Earnings Call Transcript
Seagate Technology Holdings plc (STX)
Earnings Call Transcript - STX Q2 2021
Operator, Operator
Good afternoon, and welcome to the Seagate Technology Fiscal Second Quarter 2021 Financial Results Conference Call. My name is David, and I will 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. 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, SVP, 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 posted our earnings press release and detailed supplemental information for our December quarter 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 Form 8-K that was filed with the SEC. We have not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control or cannot be reasonably predicted. Therefore, reconciliation to the corresponding GAAP measures is not available without unreasonable effort. As a reminder, this call contains forward-looking statements, including our March 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 effects 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 will open the call for questions. And with that, I will now turn the call over to you, Dave.
Dave Mosley, CEO
Thanks, Shanye. Welcome, everyone, and thanks for joining us today. Seagate exited calendar year 2020 on a very strong note, delivering December quarter performance that exceeded our objectives. Compared to the prior quarter, we grew revenue 13%, expanded non-GAAP operating profits 31%, and significantly increased the free cash flow to $314 million. We began executing our recently increased share repurchase authorization and retired over 18 million shares of Seagate stock, or approximately 7% of the shares outstanding at the beginning of the quarter. Through the combination of share repurchases and our quarterly dividend, we returned a total of $1.2 billion in the quarter. Despite the challenges of a global pandemic, Seagate grew annual revenue 2% in calendar year 2020, achieving revenue growth inside of our long-term financial target range. At the halfway point of fiscal 2021, our performance puts us well on our way to achieving our objective to deliver relatively flat revenue for the year. In the remainder of my comments today, I will provide an update on end market trends, share the progress we’ve made on our technology and product roadmaps, and offer some insight into how these advancements position Seagate with a strong secular mass data growth transition. Against the backdrop of the pandemic, 2020 was headlined by diverging end market trends. Strong cloud investments to support our remote economy and digital transformation were countered by significant disruptions to enterprise IT spending. However, during the December quarter, the enterprise markets began to recover for the first time since the onset of the pandemic. The improvement was most pronounced amongst large enterprise OEM customers, which led to strong sequential revenue growth for both nearline and mission-critical drives. We anticipate this positive trajectory to continue, which is consistent with analysts’ expectations for on-prem IT hardware investments to pick up in calendar year 2021. Cloud data center demand remains healthy, with the overall data demand drivers and tech. Analysts projected strong double-digit growth in cloud CapEx in 2021, which bodes well for Seagate and aligns with our expectation for cloud HDD storage demand to increase through the balance of the fiscal year and drive significant growth long-term. For a second consecutive quarter, we experienced stronger than expected growth in video and image applications or VIA markets, due in part to pent-up demand following the significant impacts incurred in these markets during the economic shutdowns early in the pandemic. Video and image applications are a key growth market within mass capacity storage. As the number of devices generating data explodes at the edge, mass capacity HDDs are vital to preserving and putting that data to work. For example, the rollout of 5G and the rise of edge computing supports further growth in smart and safe city initiatives, as well as smart factory opportunities. Gartner projects that the number of 5G enabled outdoor video cameras will exceed 15 million by 2023, a six-fold increase from current levels. That will translate to as much as 1 exabyte of data generated each day, which is to fill about 2 million security surveillance drives every week. The proliferation of video and image sensors and other IoT devices is expected to be a major driver of data creation at the edge in the coming years and will play a key role in the growth and evolution of the mass data storage industry. Finally, strong seasonal demand for our desktop PC and consumer drives contributed to double-digit sequential revenue growth in our legacy business during the December quarter. Overall, we expect demand for mass capacity storage to improve across the cloud and enterprise markets in the March quarter, more than offsetting an expected decline in the VIA markets and the typical seasonal slowdown in the consumer space. With the broader market environment continuing to firm, Seagate is executing well on its technology roadmap and hitting our committed milestones, highlighted by the shipments of our first 20 terabyte HAMR drive in late November. With HAMR, we could drive areal density compound growth rates of 20% or higher to support the scale of our customers’ infrastructure investments, enabling Seagate to maintain a significant economic advantage for mass capacity applications relative to enterprise SSDs, that is expected to persist over the foreseeable future. Seagate’s first to market dual actuator technology is gaining interest among a broader customer base, who require mass capacity storage with higher performance for certain applications, such as content delivery. We are increasing shipments of dual actuator drives today and expect to see higher volumes as drive capacities increase. We are also continuing to strengthen our PMR product roadmap anchored by our industry-leading 16-terabyte drives based on our common scalable platform. We broadened the adoption of 16-terabyte drives in the December quarter, gaining new cloud customers globally. We have started to increase the pace of the 18-terabyte product ramp, which will continue through the calendar year consistent with the strong progress of our qualifications and customer readiness timing. As product capacities increase, the qualification process often takes longer and adds complexity. Our common platform approach is helping customers simplify the qualification process. In fact, a number of leading cloud customers commented that the qualification of 80 terabyte drives has been the smoothest ever. Additionally, we expect to continue to leverage the quality and scalability of this platform, which is extendable through 20-terabyte on PMR technology. The strength of this platform offers Seagate the flexibility to meet customers’ timing and mass storage needs. For Seagate, the common platform strategy drives manufacturing efficiencies that allow us to ramp new technologies and production more quickly, and then use our systems business to accelerate the pace of learning and market adoption. We are maintaining solid momentum in our systems, securing multiple customer wins in the December quarter, including our biggest systems deal ever, a multi-quarter deal representing close to 8 exabytes of scalable storage. Overall, with our leadership in HDD technology and execution on our product roadmap, Seagate is in an excellent position to capture the $24 billion mass capacity storage opportunity we forecast for 2025, which is driven by the burgeoning demand for data. However, to capture value from the avalanche of data being created, CIOs must overcome cost, scale, and complexity challenges associated with moving, analyzing, and storing more data across the distributed enterprise. As a result, economics are forcing enterprises to keep proportionately less of the data that’s being created, which threatens business performance and competitive advantage. This dynamic is at the foundation of Seagate’s innovation agenda. We are enabling CIOs to address the key challenges of cost, scale, and complexity to preserve and put to work more of the valuable data they are already creating. Our Lyve Storage Platform offers a simple, cost-efficient, and secure way to manage massive volumes of data across the distributed enterprise. Lyve Mobile enables mass data transfer between endpoints, edge, and core, and Lyve Rack powered by CORTX open-source object software provides enterprises with the lowest cost per petabyte. The CORTX software is the foundation of the Lyve Storage Platform, which is maintained by a growing community of data scientists and enterprise storage experts, many of whom participated in our first-ever and highly successful Hackathon event held last month at Lyve Labs Israel. We have a growing customer interest in the Lyve portfolio and continue to receive positive feedback on our existing engagements that span multiple verticals, including media and entertainment, and autonomous vehicle technologies. Driving platform-level innovation and addressing the growing challenges faced by the distributed enterprise is a mandate that will help define our long-term growth strategy. We plan to share more details on the Lyve Storage Platform and the rest of our unfolding strategy on February 24th, when we will be hosting a Virtual Analyst and Investor event. I look forward to having you join us. With that, I will now turn it over to Gianluca to walk through the December quarter.
Gianluca Romano, CFO
Thank you, David. Seagate continues to execute well and adapt to the rapidly changing business environment, as shown by our strong December quarter performance, which was supported by the anticipated recovery in the enterprise market, record revenue for video and image applications, and seasonal demand for our consumer and desktop PC product. We achieved revenue of $2.62 billion, up 13% sequentially and above our guidance midpoint; non-GAAP EPS of $1.29, up 39% sequentially, exceeding the high end of our guidance range; and free cash flow of $314 million, up nearly 70% sequentially, reflecting our ongoing focus on operational efficiency. Additionally, we repurchased 18.2 million shares of Seagate stock. Our decision to invest in our shares in the current environment underscores our confidence in the long-term business outlook and future cash generation abilities. In the December quarter, we shipped a record 129 exabytes of hard disk drive capacity, up 13% sequentially and 21% year-on-year. Roughly three-quarters of our total exabytes were shipped into the mass capacity market, which includes nearline, VIA, and mass products. Mass capacity shipments increased to a record 97 exabytes in the December quarter. We shipped a total of 365 exabytes in the calendar year 2020, up 59% year-over-year, which is well ahead of the long-term CAGR forecast of about 35% for this market segment. Our current outlook for the March quarter supports continuing exabyte shipment growth setting in terms for calendar year 2021. On a revenue basis, HDD accounted for 92% of total December quarter revenue, and mass capacity storage represented 62% of HDD revenue. Revenue from mass capacity storage was $1.5 billion, up 12% sequentially and 15% year-over-year. Nearline revenue increased sequentially, driven by stronger than expected demand from enterprise and OEM customers. Nearline shipments were 71 exabytes, up 11% sequentially and 45% year-on-year, reflecting ongoing demand for our 16 terabytes high capacity drives, as well as increased demand for mid-capacity nearline product as the enterprise market recovers. This dynamic resulted in every capacity per nearline drive staying relatively flat at 11.4 terabytes. We are continuing to expand the adoption of 16 terabyte size and expect 16 terabytes to remain the company’s highest revenue product over the next couple of quarters. We also continue to increase shipments of our 18-terabyte drives and make positive progress on qualification plans at multiple cloud customers with volume ramp aligned with their timing. In the VIA market, revenue was above our expectation for the second consecutive quarter as pent-up demand from the COVID-related costs in the first half of the calendar year led to strong recovery in September quarter and record revenue in the December quarter. Following this period of strong demand, we anticipate the March quarter sales to be sequentially lower and below typical seasonal trend. The legacy market represented 38% of December quarter HDD revenue, compared to 37% in the prior quarter and down from 47% in the year-ago period. Revenue and exabyte shipment both increased 15%, sequentially, resulting in a total of 32 exabytes shipped into the legacy market. The growth was driven by a seasonal uptick for consumer drives and desktop PCs and improving demand for mission-critical drives consistent with the recovery in the enterprise market, which also impacts demand for our mission-critical drives. We currently expect ongoing enterprise market recovery to moderate the seasonal decline we typically see in the March quarter. Our non-HDD business made up 8% of December quarter revenue, relatively flat on a percentage basis with the prior quarter. As chosen partner for Microsoft Xbox expansion plan, Seagate benefits from strong holiday demand, which supported both double-digit growth for our SSD products and a sequential improvement in non-HDD revenue. Within our systems business, we saw early signs of recovery at large OEM customers, which along with customer wins, Dave mentioned earlier, should benefit our systems business in calendar 2021. In the December quarter, non-GAAP gross profit increased to $704 million, compared with $614 million in the September quarter. COVID-related costs increased slightly to $28 million, primarily due to elevated shipping costs. We are currently planning to incur similar levels in the March quarter, as we balanced customer demand timing with increasing freight costs and opportunities to derive lower costs, which sound great. Our resulting non-GAAP gross margin was 26.8%, including about a 110-basis-point impact from this COVID-related cost, as the margin expanded slightly quarter-over-quarter, offset by a less favorable non-SSD product mix. Non-GAAP operating expenses came in at $319 million, down $31 million from the same period of last year, reflecting ongoing benefits from working from home and overall operational efficiency. Looking ahead, we expect operating expenses to be a bit higher in the March quarter. Our resulting non-GAAP operating income was $385 million and non-GAAP operating margin was 14.7% of revenue, up 200 basis points sequentially and in the upper half of our long-term target range of 13% to 16%, despite the COVID headwind, I mentioned earlier. Based on a diluted share count of approximately 251 million shares, non-GAAP EPS for the December quarter was $1.29, the $0.19 outperformance relative to our guidance midpoint was driven mainly by higher revenue and operational leverage, while our share repurchase activity enhanced EPS by $0.05. Capital expenditures were at $159 million in the December quarter, which represented approximately 6% of revenue. We expect CapEx to represent between 4% and 5% of revenue for the fiscal year, which is below our prior target of 6% to 8% of revenue. We believe this CapEx level will align supply with demand when considering the existing installed base capacity and continued demand growth for mass capacity storage. Days inventory outstanding reduced by eight days sequentially. Inventory value was relatively flat at $1.3 billion in anticipation of continuous strong mass capacity storage demand in the near-term, as well as the need to carry higher levels of strategic inventory to better manage freight logistics and protect against potential future supply chain risk. We expect inventory levels to gradually decline as freight costs return to more normalized levels and we consume this critical component. We generated $314 million of free cash flow in the December quarter, up from $186 million in the September quarter and up 10% year-on-year, supported by our focus on operational efficiency, improvement in demand trends, and strong linearity. In the December quarter, we used $167 million to fund our dividend and utilized $1 billion to retire approximately 18 million ordinary shares, exiting the quarter with 240 million shares outstanding. We will continue to opportunistically retire Seagate stock and return capital to our shareholders. Additionally, we raised a total of $1 billion in capital, issuing two tranches of debt at the lowest average interest rate of any of our bonds. Including the new notes, gross debt was $5.1 billion and net debt was $3.3 billion. We expect the interest expense for the March quarter to be approximately $59 million, including $9.5 million on the two new tranches. Cash and cash equivalents remained relatively stable at $1.8 billion. As the new calendar year begins, we expect strong cloud data center demand and continued enterprise recovery in the March quarter to more than offset the seasonal decline in some of our other end markets. While we are still facing headwinds from COVID-related costs, we expect this will gradually decrease over the next few quarters. Taking all these factors into account, our outlook for the March quarter is as follows: revenue is expected to be $2.65 billion plus or minus $200 million; non-GAAP operating margin is expected to be in the middle of our target range of 13% to 16% of revenue; and non-GAAP EPS is expected to be $1.30 plus or minus $0.15. In closing, Seagate is executing well across multiple levels, delivering on our financial commitments, demonstrating the agility of our business model to address customer demand, and maintaining our commitment to return cash to our shareholders. I will now turn the call back to Dave for final comments.
Dave Mosley, CEO
Thanks, Gianluca. 2020 was a very challenging year, and we have continued to face hardships. We are encouraged by progress with vaccines and signs of recovery. Through the efforts of our extended team, Seagate exited the year firing on all cylinders, and we are well-positioned to capture mass data growth opportunities in calendar 2021 and beyond. We are executing our technology innovation roadmap to continue delivering the lowest cost mass data storage. We are strengthening our mass data infrastructure portfolio by building on the positive momentum of our scalable common platform family of 16-terabyte and 18-terabyte drives, and we are gaining interest for our Lyve Storage Platform, which expands Seagate market opportunities, paving the way for future growth. Our success is founded on the dedication of our employees and the ongoing support from our suppliers, customers, and shareholders. Employees remain the lifeblood of our company, and we are focused on maintaining and strengthening our culture to provide an open, safe, and respectful workplace, and ensure all employees are able to thrive. Earlier this month, Seagate released its latest diversity, equity, and inclusion report. I am proud to see a strong track record and reputation for promoting inclusion both within and outside the walls of the company, and recognizing diversity is key to our ongoing success. We are equally focused on contributing to our customer’s success, which we believe will lead to higher revenue for Seagate and greater value for our shareholders. We collect data quarterly to measure overall satisfaction across the breadth of our customer base. The December quarter indicators were among our highest ever, which reflects the care we take in providing high-quality reliable products for all of our customers. In summary, I am excited about Seagate’s growth opportunities, ability to generate cash, and enhance shareholder value over the long term. With that, Gianluca and I are happy to take your questions.
Operator, Operator
Your first question comes from Karl Ackerman with Cowen. You may proceed.
Karl Ackerman, Analyst
Hi. Good afternoon, everyone. Thanks for taking my question. Dave, I have a question for you to start. With on-prem still recovering, are you able to achieve 35% exabyte growth for your nearline business in fiscal 2021? I ask because I think you indicated in your prepared remarks that while customers are still suggesting 18 terabyte offers a very attractive upgrade path, maybe adoption timing is a bit elongated? And then second, I think you noted that your 20 terabyte drive could facilitate exabyte growth of, I think, 20% or more a year. So if you could just touch on your longer-term exabyte growth expectations as well, that would be very helpful? Thank you.
Dave Mosley, CEO
Thank you for the question. Yes, 35% is still a possibility to answer your question directly. You made a good point regarding the mix between the highest capacities and the on-prem, which tends to be lower in capacity nearline. It could be either 8 terabytes or 12 terabytes. However, we believe that maintaining 35% is a reasonable expectation for the fiscal year. Looking ahead, we think 35% will remain fairly stable. It's possible that the cloud could exceed that growth, but we need to observe the post-COVID impacts. Overall, I still believe that 35% is a solid estimate for growth in the mass capacity markets beyond just the end of the fiscal year.
Karl Ackerman, Analyst
Got it. If I may, could you discuss the shortages? Are the shortages of semiconductor components and diodes preventing you from ramping up production of your hard capacity drives, especially the 20 terabyte model? Additionally, are you able to extend your volume commitments with data center providers given the supply chain shortages? Thank you.
Dave Mosley, CEO
Yes. Two interesting questions. The first thing is one of the reasons we really like the common scalable platform is its flexibility in questions exactly like you just asked. So relative to componentry, we have long visibility. But if we were changing platforms over and over again, then some of those things might be hard to chase. And the fact that we have more capacity inertia on those platforms gives us a lot of flexibility. But to your point, I think across all the supply chains, people are witnessing some of these constraints, and they are managing well. I do think it’s forcing discussions to be a little bit more mature relative to what the mass capacity needs are and what the needs are for silicon. For example, you made reference to some of the other components and making sure everybody has enough for the growth of our customers, especially during recovery times, than what they might need later on in the calendar year.
Shayne Hudson, SVP, Investor Relations and Treasury
Thanks, Karl.
Operator, Operator
Your next question comes from the line of Katy Huberty with Morgan Stanley. Your line is open.
Katy Huberty, Analyst
Good afternoon. Thanks for the question. Just with the improvement in demand that you have seen in a number of the end markets, can you talk just qualitatively about where you are in terms of manufacturing utilization versus either a quarter ago or a year ago? And I ask, because we have started to hear that some hyperscalers can get all the product they want, we have seen some price increases in the channel. I’m just wondering how tight things got in the seasonally strong December quarter, and what that might mean for the next couple of quarters?
Dave Mosley, CEO
Yes. Katy, thanks. So in some of the markets that we were tremendously disrupted, some of the legacy markets. For example, we had ample capacity throughout the period of Q1 and Q2, with the COVID impact and a lot of supply chains disrupted as well. The cloud demand has been fairly strong and predictable for us. We are building what we had predicted. I think the way I think about our capacity constraints, our manufacturing constraints, if you will, is more of a long lead time stuff like wafer capital and some of those things, wafer process time, things like that staging for the future; that’s the stuff that’s full. At drive level, we still have some flexibility, and we did last quarter. We were able to chase really aggressively in the VIA markets, in particular that we are kind of racing ahead and there were some seasonality there, but some of it was just pent-up demand based on how the pandemic had impacted bullet all the supply chain.
Katy Huberty, Analyst
Okay. And then just a follow-up, Gianluca. Can you just bridge how you are thinking about the March quarter gross margin relative to December? Just some of the pluses and minuses sequentially on gross margin, which seems like it’s up slightly based on your guidance?
Gianluca Romano, CFO
Yes. First of all, the December quarter margin has already improved sequentially. Especially in the R&D part of the business, we had maybe some negative impact on the SSD and system solution segments, but the hard disks started to improve already in the December quarter. The mix is going in the right direction. As we said in the script, enterprise OEM was strong in December; cloud was still very healthy. Now when we go into the March quarter, we expect both segments to actually continue to improve sequentially. We will lose a little bit of the legacy segment, a little bit of surveillance. We think mission-critical will be maybe less seasonal than what we have seen in the past and then I think the quarter and the gross margin in the quarter. So I think we will continue to go in the same direction. Of course, we will have some of the costs from COVID that will continue to be there. It was fairly high in the December quarter, a little bit higher than what we were expecting, and we think March will probably be fairly similar.
Katy Huberty, Analyst
Great. Thank you for that and congrats on the quarter.
Gianluca Romano, CFO
Thank you.
Operator, Operator
Your next question comes from the line of Sidney Ho with Deutsche Bank. Your line is open.
Sidney Ho, Analyst
Thanks for taking my question. I had a kind of couple of them. Maybe first one on the nearline side, maybe two parts here. On the enterprise side, you talked about some recovery you’ve seen last quarter. How far do you think we are still below the trend line? The question is more on the on-prem nearline drive side, Q3 you talked about mission-critical? But on the cloud side, have you seen any kind of delays or pull-forwards and capacity transitions in some of your large cloud data center customers compared to what you think a few months ago?
Dave Mosley, CEO
Yes. I believe there are two parts to this. First, the on-prem enterprise segment that we mentioned during the early days of the pandemic has probably been the most affected. It is recovering, albeit slowly, as some of the on-prem challenges have not fully resolved and are likely to take time. However, it is becoming more predictable now, which is why we feel we have a good grasp on the market. This aligns with the IDC numbers we referenced earlier, indicating a 3% increase in traditional IT, which supports this observation. Regarding the larger cloud service providers globally, there are various factors at play since there is no one-size-fits-all solution in the cloud. Generally, many applications have moved to the cloud, requiring organizations to adapt based on their available budgets, technology, and platforms. Some have shifted their priorities away from building storage infrastructure, while others have focused on it, making the current situation quite complex. In my view, given the dynamics we've observed, the cloud market is likely to expand beyond our initial forecasts. We anticipate that mass capacity will grow into a $24 billion market by 2025. We expect strong long-term growth in the cloud, although the path may still be uneven due to the factors we've discussed.
Sidney Ho, Analyst
Okay. Maybe a quick follow up. I know I asked this question last quarter on Huawei, but given the current restrictions on the shipment to Huawei. Does that change the way you think about the total addressable market for this calendar year for nearline drives?
Dave Mosley, CEO
Yes. So like I said last time, we don’t comment on these specific customers. I think that the market demand globally will not change on how it’s ultimately serviced. So if that answers your question. The net demand for data storage products is out there and it will get serviced by one customer or another, by one supply chain or another, and these are very, very complex supply chains.
Sidney Ho, Analyst
Okay. Thank you.
Operator, Operator
Your next question comes from the line of Thomas O’Malley with Barclays. Your line is open.
Thomas O’Malley, Analyst
Good afternoon, guys. Thanks for taking my questions. My first one is really around capital returns. You obviously thought it was strategic to spend a decent amount in the quarter and take that from shares. Can you talk about what your view is on buying back more shares over the next couple of quarters and then obviously with the new debt rolled into the model as well? How have you viewed the pros and cons which we can take some of that down and also buying back the shares?
Dave Mosley, CEO
Yes. Tom, obviously, there’s kind of two parts to the question about what we just went through in the pandemic and the way we were looking at the market. But the bigger part is looking forward I really believe in the long-term cash generation capabilities of the company. So our decision to invest in our shares is weighing current environment and long-term business outlook and cash generation capabilities. I do think that if this is helpful that we are kind of an inflection point in data growth. From Seagate’s perspective, we had to do a lot of transition from client-server businesses, factory transitions and so on into mass capacity. We have kind of finished that and now we are seeing mass capacity growing just simply because the demand for data is growing with the edge opportunities and things like that. So I think that this is an interesting time relative to all this, and we look at the opportunistic ability to retire stock and return capital. We look at the investments we have to make in ourselves; we had a fairly strong thesis on all of this and it’s good to have cash generation capabilities to underpin it all, so we can make the trade-offs.
Thomas O’Malley, Analyst
Really helpful. The next one is just a high-level question, and totally fair if you answer it from a very high level as well, but clearly, there are a lot of concerns about flooding the market with big capacity NAND this year. How do you think in a market in which the cost environment on the flash side is decreasing, particularly your legacy markets will react? Obviously, you mentioned some seasonality in the first quarter. But do you think that you will see greater than expected declines there? Or can you just talk through the pros and cons of what you may see happening throughout this year if that flash environment weakens?
Dave Mosley, CEO
A few years ago, the situation was quite different when notebooks had not transitioned to NAND, and now they mostly have. I see this as a competitive landscape that has changed significantly. For instance, when we discuss mission-critical drives, we haven’t introduced a new platform in several years. We operate in a continuous service market with many slots available, potentially tens of millions, equipped with SaaS interfaces that provide substantial value. While we'll maintain our focus on servicing these markets, the NAND price changes the dynamics considerably. The newer architectures generally aren't SaaS architectures; many are NVMe architectures, which require us to design products accordingly. The overlap between these markets is not as significant anymore. In the mass capacity markets, even a small change in cost can lead to a big difference in the infrastructure choices organizations make.
Gianluca Romano, CFO
I think that, which is the important point in this segment is that are really growing, like cloud and enterprise OEM and even surveillance, and really overlap between hard disk and NAND at this point and we don’t expect that to happen in the next few years structure.
Dave Mosley, CEO
Yes. The way I look at the data for social dynamics, there is a big growth in edge and cloud and there are lots of different architectural components. NAND has definitely come of age and so it’s got a lot of opportunities that have to be designed for the right solutions for the customers and for mass capacity perspective, we have the exact same problem, we keep driving our roadmap, and we are going to be just fine.
Operator, Operator
Your next question comes from the line of Steven Fox with Fox Advisors. Your line is open.
Steven Fox, Analyst
I am just having trouble footing everything you said with the new CapEx advice of 4% to 5% of sales. I know you were thinking it might not be as high as 6% to 8% previously. But can you just sort of talk about what’s going into that decision and then I had a follow-up.
Dave Mosley, CEO
Yes. I will let Gianluca take this one.
Gianluca Romano, CFO
Yes. Basically, what happened in the last couple of years, Seagate, and I think in general the industry installed more capacity than what was needed. So the fact that the growing demand is now absorbing that capacity is obviously good news for the industry and for Seagate in particular, but we can still see some of the additional capacity not being fully utilized. So we don’t need to invest more in the short-term at least in order to absorb the demand and serve the demand. So we think that still investing a fairly high amount that is now 4% or 5% of our revenue is not a small number; it’s a big number, but that is the right level for us to align supply and demand over the next two or three quarters.
Steven Fox, Analyst
And then just maybe Dave, if you can give a little bit more color on the 18 TB rollout. I know you have said consistently it is dependent upon when your customers want kind of some uptick, but is there any other color you can provide in terms of what may drive it sooner rather than later or later that you expect based on, et cetera?
Dave Mosley, CEO
Yes. We did say in the script that the 18 terabyte qualifications have gone very well. To the earlier point, I don’t think from a mass capacity perspective we are in the era in the industry anymore of just rolling out a bunch of drives and then trying to ship them in at the end of the quarter or something like that. You have to have real good relationships with the customers; you have to know exactly what they want. So over the last few quarters, we have been on a theme communicating that we know where 18 terabytes is going, with the customers who are going to be asking us for, and so we are fairly clear that the ramp has begun. It starts by going back to wafer, which was many, many months ago, and then making sure we are starting the right parts, we are making the transition to that product right now, and we feel really good about it. We feel good about the quality levels, the yield levels, the ability to ramp, and all the components that we need because it’s a common platform. I think we have been signaling this pretty well. I can’t really comment on what the rest of the industry is or isn’t doing because I just don’t know, but that’s relative. That’s the way I look at our plans.
Operator, Operator
Your next question comes from the line of Aaron Rakers with Wells Fargo. Your line is open.
Aaron Rakers, Analyst
Sorry about that, guys. I was on mute. I wanted to build on the last question with regard to kind of visibility discussion. When I look at kind of growing your mass capacity at 35% loss this year, it seems to really imply a very, very healthy uptick in capacity shipment growth into these next couple of quarters. So as we think about the visibility in the business, and the change in dialogue that you have had with kind of your key customers, how would you characterize visibility into that kind of demand profile, that pickup of capacity shipped into the back half of the year? And I do have a quick follow-up.
Dave Mosley, CEO
Yes, it's not just about hitting the highest capacity point. We have a clear understanding of the needs for 16 terabytes and 18 terabytes because we engage with our customers about their requirements well in advance. Additionally, we are observing activity at 8 terabytes and 12 terabytes. This transition in products targeting the lower capacity segments of the mass capacity market is where we anticipate significant growth, which tends to be more widespread than limited to a few accounts. This gives us confidence. Furthermore, the platform transitions we are implementing are reducing costs and optimizing performance as we increase capacity. We're confident in our ability to provide better solutions as our product mix evolves. Please proceed with your follow-up.
Aaron Rakers, Analyst
Okay. Yes. And this is a quick follow-up. Given the mix of business and kind of what’s transpired over the last year or plus, I am just curious. How do you think about the variables, the drivers that gets you back to that kind of what I think you have characterized as a normalized gross margin into that kind of 29%, the 30% plus range?
Dave Mosley, CEO
Yes. As Gianluca mentioned earlier, HDDs are almost ready. There are other dynamics in different businesses, but to your point, we have new platforms that will help reduce costs. We need to ensure that we’re meeting customer needs. I anticipate some demand growth recovery in certain markets, along with growth that will help everything balance out and bring us back to our target ranges. It was a highly competitive market during COVID-19 in 2020, with companies focusing on keeping their factories full. Now, we are entering a period of growth and recovery. As Karl asked earlier, there are several questions regarding supply availability and ensuring the right supply is available at the right time. We are engaged in those discussions and expect stability to return.
Gianluca Romano, CFO
Thank you, Aaron. I think the combination of different items, of course, the focus for us is always on cost reduction, and I think we are achieving that level of cost quarter after quarter. The second very important item is this alignment between supply and demand that should bring a healthier pricing environment for the industry. And then, of course, there are those additional costs that we are incurring right now because of the COVID situation that we don’t expect to continue forever; we think a few more quarters and then hopefully, a little part of the cost will go away.
Operator, Operator
Your next question comes from the line of Kevin Cassidy with Rosenblatt Securities. Your line is open.
Kevin Cassidy, Analyst
Thank you for taking my question and congratulations on the strong results. Maybe first, with the enterprise customers coming back, have they been qualifying higher density drives? Or is that going to just start now? And was there a delay and what are the expectations going forward?
Dave Mosley, CEO
Yes. Typically, Kevin, some of the enterprise customers do lag. They don’t qualify the highest capacity point through the branded product as fast as some other people do. There are exceptions to that rule, but they do lag. There has not really been any slowdown in qualifications for any reason. I think people even through the challenges, the logistical challenges of COVID, have kept focused on what they need to do because they are seeing efficiency gains as well there. But as we make some of those transitions, I think that helps us answer the enterprise demand the right way as the enterprise demand is starting to grow again.
Kevin Cassidy, Analyst
Okay. Thanks. And just as a follow-up. With the 16-terabyte and moving over to the 18-terabyte and the visibility you talked about, do you see a crossover of shipments anytime in 2021? Or is that more of a 2022 calendar year event?
Dave Mosley, CEO
Yes. It’s not going to happen this quarter or next quarter just because of the sheer volume of the 16s. But I do see it at some point, yes. We are going to ramp really hard, and it’s the same platform. So it’s not hard for us to ramp per se. There are also other efficiencies that we get by driving to the 18 platforms. That’s why we are pretty excited about it.
Operator, Operator
Your next question comes from the line of Patrick Ho with Stifel. Your line is open.
Patrick Ho, Analyst
Thank you very much and congratulations on a strong quarter. Dave, as a follow-up to Kevin’s last question about the transition from 16 terabytes to 18 terabytes, it’s clear that the 16-terabyte model has significantly increased Seagate's market share, and you mentioned that the transition to 18 terabytes is straightforward. First, how do you perceive the potential for acquiring new customers with the 18 terabyte option? Secondly, do you expect to achieve additional market share gains when you scale up to 20 terabytes and beyond on the HAMR platform, where there are notable distinctions compared to your competitors?
Dave Mosley, CEO
Thanks, Patrick. I don’t focus on market share specifically; instead, I prioritize understanding what our customers need. For instance, some customers who were using 14 or 12 terabytes have expressed their intention to transition to 18, and they have been waiting for that change. We’ll support them during this transition and ensure we have sufficient supply. Regarding advancements to higher capacities, I can only share insights from our current discussions. I am confident about our ability to ramp up to 20 terabytes. We have capabilities in the market to reach that level, and we effectively manage those capacities. We can cater to the specific performance requirements of any customer, whether they are moving to new architectures or still relying on legacy systems. We also have to consider replacement architectures that we need to support. So, while I am not disregarding market share, my main focus is understanding the precise needs of our customers and ensuring we meet those needs.
Gianluca Romano, CFO
In terms of OpEx, you guys have done a really good job flexing OpEx during, especially these challenging times in 2020. How do you look at OpEx and especially R&D given now that they are starting to release HAMR-based products? Is there an ability to flatten out R&D in the near-term with maybe a lot of the heavy lifting related to HAMR? I don’t want them out of the way, but it leaves a lot of the initial ramp and start-up costs embedded? Yes. Actually, we have done that already. So you see the result already, at least, partially in our results of the quarter. For the long term, I think last quarter we said, probably a good model is around $330 million per quarter. Now we are a little bit below. Now we will try to stay below as much as possible. Of course, we know we always look at opportunities for cost reduction, especially online now in the technology space where we have developed HAMR. We don’t have the need for maybe all the spending that we had in the past.
Dave Mosley, CEO
Yes, it’s a really good point. Yes, it’s a really good point. There’s these HAMR technologies, smallest laser ever shipped and the smallest waveguide ever shipped, dialing it down to something 30-nanometer spot size or whatever it is. This is a really, really difficult technology. We have invested a lot to get to where we are really proud of where we are being able to ship some units, get the learning out there, and start building the volume and everything else. We don’t have to go through that investment again. We get a lot of scale from here, so I appreciate your question.
Operator, Operator
Your next question comes from the line of Ananda Baruah with Loop Capital Markets. Your line is open.
Ananda Baruah, Analyst
Happy New Year and congratulations on your solid results. Dave, regarding the 35% mass capacity exabyte growth for the year, it suggests that the June quarter is when we could see significant increases compared to March. In your prepared remarks, you mentioned that this growth continues throughout the year. I would appreciate some clarification on that. Could you comment on whether we can expect a meaningful uptick in the June quarter compared to March? I would also like to hear your thoughts on the September and December quarters. Additionally, I have a follow-up question for Gianluca.
Dave Mosley, CEO
Yes. Thank you, Ananda, and Happy New Year to you too. Looking ahead, we anticipate a recovery in mass capacity. The VIA markets experienced growth last quarter, and while they faced their usual seasonal decline, the cloud segment is expected to continue its expansion, which supports our current forecast. It's still early, and we haven't gone through the Chinese New Year yet. However, the situation feels significantly different from last year when we encountered many disruptions due to COVID. I believe it's time for those who deferred investments to begin making them. Our shift towards mass capacity is advancing on the same platform, providing us with the flexibility to effectively target markets with high volumes. This is the foundation of our confidence.
Ananda Baruah, Analyst
Okay. Great. Gianluca, you are currently operating at the higher end of the margin range and discussing several factors that could increase gross margins by 100 to 200 basis points. You've experienced a 200 basis point impact from COVID costs, and you continue to benefit from mix and pricing, which feels more normalized now for nearline drives and similar products. Given that you're already at the upper 50% of the operating margin range, and if you're anticipating a 200 to 300 basis point improvement in gross margin, how should we view the normalized operating margin range? Will that be reflected in a standardized manner, or are there investment opportunities you intend to pursue? That’s my main inquiry.
Gianluca Romano, CFO
Thank you, Ananda and Happy New Year to you. If you look at our performance before COVID, our operating margin was already at the top of the range, we were already at 16%, even a bit higher. Then COVID happened, and it’s still happening; it’s still impacting our result. But we are right now in the 15%. So we are going back to that level even with the COVID situation and even better. We are always looking internally at opportunity. Now we discussed the gross margin before; we are going in the right direction in terms of mix. We are seeing now the industry pricing is also going in a better direction compared to, for example, a year ago. So all those elements are, of course, pointing to better gross margin, better operating margin, and I am sure we will discuss that more at our Analyst Day.
Ananda Baruah, Analyst
Gianluca, that sounds like 18% to 20% operating margins to make, by the way.
Gianluca Romano, CFO
I didn’t say that.
Operator, Operator
Your next question comes from the line of Mehdi Hosseini with SIG. Your line is open.
Mehdi Hosseini, Analyst
Just as a follow-up to the prior question, it seems to me that you have made some changes to procuring subcomponents, and I want to see. I will get an idea when those cost savings would actually materialize and help you with gross and operating margin and I have a follow-up.
Gianluca Romano, CFO
Yes. Mehdi with me, thanks. We discussed the biggest impact on the gross margins was the COVID drivers and that’s largely freight and logistics-related. I think the world still has a lot of challenges on those fronts. A lot of people are feeling that. Relative to components, I think we feel fairly solid about our supply chain. It was tough in the early days of COVID. We had to make sure that people had the right factories open, and we had to, you know, get in there and work with all of our suppliers, especially the ones that are positioned for some of the products that are continuing to grow, that they are making the right investments in times that are pretty lean, but we are confident about how we did that. I don’t really, maybe be to the earlier question; I don’t really foresee any supply constraints, but it is forcing a different dialogue that we had, maybe to your implied in your comments.
Mehdi Hosseini, Analyst
And then looking at composition of nearline, especially as you highlighted opportunities with video and surveillance, could there be increased diversification of nearline and into both cloud service providers as well as the like of surveillance and adverse surveillance moving into higher capacity nearline and this way you give some diversification of end-market demand drivers?
Gianluca Romano, CFO
It's interesting to note that as we look at the script discussing how various cameras are generating substantial data at the edge, we anticipate this will serve as an indicator for the development of smart cities and smart factories. There is a significant amount of data being created, including video data, but much of this data is not being backed up in the cloud and effectively gets lost at the edge. We're beginning to see early models emerging that address how to transfer data from the micro edge back to the core since the cloud contains excellent applications for processing this data; the challenge lies in physically moving it there. Our Lyve product strategy reflects these considerations. The volume of data generated at the micro edge today is considerable, and typically, it either gets overwritten or there are decisions made during processing that you can't revisit later. In contexts like autonomous vehicles, continuous learning requires that the data remains accessible for longer periods. There are many intriguing models currently under consideration, highlighting a necessary collaboration between the micro edge and the cloud.
Operator, Operator
Your next question comes from the line of Jim Suva with Citi Investment Research. Your line is open.
Jim Suva, Analyst
Thank you. And I just have one question. It seems like on both gross and operating margins, every indicator ahead whether it be pricing looks better, COVID costs are peaking, shipping costs are likely to get lower, new innovations rolling out are helping. Am I right that just simply both operating and gross margins should just continue to trend higher through 2021 or are there some actually negatives or headwinds that we should be mindful of as we go forward?
Dave Mosley, CEO
No headwinds, Jim. The world is still a fairly volatile place that everyone’s experiencing through COVID, of course, and it’s still impacting communities quite a bit. From our perspective, we have narrowed down our product portfolio to have the right products, made sure our factories and our supply chains are already talking to the customers and things like that. The story is coming out and we do believe there’s data growth ahead, but we want to make sure that we are mindful of the realities that are in the economics today. That’s why to our comments we think we are positioned really well, but we will guide you quarter-over-quarter like we normally do.
Operator, Operator
Your final question comes from the line of Nikolay Todorov with Longbow Research. Your line is open.
Nikolay Todorov, Analyst
Thanks for squeezing me in. I just want to go back to the CapEx question and maybe try to get a little bit more color. Can you tell us a little bit more where do you see that supply and demand now fully balanced from your perspective? I have a guess, but I wanted to hear from you; and maybe can you try to quantify how much of a headwind is that underutilization to your profitability right now whether on the gross margin line?
Dave Mosley, CEO
Yes. Nikolay, it’s a little tough because if you think about what’s the demand environment that we were in calendar year 2020 and how disruptive it was? You have some of the legacy products that were impacted quite a bit. Some of them are going back a little bit, but some of that capacity can be repurposed back into mass capacity as well. Then mass capacity itself the growth of 18-terabyte drives requires, what we call, technology transition capacity, the dollars that we actually have to spend. So blending all these things together, the world has gone through this demand disruption, and supply disruption period that we got through early last year. What we are saying is we think that we can manage from here at the 4% to 5% range based on our modeling, and that will be ample supply that will be bringing online for what the demand is out there.
Nikolay Todorov, Analyst
Okay. And the way to quantify the headwind; do you see a meaningful headwind from that underutilization?
Dave Mosley, CEO
Sorry, not really. Once the factories are at full capacity, I believe the headwind will dissipate, and that should occur in the second quarter.
Nikolay Todorov, Analyst
Just a quick follow-up on the decline in legacy price per terabyte for the second consecutive quarter with double-digit year-over-year decreases, and I think we’ve seen mid-single digit declines over the last four or five quarters, which is much more manageable. Could you provide any insights on what contributed to that?
Dave Mosley, CEO
I think that’s all about a mix. Segments like consumer grew quite a bit, actually last quarter. So, some of that work from home and play from home, the gaming, things like that. Mission critical obviously is still recovering but still light compared to what it had been previously, so I think that’s the next part of that question.
Operator, Operator
That concludes the question-and-answer session. I will turn the call back over to management.
Dave Mosley, CEO
Thanks, David. Thank you to all of you for joining us today, and we look forward to speaking with you again, as Gianluca said on our upcoming Analysts Day on February 24; please join us there. I’d like to once again thank all of our customers, suppliers, business partners, and our employees for their ongoing support in Seagate. We will talk to you next quarter.
Operator, Operator
Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.