Earnings Call Transcript - STX Q4 2021

Operator, Operator

Good morning and welcome to the Seagate Technology’s fourth quarter and fiscal year 2021 financial results conference call. My name is Tabitha, and I’ll be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question and answer session. As a reminder, this conference is being recorded for replay purposes only. At this time, I would like to turn the call over to Shanye Hudson, Senior Vice President, Investor Relations and Treasury. Please proceed, Shanye.

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 June quarter and fiscal year 2021 on the Investors section of our website. During today’s call, we will refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and included in our Form 8-K that was filed with the SEC. We’ve not reconciled certain non-GAAP outlook measures because material items that may impact these items 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. As a reminder, this call contains forward-looking statements, including our September quarter financial outlook and expectations about our financial performance, market demand, industry growth trends, planned product introductions, ability to ramp production, future growth opportunities, possible effect of the economic conditions worldwide resulting from the COVID-19 pandemic, and general market conditions. These statements are based on management’s current views and assumptions and information available to us as of today and should not be relied upon as of any subsequent date. Actual results may vary materially from today’s statements. Information concerning our risks, uncertainties and other factors that could cause results to differ from these forward-looking statements are contained in our most recent Form 10-K and 10-Q filed with the SEC, our Form 8-K filed with the SEC today, and the supplemental information posted on 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 you, Dave.

Dave Mosley, Chief Executive Officer

Thank you, Shanye, and a warm welcome to everyone joining us today. Seagate ended fiscal 2021 on a strong note, delivering outstanding June quarter performance and fiscal year revenue that exceeded expectations. These results reflect broad-based demand across the mass capacity end markets and incredible execution by our global team, which together led to faster than anticipated progress toward our long-term financial targets. In the June quarter, revenue topped the $3 billion mark for the first time in six years, and we delivered non-GAAP EPS of $2.00 per share, which was at the topmost end of the upwardly revised guidance range that we provided in early June. Additionally, we expanded non-GAAP gross margin to 29.6% and expect to be inside our long-term target range of 30% to 33% ahead of schedule. The demand strength and favorable mix have accelerated the timeframe to achieve better supply-demand equilibrium, which is supporting firmer pricing conditions. We are reporting these exceptional results at a time of optimism in parts of the world as vaccinations progress and economies begin to reopen; in fact, we are hosting today’s call from Dublin for the first time in six quarters. While the pandemic remains a difficult reality for many parts of the world, we have remained vigilant in continuing to manage the business through this period. It is clear at a macro level that recovery is underway in the markets that we serve. Seagate is entering this recovery period in a very strong position, helped by the fact that we executed incredibly well throughout the crisis. For fiscal year 2021, we generated nearly 2% year-over-year revenue growth, exceeding our expectations. We grew operating profits faster than sales and achieved an operating margin of 15.4% for the year, showing the leverage in the business, and we returned a substantial amount of capital to shareholders, including $2.7 billion in dividends and share repurchases, retiring more than 13% of our outstanding shares in fiscal 2021. In addition to recording strong financial results, our innovation engine has not slowed down. We extended our HDD technology leadership, as evidenced by Seagate being the first company to commercialize HAMR technology and the first to deliver dual actuator performance drives, which are now shipping in high volume to support multiple customers. We’ve leveraged our areal density gains to streamline our product roadmap, making us better able to meet changing customer demand requirements while maintaining an attractive cost profile. We also leveraged the strength of our common mass capacity platform to execute our 18 terabyte RAM plans to meet customer demand. We expect to begin shipping 20 terabyte PMR drives in the second half of this calendar year. Finally, we expanded our product and service offerings with the launch of Lyve edge-to-cloud platforms and remain on track with the build-out of our four live cloud metro edge locations by calendar year-end. A year ago, when the business challenges posed by the pandemic were very acute, I made the statement that Seagate would emerge from the crisis stronger than ever. With the financial performance and innovations that I’ve just highlighted, I believe that our team has delivered on that claim and that Seagate is stronger than ever. We are continuing to focus on unlocking more value for our customers and shareholders. For example, last month we introduced Corvault to our family of cost-efficient high-density storage systems. Corvault combines Seagate’s internally designed storage system basis with our intelligent self-healing software and data security technologies, which results in a high-reliability storage solution at petabyte scale, ideal for private cloud and macro edge data centers. We are also working directly with customers to unlock value. Many of our hyper-scale customers already employ AI and machine learning to reduce the amount of human intervention necessary to maintain and repair their large fleets of storage drives. We recently teamed with Google Cloud to take data intelligence one step further. Together, we developed models that help predict drive failures before they occur. These models promise to lower operational costs and prevent potential problems for their end users, a clear win-win. Let’s turn now to the current market environment, starting with an area that has garnered significant interest in recent weeks. Storage center blockchains such as those used by Filecoin for decentralized storage applications, or Chia cryptocurrency which is considered an environmentally friendly alternative to other blockchains that utilize energy-intensive computational power to validate transactions, have significant interest. During the June quarter, we saw a meaningful increase in HDD demand due in part to the initial build-out of the Chia net space, which is comprised of both new and repurposed HDDs. By our estimation, new Chia demand represented at most a mid-single digit percentage of total industry exabyte shipments during the quarter, primarily into the distribution channel. This incremental demand served to tighten the HDD supply dynamics in an increasingly robust demand environment. While the future growth outlook in this space remains unclear, we are excited by the potential applications associated with innovations in decentralized file storage. For Seagate, strong growth in the traditional mass capacity market remains the primary driver of HDD demand. In the June quarter, mass capacity represented close to 70% of Seagate’s HDD revenue, supported by broad-based demand for our Nearline drives and the third consecutive quarter of sales growth into both cloud and enterprise customers. Cloud data center demand has remained healthy and steady for the last 18 months, and current indicators suggest that trend will continue. While it’s clear that the pandemic played a big role in accelerating digital transformation, hyper-scale industry leaders expect the digital adoption curve to continue accelerating even as COVID recedes. At the same time, businesses are preparing for employees to return to the workplace, which is reinvigorating on-prem IT infrastructure investments and supporting ongoing recovery in the enterprise markets. We also experienced a stronger than anticipated recovery in the VIA market during the quarter due in part to tighter supply conditions. We currently foresee relatively stable demand through the second half of the calendar year. Looking ahead, secular demand for mass capacity data combined with signs of macro recovery represent significant opportunities for Seagate and set the stage for continued strong financial performance and cash flow generation. These factors combined with our broad product portfolio underpin our forecast to grow revenue in the high single-digit percentage range or more in fiscal 2022, which is well above our long-term financial model range. I’ll now hand the call over to Gianluca to cover the financial results.

Gianluca Romano, Chief Financial Officer

Thank you, Dave. Seagate executed extremely well in the June quarter, delivering very strong top and bottom-line growth that was fueled by accelerating demand in the mass capacity market and distribution channel. Revenue was $3.01 billion, up 10% sequentially and 20% year-over-year. Non-GAAP operating margin expanded to 18.1%, in the upper end of our long-term target range of 15% to 20% of revenue, and non-GAAP EPS was $2.00 per share, up 35% sequentially and 67% year-over-year. Ongoing demand momentum for our mass capacity product supported a third consecutive quarter of record hard disk drive capacity shipments totaling 152 exabytes, up 9% sequentially and 30% year-on-year. More than 80% of total exabytes were shipped into the mass capacity market, which includes Nearline, VIA, and NAS products. Mass capacity shipments hit a record 123 exabytes in the June quarter, up 11% sequentially and 36% year-over-year. We are continuing to leverage our manufacturing agility and drive operational efficiencies to meet our customers’ timing. Mass capacity now represents close to 70% of total HDD revenue. Further demand for our Nearline drives and strong recovery in the VIA market drove record mass capacity revenue of $1.9 billion, up 16% sequentially and up 29% compared with the prior year period. Sales of our Nearline product grew strongly quarter over quarter, reflecting the rapid uptick in demand from storage-centric blockchains layered on top of healthy cloud data center demand and improving enterprise OEM customer TAM that we discussed last quarter. We attribute incremental sales of our mid to high-capacity Nearline product in distribution channels to Chia. While our cloud and OEM customers consumed a majority of our high-capacity supply, including our 18 terabyte size which are shipping in high volume. Overall, the airline shipments increased to 101 exabytes, up 6% sequentially and 28% year-on-year from record levels in each of the comparable quarters. Stronger than expected demand in the VIA market led to a sharp sequential increase in revenue as recovery got underway and customers invested to support future demand. Looking ahead, we expect relatively stable demand into the second half of the calendar year. The legacy market ended up well in the June quarter with revenue of $854 million compared with $864 million in both the prior quarter and the prior year period. Exabyte shipments remained relatively flat quarter over quarter at roughly 29 exabytes. Ongoing demand for our mission-critical drives and better-than-expected sales of our consumer product partially offset the anticipated decline for PC drives. We expect relatively stable demand for both mission-critical and consumer drives over the next couple of quarters, which would result in a more moderate year-over-year revenue decline. Finally, turning to our non-HDD business, revenue increased 16% sequentially and 42% year-over-year to a record $276 million. We continue to drive momentum in our system business, which offers simple and scalable petabyte solutions targeted for enterprise and private cloud customers. In the June quarter, non-GAAP gross profit increased to $892 million compared with $749 million in the March quarter and $686 million in the prior year period. We had $32 million of COVID-related costs during the quarter. Calendar year-to-date, the vast majority of these costs are attributed to unabated state charges, which we expect to persist through fiscal 2022; however, given the uncertainty around when or if these costs will abate, starting in fiscal Q1 we plan to stop calling them out. Our resulting non-GAAP gross margin expanded by 219 basis points to 29.6%, including slightly more than 1% headwind from COVID-related costs. Total HDD margins are already inside our target range of 30% to 33% and we now expect total company non-GAAP gross margin to be at the low end of the range in the September quarter, reflecting better alignment in supply and demand and the transition to mass capacity product that has taken place. Non-GAAP operating expenses came in at $346 million, up 5% sequentially, reflecting higher variable compensation associated with the strong performance. We are tightly managing expenses and expect to maintain opex at approximately the same level for the next few quarters. The combination of higher sales and margin expansion resulted in non-GAAP operating income of $546 million, up 30% sequentially and over 46% year-over-year. Non-GAAP operating margin was 18.1%, up 274 basis points sequentially and 330 basis points year-over-year and solidly inside our long-term guidance range of 15% to 20% of revenue. Based on the diluted share count of approximately 233 million shares, non-GAAP EPS for the June quarter was $2.00 per share, the highest level since fiscal 2012. Capital expenditures were $124 million in the June quarter and just under $500 million for the fiscal year, which represents 4.7% of our revenue, in line with our long-term target range. Through strong expense discipline and efforts to improve manufacturing efficiencies, we reduced capex by about 15% in fiscal 2021, exiting the year with better supply-demand balance. Inventory was $1.2 billion, down 6% sequentially with days inventory outstanding declining for the third consecutive quarter to 51 days. Our teams have done an outstanding job of working with our suppliers and partners to manage inventory levels and mitigate supply chain disruption, including the recent COVID-related restrictions in Asia which we continue to closely monitor. In the June quarter, we increased free cash flow to $354 million, up 29% both quarter over quarter and year over year. Our focus on optimizing profitability and cash generation provides flexibility to invest in the business and return capital to our shareholders. We used $154 million to fund the quarterly dividend and $220 million to repurchase 2.6 million ordinary shares, exiting the quarter with 227 million shares outstanding and approximately $4.2 billion remaining in our authorization. We retired 34 million shares during fiscal year 2021 and returned a total of $2.7 billion through dividends and share repurchases. Based on our current outlook, we expect to maintain a robust capital return program in fiscal 2022 while maintaining a strong balance sheet and liquidity profile. Cash and cash equivalents remained relatively stable at $1.2 billion and total liquidity was approximately $3 billion, including our revolving credit facility. These levels are more than adequate to support our operation and business needs. As we enter fiscal 2022, the team and environment remain strong and we continue to execute our product and technology roadmap to deliver on our customer requirements while driving value for Seagate. Looking ahead to our outlook for the September quarter, we expect revenue to be in the range of $3.1 billion plus or minus $150 million. We expect non-GAAP operating profit to grow faster than sales, resulting in non-GAAP operating margin at the upper end of our long-term range of 15% to 20% of revenue, and we expect non-GAAP EPS to be in the range of $2.20 per share plus or minus $0.15, representing sequential growth of 10% at the midpoint. In summary, we continue to achieve outstanding results supported by our unwavering focus on operational execution and the strength of our product and technology portfolio. We are already demonstrating performance consistent with our financial targets and enter fiscal 2022 well positioned for top and bottom line growth. I now turn the call back to Dave for final comments.

Dave Mosley, Chief Executive Officer

Thanks, Gianluca. Seagate is executing well, delivering financial performance at or above our commitments, maintaining a relentless focus on total customer experience, and deploying capital to enhance value for all stakeholders. We capped fiscal 2021 with our strongest performance of the year and we expect that positive momentum to continue moving forward. We’ve demonstrated strong leverage in our business model to grow operating profits faster than revenue and in turn drive free cash flow generation. Our ability to consistently generate free cash flow provides the flexibility to fund future growth and employ a robust shareholder return program as well. Based on the current outlook, we expect to grow free cash flow appreciably in fiscal 2022. Our employees have been crucial to Seagate’s current success and key to driving our future. Over our 40-year history, Seagate has transitioned many times to address the evolving storage industry landscape; for example, we’ve recently pivoted our factories and technology to deliver mass capacity solutions and have emerged as a leader. Now, we are focused on addressing the next mass data challenge with our Lyve product platform. To keep pace with these changes, we are investing to re-scale and redeploy Seagate employees as needed to support our future growth and respond to the changing demands of the business. For example, we’ve launched a tool called Career Discovery earlier this year, which has already helped Seagate to establish networking and mentor connections as well as redeployment opportunities for hundreds of employees. Seagate has a broad bench of talent with decades of hardware and software experience, formidable supply chain management and manufacturing skills, and deep knowledge of chip design and data analytics. This expertise and strong customer relationships allow Seagate to understand the global mass capacity ecosystem and its architectures better than anyone. Tools such as Career Discovery are helping us deploy our diverse resources to support our future needs while enabling Seagate to maintain opex efficiency. We are confident that this focus on people will put us on firm footing for continued growth and success. As we close, I want to thank both Seagate’s employees and those in our supply chain whose efforts enabled our ongoing leadership in mass data solutions. Our customers and our shareholders are equally deserving of thanks for their ongoing trust and support of Seagate. Gianluca and I are now happy to take your questions.

Operator, Operator

Our first question comes from Karl Ackerman with Cowen & Company. Karl, you may go ahead.

Leni, Analyst

Hi, can you hear me okay? My first question is regarding the feedback you have received from customers about your 20 terabyte Nearline drive. I ask this because you previously mentioned it is not a cost-effective node, yet it represents a critical step until you achieve the 24 terabyte HAMR. When can we expect the 20 terabyte HAMR to reach the fit crossover for Nearline shipments? Could this happen in fiscal 2022?

Dave Mosley, Chief Executive Officer

Yes, thanks Leni. I don’t think we ever said that 20 terabytes would be a crossover point for HAMR, to your point. We have a number of different 20 terabyte platforms coming - PMR, SMR, HAMR. There are a lot of different flavors of them, and they are targeted to different customers, so different qualification schedules exist for each. We’re very aggressive with the 20 terabyte qualification because the heads and media for the PMR version that we referenced in the prepared remarks is already in high volume manufacturing for 18 terabytes and capacity points below, as well - 16 and so on. We’re very confident in that and we’re ramping aggressively with customers, giving them samples, getting through qualifications, and I’m fairly optimistic about that for the back half of the year.

Leni, Analyst

Great, thank you. Just one more follow-up, if I may. On demand outlook and capex, how are you thinking about adding incremental heads in disk capacity relative to your fiscal 2022 outlook? Chia’s impact clearly led to a supply shortage of mid and high capacity drives for data centers, yet the fulfillment of the Jedi contract by the Department of Defense appears to meet the capex demands for the next few quarters. I’m hoping you may address your view of capacity and the outlook for data center demand over the next quarters.

Dave Mosley, Chief Executive Officer

Yes, I would say that in the head factory, which has the longest lead time, we are producing well over 100 million heads each quarter, giving us the flexibility to adjust our mix as needed. The demand changes we've observed can be easily managed within our portfolio; we've streamlined everything to be very efficient, particularly with our common platform. We can shift resources as required. We're consistently increasing our capacity by introducing more tools to accommodate new technology nodes, which is always part of our capital expenditure plan, and we will continue to monitor this. I believe we can expand our exabyte supply through technological advancements and improving areal density, and we will remain responsive to market changes.

Gianluca Romano, Chief Financial Officer

Yes, we discussed in the last few quarters about the need to realign supply and demand, and we are getting closer and closer every quarter. For overall capex, fiscal 2022 we think we will have the same target as fiscal 2021, between 4% and 6% of revenue, so we will add capacity but we will also be looking at keeping this alignment within supply and demand.

Operator, Operator

Your next question comes from the line of Katy Huberty with Morgan Stanley.

Katy Huberty, Analyst

Yes, thank you. As you walked through the various segments - Nearline, VIA, mission-critical, consumer, you talked about stable trends across the board, yet the full-year revenue growth guidance assumes that there will be a revenue run rate reduction from the $3.1 billion September guide. Can you just talk about what will drive lower revenue as you move through the year, and maybe what the first half versus second half looks like? Then I have a follow-up.

Dave Mosley, Chief Executive Officer

Thanks Katy. Yes, I think we are chasing the demand right now, obviously, and so we think the front half is a little stronger. In the back half, there will be more muted seasonality than what we’re normally accustomed. We do know that’s three quarters away, so there may be some variability there; however, we have good relationships with all of our customers across all these product sets now, and they give us a pretty strong sense of what their demand profile is going to be through the year. I would characterize this as muted seasonality for now but significantly up, we said, at least high single digits in revenue growth year-over-year, so it’s still significantly up, and we’re still chasing it.

Gianluca Romano, Chief Financial Officer

Yes, we think we will have a very strong second part of calendar 2021. Last quarter, I think we said at least 10% increase year-over-year. Right now, we think it will be at least 15%, so for another couple of quarters very strong, and then as usual we have in our plans some seasonality for the legacy market and some of the mass capacity, but the node could be different as we have seen last year, for example.

Dave Mosley, Chief Executive Officer

I think the other thing is we’re running - to the earlier question, we’re running in the high volume the heads of media that we already need to make more 18s or 20s, or whatever, so if some of the cloud markets were to take up above our plan, we could stretch there, I think, in the back half of the year as well.

Katy Huberty, Analyst

Okay, and then the pricing environment, as you said, has firmed up faster than you expected. What will determine whether those prices can hold, and what are you assuming for price change in that full-year guidance for high single-digit growth?

Dave Mosley, Chief Executive Officer

Across the whole portfolio, it’s really the balance of supply and demand, so it’s not just about the exabytes at the highest capacity points. There’s strong demand in the VIA market, there’s strong demand for 8 terabyte families this quarter, and strong demand for even some of the high-end desktop products. I think we’re trying to balance all these things for the customers. They’re giving us predictability and they need predictability; in a time of disrupted supply chain, everybody is trying to get the complete kit to attack all these market opportunities that they have, so that’s really what’s firming it up. I’ll let Gianluca quantify it through the course of the fiscal year.

Gianluca Romano, Chief Financial Officer

Yes, for the time being, we have a fairly strong pricing environment, especially for mass capacity. The legacy is still expected to decline a little bit, but in general, as we were discussing before, it all depends on the base alignment between supply and demand. But right now it’s fairly good.

Katy Huberty, Analyst

Thank you. Congrats on the quarter.

Gianluca Romano, Chief Financial Officer

Thank you.

Operator, Operator

Your next question comes from the line of Sidney Ho with Deutsche Bank.

Sidney Ho, Analyst

Great, thanks. Thanks for taking my questions. My first question is on the Nearline drives. Given how strong Nearline’s exabyte shipments have been in the past two quarters - I think it’s up 40% in the past two quarters, I know crypto is a factor, but you also mentioned cloud is strong as well. Are you concerned that we’ll see an inventory digestion space soon, or maybe asked slightly differently, do you have a sense as to how much inventory has built up in the channel or at your customers, especially cloud and enterprise guys, at this time?

Dave Mosley, Chief Executive Officer

Yes, thanks Sidney. I don’t think there’s too much inventory out there by any stretch of the imagination. It’s a little bit different if you looked at the enterprise channels - they’re relatively lower inventory, and we did see growth in the enterprise quite a bit quarter over quarter. As far as the cloud goes, worldwide I think it’s fairly healthy demand; it’s fairly well distributed. This is what we’ve been talking about for the last couple of years - we’ve always wanted a lot of different customers pulling at these levels, and we’ve seen that, so we’re fairly happy with the demand outlook and what we’ve got in the build plan right now for the next couple of quarters because the lead time is so long, as we’ve said before. That’s really what builds our confidence, is these great conversations we’re having with customers worldwide.

Sidney Ho, Analyst

Great. Maybe a follow-up question on the gross margin side, you mentioned that gross margin is expected to be within the long-term target range of 30% to 33% in the September quarter. I’m curious if you could break down the gross margin guidance and highlight some of the key factors contributing to this margin improvement. Is it related to pricing, product mix, yield enhancement, or other elements? Additionally, how should we consider these factors affecting future quarters beyond September? Thanks.

Dave Mosley, Chief Executive Officer

Yes, thank you, and I’ll let Gianluca add his thoughts as well. The first point I want to make is that there were many changes during the quarter, shifting from some planned initiatives to those that were progressing more quickly. With demand across the board, these adjustments actually indicate a stronger supply and demand balance than we initially predicted, and that's likely the most significant takeaway. Our inventories have decreased, and our factories are operating at full capacity. The heads of media factories are preparing for the next few quarters, which aligns well with our financials. We also see opportunities for cost optimization in our drives in the coming quarters, including the new family of 18s we discussed, which we find cost-effective. Additionally, we have introduced a lower capacity Nearline drive that is also proving beneficial. However, we are still facing challenges from freight issues; global logistics remain problematic and continue to impact us. Furthermore, there are rising component prices in several sectors due to global shortages, which are also presenting challenges.

Gianluca Romano, Chief Financial Officer

Yes, we had a very good quarter in FQ4, and we are already guiding FQ1 is higher levels. I would say one of the major reasons is this pricing environment that is improving. The second reason is the mix that is shifting more and more to the mass capacity. In fiscal Q4, 70% of the revenue was already on mass capacity and we expect that to continue to increase. The other major reason that you will see throughout fiscal year 2022 is the introduction of our cost-optimized drives, so the drives that are based on two terabytes on disk, and that will stay with us through the fourth quarter and will continue to bring improvement to our gross margin.

Sidney Ho, Analyst

Thank you.

Operator, Operator

Your next question comes from the line of Wamsi Mohan with Bank of America.

Wamsi Mohan, Analyst

Yes, thank you. Dave, you said mid single-digit percent of HDD exabyte demand from Chia in the June quarter for the industry, so if I map up to Seagate, it looks like Chia contributed maybe 60% of the incremental sequential exabytes. If you see this demand flatten out, how comfortable are you that supply-demand will continue to be tight enough to keep pricing favorable? Then I have a follow-up.

Dave Mosley, Chief Executive Officer

Yes, thanks Wamsi. It’s really hard to forecast exactly what’s going on in Chia, and not just because of Chia itself, because they are fairly transparent with their numbers, but because of the entire space that’s developing. We did say that on the growth of the NAS space that we’ve seen to date, there’s probably a fair amount of refurbished drives or drives that have been purchased one or two quarters ago, so it’s a relatively small contribution as of yet to Seagate’s overall revenue, and even in the exabyte growth perspective, I don’t think it’s very big, so we said maybe mid-single digits, like you referenced. I think it’s a space to watch. We love it because it’s very innovative, not just in Chia and those applications but also in the IDFS applications that we talked about last quarter. The big takeaway is if it continues to grow fast, it will have to grow with more new builds, so that’s something for us to watch. But we’re not really forecasting very much of that into our guide right now because we’re going to wait and see a little bit, and we’ll react to customers who are trying to drive more demand in the channel as it happens. Mass capacity is still our business - that’s what I would take away, and that’s how we plan our exabytes and that’s how we have our customer relationships across the breadth of our portfolio. I don’t think Chia was that impactful from in that respect in the last quarter, and looking forward we’re not really forecasting it very much. We’ll just react to it.

Wamsi Mohan, Analyst

Okay, that’s helpful. Then as a follow-up, you’ve added gross margins for next quarter within your long-term range. What would need to happen for you to fall out of that range as you go through the course of the year?

Dave Mosley, Chief Executive Officer

I believe the focus is primarily on costs and potential disruptions to the supply-demand balance we have been managing. Looking back six to eight quarters, when we decided to invest in our mass capacity platform for 16 nanometers and later transitioned to 18 nanometers, we increased our capacity and adjusted our production lines accordingly. The pandemic caused significant supply chain disruptions, which severely impacted us. What has helped us return to our model is the consistent demand for exabytes. I believe we would be much more resilient at this higher level, though that remains a point of concern. We do not predict any downturn, as we expect the demand for exabytes to continue rising significantly over the next few years, aligning with our thesis. We remain optimistic about exabyte growth without any major setbacks. However, in these unpredictable conditions, everyone is cautious, which is how I would describe the situation.

Wamsi Mohan, Analyst

Okay, thank you so much.

Operator, Operator

Your next question comes from the line of Thomas O’Malley with Barclays.

Thomas O’Malley, Analyst

Hey guys, thanks for taking my question. I just wanted to follow up on Katy’s earlier question, talking about the seasonality for the year. Gianluca, I believe you said that the second half of the calendar year would be very strong, and I think you mentioned 15% year-over-year. That would imply a down December. Can you talk about what you’re seeing into the December quarter that’s weakening, or can you clarify that 15% year-over-year comment?

Gianluca Romano, Chief Financial Officer

Yes, I said at least 15%, so I don’t think it’s implying really a decrease in the December quarter; it would be probably fairly close. I would say the seasonality that is expected is more into the March and June quarters, as it was the case in the last few years with the exception of fiscal 2021. We think in general, because the mix of mass capacity is continuing to improve, the seasonality will be more muted in the future compared to this calendar year, but there’s a little bit less visibility for us when we go into the March and June quarter.

Thomas O’Malley, Analyst

That’s helpful. My follow-up is around Nearline. I know that you guys don’t like to talk about share, but clearly you’re in a really nice leadership position here. Can you talk about that leadership position, how you feel you’re maintaining that lead, and for the remainder of the year, do you think that from a competitive perspective, you’re going to see any change in that market? Thank you.

Dave Mosley, Chief Executive Officer

Thanks, Tom. We don’t focus on market share; we’ve discussed this for a while. We are very satisfied with our platform moving from 16s to 18s to 20s and beyond, which gives us a lot of flexibility. When customers want additional units or need to adjust their plans, we can accommodate those changes directly from the factories, which is a key factor in our success. Looking back at the 16s, we had a strong advantage due to our overall capacity. We are executing our plan effectively. We engage with customers, understand their needs, and plan ahead accordingly. We mentioned last quarter that if someone wants an 18 in December, they need to inform us now because we are starting production on those units. This approach resonates well with our customers. Our planning allows us to be predictable, and we are content with our product offerings. We are not specifically aiming for market share, and it seems our customers also appreciate this predictability, as they are making significant investments and need assurance that the product will be available.

Operator, Operator

Your next question comes from the line of Steven Fox with Fox Advisors LLC.

Steven Fox, Analyst

Thanks, good morning. Just to follow up on those last comments, Dave, can you maybe talk about with now basically supply-demand balance, how you engage differently with some of those customers? What would be the incrementals that get you to add capacity going forward? Then I have a follow-up.

Dave Mosley, Chief Executive Officer

Yes, it's pretty much the same situation because if you were buying 16s before and now you're looking to increase to 18s or 20s, we're still discussing the same concept; it’s just a different approach. We are confident in our yields, throughput, and our capability to handle those high volumes. There isn't much legacy business to draw media heads from anymore, but there are still over 100 million heads available each quarter for swaps. The challenge lies in lead time, so if swaps occur in the last two or three weeks of the quarter, it becomes unfeasible. That's the shifting dynamic in the market. I don't see us returning to a situation where we over-capacitate; we will adhere to our financial model and invest in the capital expenditures that align with demand. If demand increases significantly, we can adjust our investments incrementally rather than making drastic changes.

Steven Fox, Analyst

That’s helpful. Then just secondly on the Lyve platform, it sounds like you’re getting some more technology validation, or at least proceeding like you expect it. Is it changing any of your thinking for ’22 in terms of the non-HDD business? Thanks.

Dave Mosley, Chief Executive Officer

No, I don’t think so, but the non-HDD business did grow, as we talked about in the prepared remarks. So, we’re fairly happy with the breadth of our portfolio and how it’s growing. Relative to the Lyve business, the market is clearly out there. There are people who are struggling with the data that they have on the edge, being able to move that into the cloud, find those temporary resting spots like we’ve talked about a lot with Lyve such that they can move it to its final destination in some cloud service provider or multiple cloud service provider instances, so I’m really encouraged by all the customer engagements that we have. We have to learn this market really well and then it will grow, so I’m really pleased with what I see and I hope to share that at some point in the future with everyone.

Operator, Operator

Your next question comes from the line of Ananda Baruah with Loop Capital.

Ananda Baruah, Analyst

Hey, good morning guys, or good afternoon to you guys. Thanks for taking the questions. Dave, how would you describe your thoughts around the length of this hyper-scale cycle at this point, and I guess what’s the personality of it as well? Then I have a quick follow-up.

Dave Mosley, Chief Executive Officer

Thanks, Ananda. It's interesting because the beginning of this cycle isn't really focused on adding a lot of mass capacity. It has more to do with the digital transformation that occurred during the pandemic. This involved networking and computing, ensuring that applications could handle much heavier workloads than they were initially designed for just six months ago. This has put a tremendous strain on people. Our belief is that the storage backend will eventually come and grow significantly. The steady growth we've observed in the cloud indicates that it will expand even more, making this cycle quite different. It's not about adding excess capacity and finding ways to utilize it better in the market. Instead, it’s about directing all investment into those applications that satisfy everyone on the front end, particularly from a performance standpoint, which will lead to data growth. The backend of the cloud is definitely set to increase from here, and we’re excited about that while ensuring our portfolio is as streamlined as possible before the really big numbers arrive.

Ananda Baruah, Analyst

How do you want us to think about it as we get into the March-June quarters? Typically, the brakes would come off a little bit. Is that the appropriate way to think about it this time?

Dave Mosley, Chief Executive Officer

Yes, we’ve said that there would be more muted seasonality than normal, right, because we’re not in the PC business or the legacy business anymore now that the cloud is a lot more steady. But we’ll let you know - I mean, if we start to see more recovery around the world, then the next cycle will be pulled in, exactly to your point, right?

Gianluca Romano, Chief Financial Officer

Yes, last quarter we shipped a record of 152 exabytes, so we are still growing, so this means we have some capacity still available. Based on our guidance, you can expect another increase in exabytes in FQ1, and as we discussed before, we are still planning to add some CapEx, so some capacity through the year.

Dave Mosley, Chief Executive Officer

And as we ramp to 18s and 20s and things like that, we’ll get more exabytes out obviously than the existing head media footprint that we have.

Operator, Operator

Your next question comes from the line of Mehdi Hosseini with SIG.

Dave Mosley, Chief Executive Officer

Mehdi, can you hear us?

Operator, Operator

Mehdi, your line is open.

Tyler, Analyst

Hey, it’s Tyler on for Mehdi. Our question was answered, thank you.

Dave Mosley, Chief Executive Officer

Thanks, Tyler.

Operator, Operator

The next question comes from the line of Kevin Cassidy with Rosenblatt Securities.

Kevin Cassidy, Analyst

Thanks for taking my question. Just around your discussions with your customers, are your long-term agreements being expanded or are you adding more long-term agreements? Maybe can you give us an idea of what visibility your customers are giving?

Dave Mosley, Chief Executive Officer

Yes, I think the discussion around how things are going to go six months and nine months out are continuing, and it’s really good. I think everybody wants a certain amount of predictability right now. We certainly do because we’ve got factories to run, parts to bring online, and things like that, but a lot of supply chains are tight and so people want to make sure that if they’re going to invest in those supply chains, they’re going to have the full kit together, so I think the entire industry is behaving quite well for this perspective right now. It’s helping us quite a bit to plan our business, Kevin.

Kevin Cassidy, Analyst

Okay, great. Maybe just as a comparison of hyper-scale to enterprise, is enterprise coming back stronger, or maybe just relative to hyper-scale, how is it performing?

Dave Mosley, Chief Executive Officer

You know, we debate that a lot, and I would say it’s 50/50 - it’s always been kind of a toss-up. Sometimes one races ahead of the other. Right now, as we said in the prepared remarks, there’s clearly still growth in the cloud, and then as people are coming back on-prem, they’re realizing the investments that they want to make that perhaps they hadn’t made six or nine months ago, so they’re continuing those investments. I would say there’s growth in both, and it’s not enough to knock it off the 50/50 split right now.

Operator, Operator

Your next question comes from the line of Aaron Rakers with Wells Fargo.

Aaron Rakers, Analyst

Yes, thanks for taking the questions. Congratulations on the quarter as well. I’m just curious, first of all, kind of a pointed question - do you still think that your Nearline capacity shift underpinning your fiscal 2022 expectations is still going to grow in that 30% to 35% annual range?

Dave Mosley, Chief Executive Officer

Yes, Aaron, we do. Just as I mentioned to Kevin, two years ago it was 80%, and last year it was a little less at 35%, but we believe 35% is a solid model for now. The potential for growth on the upside depends on whether we see more cloud activity in six to nine months, and we’ll have to wait and see. We have the capacity for it, and we are planning to build the necessary components regardless. Overall, I think 35% is a reasonable figure to project for this year.

Gianluca Romano, Chief Financial Officer

We had a debate on the next two quarters, so to now give you exactly the growth for the entire year would be difficult. But as a model for the long term, we think that 35% CAGR is still very valid.

Dave Mosley, Chief Executive Officer

And it’s all the same heads and media parts, I guess is the point, so we can be flexible.

Aaron Rakers, Analyst

Right, right. Then the follow-up question is, Gianluca, when you talk about the model and we now talk about 30% to 33% gross margin and confidence around that, I’m curious as to how you’re thinking about operating expense investments. You talked about opex remaining at similar levels these next couple of quarters, but should we start thinking about that you’d let that drop through above that to drive an above-20% operating margin, or would you start to reinvest that and cap off margin at that long-term high end of the target model?

Gianluca Romano, Chief Financial Officer

For the opex, we think the level of FQ4, we can maintain that level through the fiscal 2022. We are now managing more, we are a little bit more cautious about expenses. The performance is very good, so comparing to maybe the prior year, we also have a little bit higher variable compensation. But this level, if we can keep it between $340 million and $345 million per quarter, I think we can do it.

Dave Mosley, Chief Executive Officer

If we exceed the upper end of the range, we will consider making investments because there are several markets currently experiencing growth. As mentioned earlier, we have considerable flexibility within the $340 million to $350 million range. Our initial step would be to reallocate resources within that budget, and we could accommodate additional investment if we see growth beyond the top end of the range.

Gianluca Romano, Chief Financial Officer

Operating margin is already 18% right now, so when you model increasing revenue and this level of opex and the gross margin you were mentioning before, you will see a very good result in terms of operating margin.

Aaron Rakers, Analyst

Right, thank you very much.

Dave Mosley, Chief Executive Officer

Thank you.

Operator, Operator

Your next question comes from the line of Patrick Ho with Stifel.

Patrick Ho, Analyst

Thank you very much, and congrats on the nice quarter. Dave, maybe first off, in terms of the ramp of your 18 terabyte drive, can you just give a little color of when you expect to see the crossover from 16 to 18, where you’re shipping more exabytes from the 18 terabyte ramp?

Dave Mosley, Chief Executive Officer

I don’t think we’ve formally looked at it that way, so I don’t have an answer. But I think it’s pretty soon; it’s in the next few quarters. From my perspective, it’s the same product family, so the heads and media are already in the pipeline and some customers are asking for 16s, some customers are asking for 18s, but I think it’s very soon. Then the same heads and media will take us to 20 terabytes on that PMR platform that we talked about, so we may actually spend some of those heads and disks on 20s as well. But I do think we’re going significantly far north of 16 very, very soon.

Patrick Ho, Analyst

Great, that’s helpful. Maybe as a follow-up for you, Gianluca, or yourself, Dave, in terms of the Lyve platform, obviously we’ve seen now the rollout of several product iterations from that family. As it relates to opex, is a lot of that R&D spending done, or are you continuing to invest in Lyve where we’ll see future product introductions? Is that part of the, I guess, help in terms of maintaining opex at current levels?

Gianluca Romano, Chief Financial Officer

Yes, it’s part of the opex guidance we discussed before, and we are investing more in Lyve. We think this is a big part of our future business. We are very positive on the possible outcomes from that business, so we will invest; but as I said, we will stay around that level of opex that we discussed before.

Operator, Operator

Your last question will come from the line of Shannon Cross of Cross Research.

Shannon Cross, Analyst

Thank you very much. I was just wondering, can you talk about the materiality of the dual actuator drives? It looks like you’ve expanded access to certain other customers recently, and I’m just wondering how we should think about it in terms of ASP and benefit as we look forward. Then I have a follow-up, thank you.

Dave Mosley, Chief Executive Officer

Thanks Shannon. It’s growing quite nicely, actually, growing volume in the factories. It’s not a small volume product anymore; it’s becoming a large volume product. We’ll be talking about it more and more over the quarters. It is a 14 terabyte drive right now, so if people are making trades for 18 terabytes, they may want to go to the single actuator, but it’s very specific to a few applications out in the cloud world that people need the dual actuator already. Remember, fundamentally we believe that by the time you get to 30 or 40 terabytes, you can’t have all that behind one actuator; you need to have dual actuators at least, and we have to solve all the power problems and all the interface problems with our customers and things like that to make that happen. We’re quite excited about getting the learning on the technology. The fact that we have the platform continuing in development - you know, parallel drives that as we launch the new high capacity drive, we have the same capacity points on dual actuator.

Shannon Cross, Analyst

Okay, thanks. Then just a clarification - I think during the script, you mentioned strength in high-end desktops, and I’m not sure if that includes gaming, but I’m wondering, are you seeing benefit from customers coming back to the office and needing to refresh desktops that perhaps are 18 months old now at this point in time? Thank you.

Dave Mosley, Chief Executive Officer

Yes, I wouldn’t say it’s desktop PC anymore. There is gaming that’s happening, but I would say more it’s distribution channel around things like crypto applications and things like that. There are people who are looking just for the absolutely lowest cost per terabyte that they can find, and so that’s one of the reasons why the average drive capacity is mixing up. It’s going from two terabytes to four terabytes, last quarter we were over five terabytes, and I expect that trend will continue. It’s happening certainly in consumer channels and things like that. Okay, thanks Tabitha. Seagate’s delivering strong performance, demonstrating financial results consistent with our long-term targets, and executing our product and technology roadmap to capture long-term secular growth opportunities for mass data infrastructure. I’ll close by expressing my appreciation for our customers, suppliers, our employees, and our shareholders for your ongoing support of Seagate. Thanks again for joining us today.

Operator, Operator

Thank you. Ladies and gentlemen, that concludes the conference call. You may now disconnect.