you didn't get because you were not here. On the legacy part of the business, we have some pricing pressure. On the mass capacity, the mid-capacity, there is some reduction, but on the high-capacity drives, the pricing is very stable.
Toshiya Hari, Analyst
Got it. That's helpful. And then, Gianluca, on free cash flow, as you go through this inventory digestion phase and lower levels of revenue, should we brace for a quarter or two of negative free cash flow? I don't think that's happened with you guys in a very, very long time. Or do you think you have enough levers on the working capital side to stay positive free cash flow for the next couple of quarters? Thank you.
Gianluca Romano, CFO
We think we'll stay positive. I said before, we also have a fairly high level of inventory that we are reducing. So this will help also with our free cash flow. So we don't expect so far any negative quarter of free cash flow.
Toshiya Hari, Analyst
Thanks so much.
Gianluca Romano, CFO
Thank you.
Operator, Operator
And this will conclude our question-and-answer session. I'd like to turn the conference back over to management for any closing remarks.
Dave Mosley, CEO
Thanks, Cole. As always, I'd like to thank all of our stakeholders for their ongoing support. I'm confident Seagate will navigate through these near-term difficult conditions and be in a stronger position to meet our customers' needs for innovation and cost-effective storage solutions well into the future. Thanks for joining us today, and we look forward to further engaging with our shareholders over the next few months.
Operator, Operator
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.