Seagate Technology Holdings Plc (STX) — Q1 2022 Transcript

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 September quarter fiscal 2022 on the Investors section of our website. During today's call, we'll refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and included in our Form 8-K that was filed with the SEC. We've not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control or cannot be reasonably predicted. Therefore, a reconciliation to the corresponding GAAP measures is not available without unreasonable effort. Before we begin, I'd like to remind you that today's call contains forward-looking statements, including our December 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'll open the call for questions.

Thank you, Shanye, and hello to everyone joining us on today's call. Seagate has an outstanding start to fiscal 2022, underscored by our September quarter results. Revenue of $3.1 billion was spot on with our expectations and reflects robust growth, up 35% year-over-year and 3% above a very strong June quarter. Non-GAAP gross margin expanded to 31%, well inside of our multiyear target range, and non-GAAP operating margin increased to 20.1%, the company's highest level in nearly a decade. Overall, our results reflect record demand for our industry-leading mass capacity products and solid execution on cost reduction plans and our ongoing focus on balancing supply with demand. We are confident in our ability to deliver excellent results for the fiscal year. Based on our current view, we are raising our fiscal 2022 revenue growth outlook from the high single-digit percentage range to the low double-digit range. Further, reflecting on our long-term confidence in the business, I'm delighted to announce that our Board has once again approved an increase to the quarterly dividend by 4.5%. I've been very proud of our team's ability to post consistent financial results through an industry environment that remains very dynamic. We are seeing a confluence of factors creating inflationary pressures and acute supply chain disruption. These include semiconductor component shortages and freight logistics challenges that are creating cost pressures and the impact in critical end product assemblies for certain customers. Notwithstanding these obstacles, underlying demand remains solid for Seagate's products, particularly in the mass capacity market, which is why we maintain a high level of confidence in our fiscal year growth outlook. Revenue from the mass capacity markets exceeded $2 billion for the first time, reflecting broad-based growth across each of the end markets. The cloud is the strongest contributor to the mass capacity markets and Seagate's revenue growth. Ongoing investments to build and equip new data centers have translated into stable, healthy demand for multiple quarters now, and we expect this trend to continue. Over the past 5 years, the number of hyperscale data centers has more than doubled to nearly 600 worldwide with approximately 200 more on the way. Many of these planned data centers are being built by large cloud customers, but the timing of their investments and infrastructure buildup is not synchronized, which supports a more stable long-term growth outlook for hyperscale investment. Seagate's high-capacity drives are essential to the world's largest data centers. We have very close relationships with our cloud customers to ensure our manufacturing and technology road maps continue to enable their investment plans and performance requirements at a favorable total cost of ownership. In the enterprise and OEM markets, we achieved a fourth consecutive quarter of sales growth, supported by increasing IT hardware spending. Over the near term, the broader supply constraints that I've highlighted may delay some of our customers' new product builds due to non-HDD shortages. However, based on customer conversations, we believe any pause would be temporary until shortages are alleviated. Demand for video and image applications increased significantly during the quarter, supported in part by a broadening of use cases that extend beyond traditional security and surveillance applications. The combination of high-definition cameras and data analytics enabling productivity gains, cost savings and revenue generation opportunities are actually driving adoption by a wide range of industries, including retail, manufacturing and health care. High-capacity HDDs play a crucial role in helping businesses economically manage and extract value from an ever-increasing growth in data across a more distributed enterprise. Without question, the HDD industry is being driven by long-term secular demand for mass capacity storage, a market that we expect to more than double by calendar 2026 to $26 billion, and Seagate is well equipped to answer the call. We continue to leverage our strong arsenal of innovative technologies, manufacturing agility and industry expertise to deliver attractive total cost of ownership solutions aligned with our customers' road map. Our common platform approach illustrates these points well. We have been able to seamlessly transition from 16 to 18 terabyte drives and are now offering multiple varieties of 20-terabyte drives to meet the breadth of customer demand. We began ramping 20-terabyte products in the September quarter, and I'm thrilled with the strong customer interest. I'm equally excited by customer reception for our MACH.2 dual actuator drive, which are now shipping at large scale. As we were anticipating a few months ago, we are seeing greater adoption of our MACH.2 drives for core and edge applications, benefiting from the read and write performance gains that we deliver with these products. We expect dual actuator drives to become more mainstream as capacities increase beyond 30 terabytes to support both cost and performance requirements. I'm also confident in achieving 30-terabyte capacities and beyond. We continue to execute our research and development road maps and have recently achieved great camera test results in staging aerial density growth that supports future product launches. Based on these demonstrations, our product development plans are on track. But our product introduction strategy has not changed. We will leverage HAMR's aerial density gains to offer customer step function and capacity increases that deliver a strong TCO proposition and enhance value for both our customers and Seagate. Our focus on total customer experience is top of mind for the Lyve Cloud business. Our simple, secure and cost-efficient mass data storage as a service platform is resonating well among customers, particularly for backup solutions. Today, Lyve Cloud is certified with the majority of the vendors identified by Gartner's Magic Quadrant Leaders for enterprise backup and recovery software. This quarter, we announced a multiyear deal with a leading video communications provider. I am excited by this partnership and recognize the trust all of our Lyve customers are placing in Seagate. We will continue to be deliberate in scaling infrastructure and developing an ecosystem to ensure that we delight our customers. Wrapping up, Seagate continues to deliver consistent financial results underpinned by strong operational discipline, a focus on profitability, and growing demand for mass capacity storage. We believe these trends reflect the healthy structural changes that have taken place in the industry in recent years. Seagate is poised to benefit from our technology leadership position and strong track record of execution. I'll now hand the call to Gianluca to cover the financial results.

Thank you, Dave. Our September quarter results highlight solid growth across nearly all financial metrics and demonstrate disciplined execution and ongoing focus on running profitability and free cash flow generation. Revenue was $3.12 billion, up 3% sequentially. Non-GAAP operating margin expanded to 20.1% of revenue, up 200 basis points quarter-over-quarter, and non-GAAP EPS was $2.35, up 18% sequentially and at the high end of our guidance range. We grew total hard disk drive revenue to $2.9 billion, up 5% sequentially and 24% year-over-year. HDD capacity shipments increased 4% sequentially to 159 exabytes, up 39% relative to the prior year period. Growth was driven by increasing demand for our mass capacity product, which contributed 71% of total HDD revenue and 83% of HDD exabyte shipments. Revenue from the mass capacity market increased to $2 billion, supported by growth across each of the underlying end markets, which include nearline, VIA, and NAND products. Mass capacity revenue was up 8% sequentially and up 51% compared with the prior year period, while capacity shipments into this market were up 7% sequentially and 53% year-over-year. Based on our current outlook, we expect mass capacity exabyte shipments to remain strong in the December quarter, with financial year '21 annual growth slightly above our long-term CAGR forecast of about 35%. In the September quarter, nearline revenue demand was driven by improving enterprise spending and healthy growth from cloud data center customers. Nearline shipments totaled 106 exabytes, up 5% sequentially and 65% year-on-year, reflecting demand for our high-capacity products, strong growth for dual actuator drive and ongoing market momentum for our common platform products spanning 16 through 20-terabyte drives. Robust demand in the bear market led to sequential revenue growth that was above the average for the mass capacity market, and we expect solid demand to continue in the December quarter. The legacy market made up the remaining 29% of HDD revenue, holding relatively stable at $821 million, down 3% sequentially and up 5% year-over-year. Improving enterprise demand boosted sales for mission-critical drives, which partially offset the decline in consumer drives following a strong June quarter. We are starting to see a moderation in the pace of annual revenue decline following the significant market disruption brought on by the pandemic. While we could see some fluctuations in a given quarter, we believe the most pronounced impacts are behind us. Finally, turning to our non-HDD business, revenue came in at $151 million, down 9% sequentially from record June quarter levels. Our systems business has been partially impacted by some of the supply constraints that Dave discussed. We are working closely with our suppliers to mitigate risk, and we continue to gain new customer wins to support longer-term growth in the business. Overall, strong demand trends, combined with positive industry dynamics, led to non-GAAP gross profit of $966 million in the September quarter, up 8% sequentially and 57% year-over-year. Costs relating to freight and logistics are continuing to increment higher. While we will continue to take steps to reduce the impacts of these costs, we believe that we remain a headwind to the business through the fiscal year. Our resulting non-GAAP gross margin expanded by about 140 basis points to 31%, well inside our long-term target range of 30% to 33%, including higher freight and logistic costs and component prices. HDD margins are now in the upper half of the range, reflecting better alignment in supply and demand and the transition to higher capacity drives. We anticipate continued solid gross margin performance with the opportunity to increment higher as we ramp our cost-optimized products. Additionally, as COVID cost headwinds abate, we would expect margins to expand into the upper half of our target range over time. Non-GAAP operating expenses decreased to $339 million, reflecting certain one-time savings. This expense management, combined with higher revenue and margin expansion, resulted in non-GAAP operating income of $627 million, up 15% sequentially and more than double the year-ago period. Non-GAAP operating margin expanded to 20.1%, which is the top end of our long-term target range of 15% to 20% of revenue. Importantly, the September performance demonstrated our ability to grow profits faster than revenue, supporting our strategy of long-term value creation.

Based on diluted share count of approximately 231 million shares, non-GAAP EPS for the September quarter was $2.35, the highest level in close to a decade. We have the inventory relatively flat with the days inventory outstanding at 50 days. We are working with suppliers and managing strategic inventory levels to mitigate the risk to the business, while we continue to monitor the dynamic situation. Capital expenditures were $117 million for the quarter. We currently expect fiscal year CapEx to be at the low end of our long-term target range of 4% to 6% of revenue, which is sufficient to support our future product roadmap while maintaining expense discipline. Free cash flow generation increased to $379 million, up 7% quarter-over-quarter and more than double year-over-year. We delivered strong performance in the September quarter and expect to improve free cash flow generation through the fiscal year, enabling us to fund our growth opportunities and return capital to our shareholders. We used $153 million to fund the quarterly dividend and $425 million to repurchase 4.9 million ordinary shares, exiting the quarter with 225 million shares outstanding and approximately $3.8 billion remaining in our authorization. As Dave mentioned earlier, the Board approved a $0.03 increase to our quarterly dividend, raising the quarterly payout to $0.70 per share. We ended the September quarter with cash and cash equivalents of nearly $1 billion, and total liquidity was approximately $2.7 billion, including our revolving credit facility. Adjusted EBITDA was $724 million for the quarter and $2.4 billion for the 12-month period ending in September. Total debt balance at the end of the quarter was $5.1 billion with a leverage ratio of 2.2x. In early October, we took advantage of the current attractive market environment to raise $725 million in capital through a new $600 million fixed year term loan and upsized our existing term loan during fiscal 2022. These actions are consistent with our growing business and provide the opportunity to repay $120 million in debt coming due in March. We reduced our average interest rate by 25 basis points and expect interest expenses for the December quarter to be approximately $66 million. Looking ahead to our outlook for the December quarter. We anticipate a continuation of the strong demand environment that we experienced in the September quarter. We expect revenue to be in a range of $3.1 billion, plus or minus $150 million. We expect non-GAAP operating margin to remain around the top end of our long-term range of 15% to 20% of revenue. And we expect non-GAAP EPS to be in the range of $2.35, plus or minus $0.15. In summary, we had an outstanding September quarter, placing us on solid footing to deliver strong top and bottom line growth in calendar year 2021 as well as fiscal 2022. I will now turn the call back to Dave for final comments. Fiscal 2022 is off to a tremendous start, and I feel positive about the current and healthy demand environment, which is reflected in our increased revenue growth outlook for the fiscal year. I'm equally bullish on Seagate's longer-term growth opportunities supported by secular demand for mass capacity storage. Our mass capacity innovation roadmap puts Seagate in an excellent position to thrive in this environment and continue to deliver revenue growth beyond fiscal 2022, in line with our long-term target of 3% to 6%. We are in the right place with the right technology and innovative customers with whom we are partnering closely to enable their roadmaps. Further, our robust capital returns program, including today's dividend increase, round out what we believe is a compelling investment story. With the UN Climate Change Conference scheduled to begin in less than 2 weeks, I wanted to highlight Seagate's commitment to ESG. Starting in fiscal 2022, we have incorporated sustainability into our executives' long-term compensation plan based on the achievement of specific quantitative environmental and social targets. Our environmental goal is linked with established plans to reduce the company's carbon footprint in support of achieving our science-based targets. From harnessing renewables at our California and Northern Ireland campuses to installing solar capacity at our facilities in Thailand, Seagate continues to put our commitment to the planet into action. We have also incorporated an executive compensation goal to increase gender diversity in our leadership as we strive to cultivate a more diverse, equitable, and inclusive workplace. For a third consecutive year, Seagate is among the best companies for women according to social media platform Ferrygodboss as well as one of the best places to work for LGBTQ+ equality by the Human Rights Campaign. In closing, I'd like to thank the Seagate team for their tireless efforts, our customers and suppliers for their continued support, and our shareholders for placing their trust in Seagate. Gianluca and I are now happy to take your questions.

I have 2 questions, please, 1 for Dave and 1 for Gianluca. Dave, it's great to say that over 2/3 of your business has now transitioned away from consumer towards enterprise. As you know, which tends to be higher margin, yet influenced by data center CapEx. There have been some recent concerns by investors that cloud spending will moderate after being robust in the last 6 quarters. So I was hoping you could discuss how you see the demand trajectory playing out for nearline, both in the December quarter and also into the second half of your fiscal 2022?

Yes. Thank you for your question, Karl. If you have another question, you can also reach out to Gianluca Romano. From my perspective, please continue.

Sorry, I was going to say for my second one then, Dave, the improvement in your profitability has been impressive. And our own checks indicate you have been successful in passing along these rising input costs. Some investors have been fearing that margins might moderate as enterprise is also moderate. But I was hoping you might discuss why that might not be the case for some high-capacity offerings and what initiatives you have at your disposal to support profitability regardless of demand.

Thank you. So, Gianluca will address that. Regarding the cloud, demand has remained consistent since the start of 2020. As mentioned in the prepared remarks, we are expanding our customer base beyond just a few hyperscalers, which has significantly benefited us alongside the product transitions we’ve discussed. We are reaching higher capacity points that offer better total cost of ownership for the end customer as well. Several macro trends, including digitization, AI, multi-cloud strategies, and the overall shift to the cloud, were significantly accelerated during the pandemic and remote work era, prompting many to adopt cloud solutions. While not all cloud customers are aligned, we believe the current demand reflects a mixture of these behaviors. Additionally, our longer product cycles provide us with excellent visibility. We have established strategic long-term agreements, showcasing our capabilities for 2, 3, 4 quarters ahead, while actively seeking to understand customer needs. This approach is contributing to the stability we’re witnessing, and we are confident that the latter half of this fiscal year and into the next will drive growth that translates into revenue.

Yes. On the profitability question, I would say we are executing well on our plan. We discussed a few quarters ago how we could improve our profitability quarter-after-quarter. Even in the last quarter, we improved our gross margin by 140 basis points, and we are at the top of the operating margin range. So we are happy with the performance. But of course, we are always looking at the opportunity for improvement. As we were saying in the prepared remarks, there are some costs that are increasing, and we are looking into that, how to moderate that impact and continue to improve our gross margin and operating margin in the next few quarters. So we are positive, that we continue that trajectory, and demand is strong. So this is helping. When we have a good alignment between supply and demand, usually, we come out with good profitability. So we are happy with the situation.

Congrats on the strong results and outlook. I had 2 as well. You're returning cash well above 100% of free cash flow, and you just raised your dividend as well. I know you spoke about a very strong capital return program at your Analyst Day earlier. Just wondering, as you're thinking about the outlook here, anything that has changed in the market that from a pricing or demand standpoint, that is sort of bolstering the confidence. And secondly, last night, Intel spoke about China Cloud slowdown given regulatory pressures over there. Are you seeing any of that? And is that contemplated in your raised fiscal year guide?

I believe it's connected to your questions regarding the visibility we have. We have a long history of returning cash to shareholders and remain committed to our dividend, having increased it for the third consecutive time. This reflects our confidence in our long-term free cash flow generation. We are focused on balancing supply and demand in relation to the growing data landscape. We'll continue to be strategic with share buybacks, and our track record over the past decade clearly illustrates our commitment to returns. We are also prioritizing investing in ourselves and optimizing our capital use for long-term value creation. We managed our cash well, even during the challenges of the pandemic, which gives me confidence. Regarding the slowdown in China’s cloud market, we have strong customer relationships that allow us to anticipate their needs. Not all infrastructure investments align perfectly with memory, compute, networking, and storage, leading to varying investment strategies over time. This could explain why different companies perceive the market differently in the coming quarters. We have not observed any significant inventory buildup; instead, customers have been predictable about their needs for disk drives to support data center operations, which supports our confidence. We do not see a slowdown in exabyte growth.

Do you have a follow-up, Wamsi?

Your next question comes from Timothy Arcuri from UBS.

I had a question about CapEx discipline and supply-demand balance. There's been a lot of structural changes in the industry that seem like they could be pretty significant longer-term margin tailwinds in some ways, maybe similar to what's happened in DRAM. And I guess my question is, as we sort of enter a new cycle of CapEx, how do you ensure CapEx discipline? And how do you think about that in the context of overall supply-demand balance? I mean the old axiom is that it only takes one supplier to sort of tip the apple cart. So I'm wondering if you can talk about CapEx discipline.

It's beneficial to look back at our progress. At the height of the client-server era, our drives typically contained one disk and two heads, and we produced many of those drives. Our factories are now highly focused on flexibility and back-end capacity for notebook drives. We've transitioned to mass capacity drives with multiple disks and heads, resembling a semiconductor process. Although there are notable differences in the processes, the lead times for wafers are quite long and specialized for us. Much of our capital expenditure is being directed towards this area due to our shift over the last decade. We are now fully engaged, as reflected in our investments in heads and media, and no longer experiencing overcapacity in drives. It's an interesting change as we've made this transition. We have discussed strong secular demand for mass capacity storage extending through 2026 and beyond, with our total addressable market pegged at $26 billion in five years. We are working to align supply and demand accordingly. In response to your question, the constraints are primarily the lead times for wafers and capital equipment needed for expansion. As long as we make smart investments, we can maintain a balance between supply and demand, which reflects our CapEx discipline. If we need to accelerate the HAMR transition, we have sufficient cash to increase our investment. We will closely monitor the supply-demand balance and deploy funds wisely. We're collaborating closely with our customers to understand their specific needs, which is why I mentioned long-term agreements when Karl posed his question. This insight helps us plan the necessary build-outs judiciously over time.

Yes, Tim, on the CapEx, no, we have a guidance range of 4% to 6% of revenue. We have also said that for this year, we will be probably at the low part of that range. We are fairly happy with the supply and demand alignment at this point and the utilization of our factories. And of course, we want to keep this good alignment for the future.

I guess as my follow-up, can you talk about channel inventory? Where does channel stand at this point? And did your pricing in your mass capacity segment, did that benefit at all from channel refill in the third quarter, calendar third quarter?

I think the answer is no. We have multiple channels, and in this case, we are discussing a distribution channel primarily for legacy products. There is a small channel for mass capacity, but many people are focused on legacy products, which we value along with our customers. However, we are not heavily investing in that area. We ensure that our channel inventories are well balanced. Any fluctuations we may have experienced, such as two quarters ago due to cryptocurrency, have quickly stabilized and do not affect the mass capacity channels. From my perspective, our inventory levels are strong. Inside Seagate, our inventory has significantly decreased, which reflects the challenges we face in managing supply and demand as end customers struggle to obtain the necessary parts. It is important for us to avoid exacerbating any temporary issues they may have while assembling their final products. This is vital for our long-term economics and industry structure. Therefore, we must strategically balance supply and demand, and I believe we are doing a good job of it.

Congrats on the nice quarter and outlook. Dave, maybe first, a big picture question. It was really encouraging to hear about the efforts on the multi-actuator run like the MACH.2. I was just wondering to get a little more color on the HAMR side of things. You mentioned the progress there that continues to be on track. But can you talk about, I guess, customer discussions and when you believe the inflection point will be when customers transition over the HAMR drives?

Thank you for the question, Patrick. I'm glad to hear your optimism. The team is definitely experiencing it with our current results. These efforts have evolved beyond experimental phases; they are now fully engaged in product development. We've discussed HAMR extensively in the past, have produced numerous components, and provided drives to our customers. They have been able to observe the performance of those drives within their systems. We are actively collaborating with customers to discuss our recent results. To clarify, HAMR is our pathway to achieve 30 terabytes and more, and we are confident about that, as highlighted in our prepared remarks. There are still many aspects we need to align to ensure we have the manufacturing capability. Additionally, there are other components of the recording chain that must be optimized for the readback process. HAMR primarily focuses on writing, requiring advancements in the media technology used in our discs. We are determined to address all these areas effectively. We are very encouraged by the results so far. I think the industry has not communicated this clearly, but we feel confident not only regarding capacities of 20, 22, 23, and 24 terabytes, but significantly higher levels based on our current observations. We are putting in considerable effort to achieve this, and our customers are aware of our progress and have seen samples. We will continue to push forward to meet these milestones. While I don’t want to announce any new products at this moment, we will keep you updated when they are ready.

Great. That's helpful. As a follow-up for Gianluca, your results demonstrate strong execution. Considering the current supply constraints in the industry, the results are impressive. I was curious about your operations in Malaysia and any labor constraints you may be facing. Are those issues improving? How did you navigate the September quarter given the challenges in the country related to COVID? What actions did you take to maintain the strong results you achieved in September, as well as your outlook for December?

Yes. I would say, no, first of all, thank you for the congratulations. I think the same quarter actually came a little bit better than how we guided at the beginning. But in terms of revenue it's very well aligned. And the profitability is a bit better. I would say in terms of the legacy part of the business right now, we are seeing a better trend compared to maybe a year ago, 2 years ago. Of course, not all the segments are the same inside legacy in the last quarter. Sequentially, consumer was a little bit down compared to June, but June was an extraordinary quarter for the consumer business. Now we see consumers coming back fairly strong in December. But at the same time, we see compute as a little bit weak. So it's always difficult to look in towards the details. But again, we see a better trend. And also when you look at the volume, not only the revenue, we think in the future, you will see maybe some more reduction and then a good stabilization of the business. And Dave, you want to add something?

Yes, Patrick, regarding your point about supply chains and disruptions. Supply chains fundamentally depend on people. It's essential to ensure that people feel safe at work, at home, and in their communities. We've been focused on this with our employees, suppliers, and customers. I believe everyone has a solid understanding of the situation throughout the supply chain. There have certainly been challenges, as you mentioned, but I think we're handling them quite well. People want their factories to operate efficiently, and they have a financial incentive to make that happen. So, we all need to maintain communication, treat each other fairly, and manage for the long term, particularly at the scale required in our supply chain.

Dave, just given it's such an important driver of gross margins. Can you talk about what percentage of mass capacity is now coming from the common platform drives? And where you think that revenue mix might exit the year and how the margins differ for the common platform drives versus the rest of the mass capacity portfolio? Then I have a follow-up.

Yes, thanks, Katy. I'm not sure about the exact number right now. For the common platform, we have 16, 18, and 20 models, as well as some 14s included. Our mid-cap nearline drives are performing very well, and we've recently refreshed the product, which will also benefit us. I want to emphasize that we are continuously reducing costs associated with the common platform. Even as we move from 18s to 20s, there are opportunities to lower costs through new components, and we are also amortizing the tooling for what we have already installed. All these factors are positively impacting our margins.

Yesterday, we mentioned that 83% of the exabyte volume currently consists of mass capacity. I would say that most of that volume comes from the common platform.

Okay. Great. And Gianluca, 3 months ago, you talked about gross margins improving every quarter of this year, even with some expected seasonality as you go into the back half of fiscal '22. Can you just talk about how, if at all, those assumptions have changed? Obviously, you're coming from a very impressive gross margin performance in September. So you're starting from a higher base. But just any update as to whether we should be modeling gross margin improvement every quarter and how you're thinking about revenue seasonality as you go into the March and June quarter?

Yes. I would say probably compared to what we were discussing 3 months ago or 6 months ago, I see the COVID costs a little bit higher than what we were expecting, in particular, for freight and logistics. At the same time, demand is maybe a little bit stronger. So our utilization rate is really good. This is helping our unit cost to decrease quarter after quarter. So until we can keep this good alignment between supply and demand, I'm fairly confident we can do further improvement in the gross margin as we were discussing. And every quarter is a bit different. So it's difficult to be very precise for the next few quarters, but we are confident we can do some more progress in the margin.

Yes, Katy, demand is clearly the main factor influencing our situation, and we expect this to continue through the second half of this fiscal year and into the next one. The trends in exabytes remain strong. However, tactically, we face some challenges with costs and logistics. For instance, if a customer requests a swap just three weeks before the end of the quarter, getting them the product might be difficult. Nonetheless, none of these issues will compromise demand. Since demand is critical for us, that's the narrative we want to emphasize. Additionally, we anticipate some typical lulls at the end of the year and during the Chinese New Year, which could provide an opportunity for some to start replenishing their positions in the supply chain. This adds to our confidence.

Congrats on the strong execution. I wanted to follow up on your fiscal '22 revenue guide, I guess, now low double-digit growth relative to fiscal '21. If we take that and your December quarter guide, I think it's pretty clear that implicitly, you're assuming a down quarter sequentially in March and/or June. Just curious what's embedded there? Is it seasonality in your legacy business? Is it something in nearline, conservatism, supply chain, all of the above? Any context, any color there would be helpful? And then I've got a quick follow-up.

Yes. Thanks, Toshiya. So I think if you go back to last quarter, it would have been seasonality and it would have been more biased towards the legacy business. Obviously, the VIA markets are seasonal as well. And I would say now it's even more muted seasonality and some of the strength in the exabyte growth that we see in the cloud, particularly at the top end of the mass capacity markets. So that kind of explains what's changed, I think, in the last 3 months.

Yes, we see the nearline still very strong. And of course, every quarter, we will update our visibility on the fiscal year.

Got it. That's helpful. And then my follow-up is on the long-term model, guys, and I realize it's only been, what is it, 8 months since you announced the update, and I certainly wouldn't expect you to update your long-term model every 6 to 9 months. But it does look like, from a gross margin perspective, from an operating margin perspective, gross margins despite all the challenges, you're comfortably in that range. Operating margins, you're guiding to the second consecutive quarter of you guys being at the high end of that range. So I guess my question is, should we be thinking about a positive bias to what you presented earlier this year? Or is this as kind of as good as it gets and we should expect some sort of normalization or reversion over the coming quarters?

Thanks. Yes, we've been looking at exactly what you're talking about. I don't think we're prepared to say anything about it today. Although, I will say that it all is predicated upon supply/demand balance, and demand continues to be strong. When you look back at 8 months or 9 months or whatever, we were still kind of at the front end of the pandemic. There were a lot of challenges that were going on then, that we didn't have great visibility into. So I think the further time marches along, and we see how much data move to the cloud, and we see how much the edge is growing and all these new business models and things like that, we can look at demand versus our supply picture and see whether we update those models also. We'll keep you posted.

Yes. I would just add that we are encouraged by the gross margin level that we generate in our mass capacity part of the business. And no, we need to see how this will continue to develop in the next quarters and in the next fiscal year. But so far, we are very confident.

Yes, I have two questions. First, Dave, you mentioned earlier about strong demand as we move into fiscal year '23. I would like to hear how you and your team are viewing this cycle. Do you expect it to decline like previous cycles have, or do you see it continuing into the second half of calendar '22 and the first half of calendar '23? I also have a follow-up question.

Yes, I believe that the underlying trends for long-term growth, particularly in mass capacity cloud, remain consistent. If we consider 20-terabyte drives expected next year compared to the 16 or 14-terabyte options that were popular a couple of years ago, the total cost of ownership for these new drives and the construction of new data centers remains significant. The ongoing replacement cycle is substantial as well. The capacity factor is important, and there are additional features associated with these new drives that enable more efficient management of data centers concerning power usage and reliability. This suggests that the investments being made will be more structured and systematic, which we are discussing with customers around the globe. This contributes to our overall visibility. Regarding the VIA markets, the growth in edge application areas is accelerating quickly. We are seeing developments in sectors like retail and healthcare, which underscore the importance of large-scale data. Numerous edge applications are expanding year over year, reinforcing our positive outlook. This is why we incorporated that anticipated revenue growth into our long-term projections.

That's great context and very helpful. I would like to ask about lead times. In previous calls, you mentioned the lead times for the highest capacity nearline drives. At one point, you indicated that the implied timeframe was around December, which would be about six months from spring. I would appreciate an update on the current lead times and how long it's taking to ship those high-capacity drives. Additionally, I have a pricing question: when you take orders, is the pricing based on the order date or on the expected price six months later when shipping occurs? I'd love to have clarity on both of these points. That's all from me.

There are many different types of customers, so I won't comment on pricing. Regarding your first question about long-term agreements, it relates back to a comment I made about nine months ago: if you want something for Christmas, you need to let me know now. That's the kind of lead time we're discussing. We're starting capacity planning in our wafer factory for timelines, and we're communicating to customers what we can realistically produce in that timeframe. It's important that our plans are aligned. It’s not only about capacity; there are also architectural changes we're implementing to provide the best value for their data centers. This involves significant planning on their part within their supply chain. If you need one drive, we have one available. However, if you require hundreds of thousands or millions, we need to start those conversations well in advance. I believe that's contributing to the stability of our business.

Congrats on the nice results. Dave, I wanted to kind of double-click into the non-HDD business. Obviously, you're raising the full year guide here. Can you talk about the contribution of the non-HDD business has to that growth rate, what do you see that kind of growing this fiscal year?

Yes, Tom, thanks. The non-HDD business has experienced some fluctuations. There are areas where we can leverage our brand for continued strength, and we take advantage of various opportunities, although those can vary over time. In terms of profitability, the non-HDD business is actually improving, indicating that we're effectively using our brand to generate additional revenue without the level of dilution seen in the past. However, with the systems business, we need to be cautious due to the numerous components and lower volumes we are dealing with compared to the HDD business, which makes supply chain management quite challenging. The systems themselves are large, so shipping and logistics pose significant hurdles. We aim to deliver the same brand value and predictability to our customers as mentioned earlier. Overall, while there are opportunities for increased revenue, managing some of these businesses is quite challenging due to supply chain issues.

Yes, I would say from a financial standpoint, even if the non-HDD business had a lower gross margin, it is a very good contributor for our free cash flow. So we are in keeping the effort on the non-HDD drive business.

Yes, I wanted to follow up on the systems business. You mentioned it was particularly affected by the supply chain, and I believe you just emphasized that again. Can you discuss which products are involved? Clearly, these are large and complex machines you are selling. Where are the bottlenecks? In which areas are you observing the supply chain issues? Any specific examples would be appreciated. Yes. I think all things silicon, all things power, all things kind of the things that we typically don't control very much are tight. And I would say it's not only a matter of being able to actually procure something. It's also a matter of getting it through all of the factories that it needs to get to be finally consumed for us that's been the complexity. So we have tried really hard with our systems business over the years to reduce the complexity of our offerings so we can go a little longer on inventory positions and be more flexible for our customers, but it is a challenge right now, as you can well imagine.

Great. I have 2 questions, too. The first one is on pricing. How would you characterize the current pricing environment? Maybe you can parse out the crypto impact. Also interested in whether you're able to pass on the high cost to your customers? How much of a tailwind is that to your gross margin forecast over the next few quarters?

For the pricing, I would say that the pricing environment is still very favorable, similar to the prior quarter, I would say. And no, we expect this to last even in the current quarter and hopefully even in the future. Parsing the cost, I don't think it's so automatic. We negotiate pricing based on demand and the alignment between supply and demand and not too much on parsing specific costs to our customers.

Okay. That's fair. Maybe my follow-up question is on the technology roadmap a little bit. Obviously, you're starting to ramp up the 20-terabyte right now. But with HAMR, not likely being high volume until it sounds like later, maybe 30-terabyte. How confident are you that you can accomplish the cost reduction improvement you talked about at your Analyst Day, not just the magnitude, but also within the time frame you talked about?

Thank you, Sidney. There are a few points to consider. It's not solely about reaching the highest capacity. We can also remove heads and disks from lower capacity points, which helps improve margins. This change increases our capacity without requiring additional capital expenditures, as we become more efficient in our factories. While we focus on 30-terabyte capacities, there are plenty of opportunities to sell 16-terabyte drives using fewer heads and disks. This is an important aspect of our progress towards higher capacities, allowing for cost efficiency. Historically, during the peak of client-server models, significant increases in density were necessary when using one disk and two heads. Now, with eight or nine disks in a unit, we can remove one, two, or even three disks and still reach the same capacity, which provides considerable cost efficiency and makes transitions easier. I hope this helps clarify our approach.

Congratulations on the quarter. My first question is about the capital return strategy. The company has done an excellent job of returning capital over the past several quarters. However, we have noticed that the net debt position continues to decline. So my question is, how do you assess the appropriate level of liquidity or cash on the balance sheet as we consider your ongoing willingness to engage in share repurchases?

I think we discussed this a little bit at our last Analyst Day, and we said no, we are comfortable with the liquidity level at least of $2 billion, and this includes our great revolver. So we are still well above that level. And so we have great opportunities. First of all, because we generate very strong free cash flow. We were talking about that before. The last quarter was very good, almost $380 million. We expect free cash flow to continue to improve during the fiscal year. So this will give us the opportunity for a further return to our shareholders.

And I think, Aaron, there's a lot of other levers that we have at our disposal. You see us managing our working capital really well. If you look at our inventory positions against what our final objectives are, that's part of how we get done what we need to get done to maintain the liquidity and flexibility that we want.

Yes. As a follow-up on the pricing discussion, the HDD industry is not only competitive but also experiencing a significant shift in nearline capacity, with over 65% concentrated in that sector. It was previously believed that hard disk drive prices would decline by about 10% to 15% annually. Should we consider a different perspective on this? Is it reasonable to expect a more stable and flattened price trend for hard disk drives as we focus on long-term model implications?

I think as drives have changed towards content-rich heads and media, then I think the lead times of your investment are going to be longer. And so therefore, I think that you'll see less fluctuation in supply-demand misalignment. Now you could still have demand shocks like we saw at the front end of the pandemic. And then there may be other supply shocks as well. But from my perspective, the industry is doing a good job of managing supply-demand balance because the process content that's required to make a drive as a mass capacity drive at the front end of it is really has a lot of long lead times and very complex parts. So I think that's what's changing the behavior rather than anything else.

And I just have one question, and that is on your cloud business that you're seeing. Some suppliers to the cloud customers see very, very lumpy business, a really strong quarter then a couple of quarters of digestion. I'm wondering now that you're seeing such strong strength in cloud. Is it something that you anticipate some lumpiness or with the visibility you mentioned that they're kind of installing and using and ordering what their needs be? Is there just less lumpiness for your products compared to some other server switches compute products out there?

It's interesting, Jim. From my perspective, we need to be cautious about labeling everything as one size fits all, as there are various business models and application areas, even within individual customers who have multiple applications. At the start of the pandemic, when everything transitioned to the cloud and remote work became the norm, we observed significant investments in what I would describe as transactional architecture, which is very compute and memory-intensive. This doesn't mean that mass capacity wasn't growing; rather, it indicated that the immediate focus for some customers was on meeting their service level agreements with end customers migrating to the cloud. This might explain why, when looking back over the last year, people discuss inconsistencies—achieving the right balance can be challenging. Companies may invest in one architecture or application, only to identify opportunities elsewhere and pivot accordingly. These are complex challenges for those building cloud data infrastructure and application layers. Regarding mass capacity, I believe the development has been more deliberate over time. While strategies and opportunities do shift as they discover ways to increase efficiency, the market has diversified enough, and our customer predictability has improved to a point where I feel confident that we are witnessing a stronger, more consistent demand picture.

Thanks very much, everyone. I want to thank you for participating in this call and really thank our employees for all their hard work up and down the supply chain and the suppliers and customers. Many thanks from the Seagate team as well. And again, thank our shareholders for their continued support in Seagate. We'll talk to you next quarter.