Seagate Technology Holdings Plc (STX) — Q2 2023 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've posted our earnings press release and detailed supplemental information for our second quarter fiscal 2023 on the Investors section of our website. During today's call, we'll refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and included in our Form 8-K that was filed with the SEC. We've not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control and/or cannot easily be predicted. Therefore, a reconciliation to the corresponding GAAP measures is not available without unreasonable efforts. Before we begin, I'd like to remind you that today's call contains forward-looking statements that reflect management's current views and assumptions based on information available to us as of today and should not be relied upon as of any subsequent date. Actual results may differ materially from those contained or implied by these forward-looking statements as they are subject to risks and uncertainties associated with our business. Regarding the matter raised by the proposed charging letter from the U.S. Commerce Department's Bureau of Industry and Security, or BIS, Seagate maintains that it has complied with all relevant export control laws and regulations. We've been cooperating with BIS and engaging in discussions with BIS to seek a resolution. Please note that we won't be addressing questions regarding this matter on today's call, but we'll provide additional updates as appropriate moving forward. To learn more about the risks, uncertainties, and other factors that may affect our future business results, please refer to the press release issued today and our SEC filings, including our most recent annual report on Form 10-K and quarterly report on Form 10-Q as well as the supplemental information, all of which may be found on the Investors section of our website. As always, following our prepared remarks, we'll open the call up for questions. Let me now turn the call over to you, Dave, for opening remarks.

Thanks, Shayne. Good afternoon, everyone, and thanks for joining us today. Seagate delivered on what we set out to do in the December quarter, and I'm proud of our team's accomplishments amid this tough business environment. Revenue and non-GAAP EPS came in slightly above the midpoint of our guidance range and free cash flow generation increased by more than 50% quarter-over-quarter. We are managing well what is in our control and executed on the actions we outlined on our October call. We retired more than $200 million in debt, strengthening our balance sheet. We lowered operational costs by realizing a meaningful portion of the expected savings from our restructuring efforts. We reduced capital expenditures by more than 40% sequentially while still accelerating the launch and development schedules for new mass capacity products, and we adjusted our factory production output to support strong supply discipline as demand recovers. These actions, we believe, put Seagate on solid footing to weather the near-term industry dynamics while continuing to make the technology investments to meet our customers' evolving needs and thrive over the long term. Relative to market conditions, three primary external factors have been impacting our business over the past several months. The COVID-related economic slowdown in China, the work down of nearline HDD inventories among U.S. cloud and global enterprise customers under a more cautious demand environment, and macro-related disruptions primarily impacting our consumer-facing markets. These factors remained at play during the December quarter and weighed heavily on the mass capacity markets, resulting in a 10% sequential decline in mass capacity revenue. Having said that, we are already seeing some encouraging indicators. Within China, we believe first steps toward recovery are being implemented through government policies aimed at improving economic conditions, including the faster-than-expected reversal of zero COVID restrictions and a show of confidence following the policy shift; several major banks raised their 2023 outlook for China's GDP. We expect it will take time for consumers and businesses to work through disruptions related to the COVID policy pivot and for the economy to fully reopen. Based on our customer conversations, we anticipate regional sales into the VIA and nearline markets to remain subdued in the March quarter and gradually improve as the calendar year unfolds. We will continue to monitor demand signals and expect to gain a better picture following the Lunar New Year celebrations. Turning to the U.S. cloud and enterprise markets. Customers have focused on working down the HDD inventory levels that were built up during the pandemic as non-HDD component shortages created inventory imbalances. We believe some progress has been made in recent months supported by an improvement in non-HDD component availability. While inventory adjustments are customer-by-customer events, and ongoing macro uncertainties have led to more cautious near-term buying decisions, we expect nearline sales will improve slightly in the current quarter, particularly for our high-capacity drives. Our view is supported by the ongoing adoption of our 20-plus terabyte family of nearline products, which represented close to 60% of nearline exabyte shipments in the December quarter and is expected to trend even higher in the current quarter. Relative to our products, we are seeing a wider variety of nearline capacity points and configurations being adopted across our customer base, depending on their specific data center architectures, workloads, and application needs. Seagate is well equipped to address these individual unique requirements with our deep customer relationships and broad technology portfolio, spanning traditional perpendicular recording technology or PMR drives to performance-oriented dual actuator products to TCO enhancing SMR technology. In addition to our device portfolio, Seagate's Systems business offers cost-efficient, scalable petabyte solutions for both enterprise and cloud customers. While system sales were down sequentially off of a very strong September quarter, we captured a record number of new customer wins with our CORVAULT products. CORVAULT offers features such as self-healing, autonomous drive regeneration, which increases productivity while reducing electronic waste. The momentum that we're seeing across the systems business supports revenue to move higher in fiscal 2023. Our strong product pipeline is underpinned by the technology advancements we're bringing to market. We are leveraging our technology leadership to scale drive capacities through aerial density gains rather than additional heads and disks. As a result, we can deliver our trademark TCO advantages to customers with attractive margin opportunities for Seagate. Our 20-terabyte product features 2 terabyte per disk capacities, and we have started to ramp up the volume of 22 terabyte products deployed on 2.2 terabyte per disk capacities. The 20-plus terabyte platform is based on traditional PMR technology, and some customers are choosing to enable SMR technology as an additional feature that slightly increases the drives capacity for certain applications. In the December quarter, about 35% of our nearline exabyte shipments were deployed as SMR drives. We are executing plans to deliver another 10% gain in per disk capacity for this PMR platform to offer drives in the mid- to upper 20 terabyte range. However, I'm most excited about our HAMR technology. It was nearly four years ago to the day that I first shared our lab results demonstrating 3 terabyte per disk capacities. And today, we have demonstrated capacities of 5 terabytes per disk in our recording physics labs. In the current market environment, we've been taking advantage of our reduced factory utilization to accelerate cycles of learning around HAMR productization. We are meeting or exceeding all product development milestones and reliability metrics, and we will be shipping prequalification units to key cloud customers in the coming weeks. As a result of this progress, we now expect to launch our 30-plus terabyte platform in the June quarter, slightly ahead of schedule. The speed of the initial HAMR volume ramp will depend on a number of factors, including product yields and customer qualification timelines. However, we plan to use our systems business to quicken the pace of learning and time to yield. Our tremendous progress reinforces my confidence in HAMR products and our ability to execute. These innovations were only possible through the hard work and dedication of our global team, and I would like to thank them for their many efforts. Our multi-decade focus on HAMR R&D and our innovation across all facets of drive production have resulted in a development advantage that we believe is measured in years, and we're excited by our collaborations with cloud customers on HAMR capabilities. The technology innovations driving aerial density higher will deliver strong and consistent cost reductions at the highest drive capacities and enable future cost-efficient refreshes of our mid-range capacity drives. We believe these products serve as the foundation to expand our margin profile back into and possibly beyond the long-term target range. Wrapping up, Seagate is executing with speed and agility through the near-term macro challenges. We've made meaningful improvements to our cost structure and balance sheet while steadily advancing our product and technology roadmaps. With signs starting to emerge that market conditions could improve as we progress through the calendar year, Seagate is well positioned with an industry-leading mass capacity portfolio that we believe supports the return to our long-term financial model over time. Thanks, and I'll now turn the call over to Gianluca.

Thank you, Dave. Seagate is navigating through the near-term macroeconomic cross-currents and executed to plan in the December quarter. We delivered top and bottom line results that came in slightly above the midpoint of our guidance ranges, revenue of $1.89 billion and non-GAAP earnings of $0.16 per share. Our actions to reduce costs, strengthen the balance sheet and improve long-term profitability have yielded desired outcomes, including a continuation of positive free cash flow generation, without sacrificing investment necessary to extend our technology leadership. Total hard disk drive shipments were 113 exabytes in the December quarter, down 5% quarter-over-quarter, with HDD revenue declining 6% sequentially to $1.7 billion. Multiple factors led to an expected decline in the mass capacity business, including the inventory correction among cloud and enterprise customers, COVID-related disruption in China, and Seagate's own action to reduce production. Mass capacity sales were offset by a slight seasonal improvement in the legacy market. Shipment into mass capacity markets totaled 97 exabytes, down 7% quarter-over-quarter. Of this total, roughly 82% were derived from nearline products, shifting to cloud and enterprise OEM customers. Nearline shipments of 80 exabytes were down 6% sequentially and roughly 30% of our recent high. We believe the actions we have taken to quickly adjust our production output have aided customers to start making progress in working down their inventory levels. The degree of progress varied from customer to customer and notwithstanding the current macroeconomic uncertainties, we would expect it will take a few more months to reach more normalized inventory levels across the customer base. On a revenue basis, mass capacity sales were down 10% sequentially to $1.2 billion, reflecting the nearline trend that I just described as well as lower demand in the VIA market. As we expected, the prolonged economic slowdown in China continued to impact sales of our VIA products, and we did not see the typical seasonal pickup in sales during the December quarter. As Dave mentioned earlier, the Chinese government is taking action to boost the country's economy, including the rapid reversal of COVID policy restrictions. It will take time for these changes to take effect. And while still early, emerging customer dialogue supports these encouraging leading indicators. As a result, we anticipate conditions to gradually improve over the next couple of quarters. Within the legacy market, revenue was $421 million, up 8% sequentially, primarily driven by a seasonal uptick in consumer demand, although at a more subdued level compared to the prior year. Finally, revenue for our non-HDD business was $224 million, down 15% sequentially, reflecting the expected decline in our enterprise system business following a very strong September quarter. Overall, we are making great strides in growing the system business, increasing sales of our branded channel products and building customer momentum with our CORVAULT self-healing technology. While we are continuing to navigate lingering supply constraints for a couple of system components, we expect non-HDD revenue to improve through the remainder of the fiscal year. Moving to our operational performance. Non-GAAP gross profit in the December quarter was $403 million. Embedded in that figure are the underutilization costs associated with lowering production output to support inventory reduction, both as a customer and on our own balance sheet. Underutilization costs of $79 million were somewhat higher than we had projected at the onset of the December quarter and translated into a 420 basis points of margin headwind. Accounting for risk costs, non-GAAP gross margin was 21.4%, down from 24.5% in the prior quarter. Based on our current outlook, we are planning to begin ramping production output in the March quarter, sometime after the Lunar New Year. Cost and efficiencies associated with restarting and ramping production are expected to largely offset the benefit of lower underutilization costs for the March quarter. However, as demand recovers in the coming quarters, we expect both gross profit and gross margin to move higher. We significantly reduced non-GAAP operating expenses to $294 million, down $20 million quarter-over-quarter due to savings associated with our restructuring plans and proactive expense management. We expect quarterly non-GAAP OpEx to remain around the $300 million level through the balance of fiscal year 2023. Based on the diluted share count of approximately 207 million shares, non-GAAP EPS for the December quarter was $0.16. Moving on to the balance sheet and cash flow. We executed planning action to strengthen our balance sheet over the near term. We ended the December quarter with a liquidity level of approximately $2.5 billion, including our revolving credit facilities, flat with the prior quarter. We believe these levels are sufficient to support our strategic plans and meet customer demand. We drove a significant reduction in inventory to approximately $1.2 billion, down $400 million from the prior quarter, reflecting our effort to work down strategic inventory and finished goods. We expect inventory to remain around this level over the next couple of quarters, but we'll continue to focus on aligning our supply chain and finished good levels to the prevailing demand environment. We reduced capital expenditures to $79 million, down 41% quarter-over-quarter. CapEx is expected to trend lower through the second half of the fiscal year with total fiscal year expenditure below the long-term target range of 4% to 6% of revenue. Free cash flow generation was $172 million, up 54% sequentially with lower capital expenditure and a $51 million improvement in working capital. We expect free cash flow to remain positive throughout calendar year 2023 and more than sufficient to support our dividend program. We used $145 million for the quarterly dividend. And as previously communicated, we paused our share repurchase program, exiting the quarter with 206 million shares outstanding. We are not currently planning to repurchase any shares for the balance of the fiscal year, consistent with our near-term focus on optimizing cash flow through the current macro environment. Returning capital to shareholders remains an important aspect of our financial model, and we will assess resuming our program in fiscal 2024, depending on business conditions. We lowered overall debt by approximately $220 million, largely through a debt exchange, requiring minimal cash outlay. Additionally, we successfully renegotiated our debt covenants to temporarily increase the leverage ratio to 5x. Our debt balance exiting the quarter was $6 billion, and adjusted EBITDA for the last 12 months totaled $1.6 billion, resulting in a gross debt leverage ratio of 3.8x. Interest expense in the December quarter was $77 million and is expected to be approximately $82 million for the March quarter, reflecting higher interest rates associated with the new debt. We continue to evaluate options related to debt structure and reducing interest expense. Turning to our outlook for the March quarter. The broader macroeconomic and geopolitical uncertainties continue to impact the business environment and shape recovery. However, as indicated earlier, we are encouraged by the actions being taken to improve economic conditions in Asia and the early indications with cloud and enterprise customer inventory levels are trending lower. As a result, we expect March quarter revenue to be in the range of $2 billion, plus or minus $150 million, up about 6% quarter-over-quarter at the midpoint. We project incremental improvement in the mass capacity business from cloud and enterprise customers and higher system sales to offset seasonally decline in the legacy market. At the midpoint of our revenue guidance, we expect non-GAAP operating margin to be in the mid- to upper single-digit range, which includes both underutilization costs and inefficiencies associated with the resuming production output. And we expect non-GAAP EPS to be in the range of $0.25, plus or minus $0.20. I will now turn the call back to Dave for final comments.

Thanks, Gianluca. Seagate continues to demonstrate resilience in the most dynamic of times. We are executing on what is within our control, generating positive free cash flow and advancing our product roadmap. As I indicated earlier, we expect mass capacity market conditions to gradually improve as we progress through the calendar year, which supports stronger revenue and profitability in the back half of 2023. Longer term, we remain excited by the secular trends driving demand for mass capacity storage, and Seagate's unique capabilities to capture these future growth opportunities. We are leveraging our aerial density leadership to increase capacity per disk, which we believe enables the most cost-efficient product solutions for mass capacity storage. We will begin shipping products based on 3-plus terabyte per disk capacities in the coming months, which is up to 35% more than comparable drive capacities available today. Amid a challenging macro and industry backdrop, I'm incredibly proud of the partnerships and hard work from our suppliers, customers, and our employees. Earlier this week, we published our fourth annual diversity, equity, and inclusion report, which highlights how Seagate aims to build and support its global team. The principles outlined in this report are foundational to Seagate's technology innovations and long-term success. I encourage you to read the report in full on our website. I will conclude by thanking our shareholders for your ongoing support. Our objective remains taking the decisive steps to best position Seagate for long-term value creation. Gianluca and I will now take your questions.

Hi. Good evening, guys, and thanks for taking my question. My first question is just on the nearline market. You're talking about a slight recovery from a unit perspective in the March quarter, you may refer to exabytes. I guess you could clarify that first? And then can you just talk about what you're seeing there that gives you the confidence that, that's inflecting. In the December quarter, clearly, you saw other mass capacity accelerate pretty robustly based on the numbers you gave. But what are you seeing on the nearline side? And what gives you the confidence that the March and June quarters are going to be sequentially higher? Thank you.

Thank you, Tom. It’s quite complex to analyze the situation following last summer, when we ceased operations at our factories and shifted focus away from older generation programs, favoring higher capacity options like the 20 terabytes. While I won't disclose unit figures, I can mention exabyte growth, which we anticipate will translate into revenue. Currently, we’re in a historically low period, but we are witnessing progress and engaging with customers about their specific needs. When considering the cloud service providers, it’s important to recognize the varying business models. Even within a single provider, there are distinct application areas and workloads that affect inventory. It’s a complex situation. Our aim is to avoid overproducing older products and to concentrate on new offerings. The clarity we gain from understanding what the providers are building instills confidence in a potential recovery in the latter half of the calendar year.

Thank you. My second question is for Gianluca. You mentioned $79 million in underutilization costs for the December quarter. Considering the midpoint of guidance, I'm seeing slightly improved gross margins, but with better revenue, I would expect a bit more leverage. Can you explain how the costs related to ramping up the factory after Lunar New Year may offset the decrease in underutilization costs? I'd like to understand the factors at play and their impact on gross margins. Thank you.

Thank you, Tom. Yes, the March quarter is a bit complicated from a cost standpoint because we are starting the quarter with a fairly low level of production, so we will generate underutilization costs for the month of January and maybe also a little bit of February. After that, we will start ramping production. That is good news. But for who is familiar with manufacturing, they know that ramping production has some inefficiencies. Now you need to restart the line, you need to recover those equipment, you have some additional scrap, lower yield. So for the first few weeks of a reramp has some costs associated. So when we put the two costs together, right now, we are assuming to come out fairly similar in terms of additional one-time cost of what we had in December. This improvement of the gross margin, of course, is coming from the VIA revenue and a little bit better level of production.

Thanks. Appreciate it.

This is Hadi for Krish. Congrats on the strong results. I have a more short-term question. First, your yields on HDD exabyte shipments were down year-over-year and Q2 well below the structural growth rate of 30%. At what point do you expect year-over-year growth to turn positive?

Sorry, Hadi, you're breaking up just a little bit. Could you repeat your question, give another try?

Your new HDD exabyte shipments were down nearly 30% year-over-year in Q4. At what point do you expect that growth rate to turn positive year-over-year?

Thank you. I believe I understand, and we will proceed from here. The underutilization charges are currently the biggest challenge for us, particularly in relation to shutting down our factories. From my viewpoint, we intentionally reduced factory operations to avoid overproducing outdated products. We are currently focused on the newer models, like the 20s, 22s, 24s, and 30s, as we discussed earlier. This will help us boost factory output. Consequently, we expect to generate more exabytes, which should improve our financial returns. I hope that addresses your question.

Yes. And do you guys have any color on when we should expect HAMR manufacturing yields to become close to the corporate average? Is second half of calendar '23 reasonable?

Yes. I won't speculate on that right now other than I'll say that we're now in a position on HAMR that, that's exactly the problem we're working. No longer is it a question of whether or not the technology is viable, the parts that are out of the oven. And from our perspective, this is what we do really well as well, which has ramped high-volume production. We've got everybody and the team focused on it, and we'll get there as fast as we possibly can.

Hi. Good afternoon, guys. Thanks for taking the question. Dave, just for you, great to see the continued confidence in the June HAMR launch. I'd love to know just kind of what the feedback is that you're getting from prospective customers. Clearly, we're in a more cautious macro environment we've heard the term like optimizing cloud spend more often. And so is this a technology and a capacity size that they're really pushing for now despite the slowdown that we're seeing in the market? Or are there other factors driving the timing of the launch? I would just love if you could unpackage that question. Thanks.

Yes. Thanks, Erik. I would say that the onus is really on us. It's a control of ours to make sure that we can drive the transition exactly to Hadi's question about getting the yields up and getting the production capability to where we want it. I like to think that somebody making a decision to build out a data center would much rather have a drive with 3x terabytes instead of 2x terabytes. And because that's such a great TCO proposition for them over the long haul. We have deep customer relationships, obviously, on this front. This is not a surprise to them. The results that we're showing in our labs are not a surprise either. So they're very well connected with us on it. Where their spending profile might be muted, say, in the first half of this year because of all the issues that CSPs are going through, and they've shared some of those with us and they're the tough problems themselves. I do think that the secular demand for mass capacity in those data centers is still going to be huge. And we want to make sure that we're staging the absolute best value proposition for us and for them when we get there. So it's really ours to go drive.

Super. That's really helpful. And then Dave or Gianluca, I'm not sure. Can you just remind us exactly how we should think about the potential margin impact of launching HAMR and ramping that platform just as we think about, again, the next 12 months? And that's it for me. Thanks.

Yes. Thanks, Eric. I'll pass it over to Gianluca in a second, but it really does come down to yields and scrap. I mean, we're going to be targeting most of this at the highest capacity points, although there are opportunities in lower capacity points if we can take disks and heads out of already existing platforms in the 20s or teens, then we'll go do it. And we have to go work that through qualifications with our customers. That's how we get margin oxygen, if you will, back into the system. And so yields, scrap, our ability to go through the cycles inside of our factory, those are the relevant parameters.

Yes, HAMR is a new product. So we need to go through a little bit of the learning curve, something different from what we have done in the last several years. But as Dave said, Seagate is very good in operations and manufacturing. And therefore, we are very confident now we can have very good results, results that at a certain point will be similar to the PMR, but exactly when it's a bit difficult to say right now. So we are going step by step. But we are actually growing faster than what we were expecting. And as Dave said, we are ready for launching the product in the June quarter, but it is a little bit before what we were discussing just three months ago.

Yes, I believe the data coming from the labs is really encouraging. While there are additional features in a HAMR drive compared to a standard PMR drive, PMR drives themselves are quite complex. However, there isn't a significant shift that would lead to major cost adjustments. We have challenges to address, and that's where our strengths lie. We have experience in managing such transitions, and we are on top of this. Our planning for this has been ongoing for a long time.

Great. Thanks, guys. Congrats.

Thank you.

Yes. Thanks, everyone. Good afternoon. Two questions, if I may. As it relates to the March quarter guide, it's great to see an improvement in revenue in March because seasonality is usually down a few points. But of course, nothing is seasonal at this point in time. But I guess, as it relates to that, you spoke about improvement within nearline. And so two-part questions to that. I guess, are cloud customers increasing or LTA baseline orders today going into March? And then second, are you beginning to see cloud customers procure orders for HAMR from new or existing LTAs because I'm also curious how you look for signposts regarding the uplift of HAMR demand in anticipation of your launch?

That's a great question, Karl. Let me respond like this. Typically, when supply significantly trails behind demand, we enter into long-term agreement discussions. However, in this situation, our suppliers are facing challenges, we have our own difficulties, and our customers are also encountering issues. Therefore, it’s crucial for the entire supply chain to collaborate effectively. Right now, demand is low, and supply is abundant. However, we are all very aware of our cash flow and the financial results we want to achieve. We are still engaged in long-term agreement discussions. The terms of these agreements may not reflect the previous situation when demand exceeded supply. But what we need is predictability to keep our factories operating, ensure our employees are paid, and allow for reinvestment so we can offer the right products at the right costs. Specifically regarding your HAMR inquiry, I would say the answer is no at this moment, but we might soon be in a position to specify the volume ramp of HAMR for this customer, which would then become part of the long-term agreement. However, we are not there yet.

We will have to go through the call. And then after the call, we start discussing volumes with customers and eventually doing LTAs.

Understood. Thank you. If I may ask one more. I was under the impression your SMR drives were closer to 25% of your mix, you're suggesting it's close to 35% of your mix today, which is quite impressive. So I'm hoping you could discuss what sequential improvement you've seen in SMR drives this quarter and whether you are seeing better economics within this area of mass capacity? Thank you.

Yes, thanks. I think there's a lot of confusion in the space on this, so let me try this. We've been shipping SMR since I think 2014 into the cloud. We also have shipped hundreds of millions of SMR drives on the client side. So SMR is a great technology add. If you can adopt it for very specific cloud applications, it can be quite complex. And so some places, people choose not to do it. Redeployment of drives, for example, from application to application becomes limited or there's a lot of inertia around it if you try to do that. So we have great SMR solutions. We've been working on this for years and years and years. If customers ask and if their applications desire, then we'll go there for them. And so I really look at this as a customer by customer, sometimes application by application, specific ask for, say, a business unit or something like that, and we just react to it. And that's I don't think there's any big shift towards more SMR out of the Seagate portfolio. I think there are customers who, over time, are adopting more SMR, so that may be part of the reason for the trend that you talked about. But it's not something that's, I'll say, deliberately being pushed on our front. We look at it more as let’s just solve the problem for the customer.

Yes, I would say on a quarterly basis, the percentage change based on the mix of our customers. So depending on which quarter, one customer can be a bit higher than another one, we can have a little bit more SMR or less. But for us, as Dave said, we have both is actually a fairly easy way for us to convert the PMR into an SMR. So just a matter of where the demand is in the specific quarter.

Thank you.

Yes. Thanks for taking the question. Two if I can as well. I guess the first question, you mentioned, obviously, in the numbers that you're shipping about 30% below what was the peak level seen a year or so ago. As we think about the efforts that you've made on rationalizing your production capacity, is there any way to gauge how we could think about what kind of fully utilization looks like on an exabyte ship basis as we move forward? Just trying to think about the trajectory based on that number relative to gross margin? What's kind of the capacity footprint that you guys have normalized to now?

Yes. Hi, Aaron, I think there are several different aspects to your question. From an equipment standpoint, all the equipment is still intact. In fact, as we transition to higher capacities, such as 2.2 terabytes per disk or 2.4 terawatts per disk, up to 3 terabytes per disk, we are able to utilize our available parts more efficiently, although there are some challenges with processing content. Overall, our capacity footprint has increased. To directly answer your question about our current state, we had to reduce operations in our factories, but scaling back up won’t take a lot of time as it primarily involves our workforce. This period has been incredibly challenging for our employees, those in the supply chain, and our customers as well. Therefore, while our theoretical capacity remains high, we can’t make immediate adjustments to reach it; proper planning is necessary. In the past, we reached 165 exabytes, and with all the technological advancements, we can achieve that level again and potentially exceed it.

Yes, yes. That's helpful. And then as a quick follow-up. I think last quarter with the headcount reduction effort, you had talked about I think it was getting to realizing the annualized expense savings of about $110 million starting in this current quarter. How do we think about the effect of that on a net basis in this current fiscal quarter?

Yes. We realized a big part of that saving already starting in the December quarter, as we were discussing beginning of November. The majority of our restructuring actually happened at the beginning of November. So we had basically two full months out of the three where we could take the benefit of the cost reduction. And now in OpEx, there are always a few other items that impact the cost of the quarter. In the script, I said we expect this quarter and even next quarter to still be around the $300 million.

Thank you.

Hi. Thanks a lot. This is Jason on for Tim from UBS. I have a couple of questions. So the first question is on December quarter. Sorry if I missed, but I see that there's about $100 million purchase order cancellation fees in December quarter. Could you guys help us understand what that line item really is? And also, would there be any possibility of this repeating in a similar magnitude next couple of quarters if demand remains weak? And I have a follow-up. Thank you.

Yes. That is related to our reduction in production. Of course, we had some commitment with some of our suppliers that, of course, we want to comply with. So on those cases, we had to stay for take-or-pay products that we didn't need, and we decided not to take based on our focus on reducing our own inventory on top of reducing customer inventory. I think we have taken all those liabilities into the December quarter. So I don't expect at this point these liabilities to come back in the March quarter.

Got it. Thank you. Yes. My second question is on your debt paydown schedule and cash level. So on the back of your recent debt exchange, how are you guys thinking about the pace and magnitude of debt pay down in the next few quarters? And in light of that, how can we think about the new cash level you guys are comfortable operating under going forward?

Yes, we are generating still a fairly strong free cash flow. In the December quarter, we generated $170 million; I think this quarter will be higher than that. We have a note that will mature at the beginning of June that we want to repay and we will not refinance, that is about $540 million. So we will use our cash. We have actions going on to optimize our cash between now and June. But I would say, right now, our focus is actually on reducing the debt and reducing the full amount of those notes.

Thank you.

Thank you for taking my question. Congratulations on advancing the launch schedule of HAMR drives. I have a couple of questions. How do you see the adoption of HAMR drives progressing in the second half of this year and into 2024? Is it expected to be more widespread, or is it concentrated among a few customers? I understand it's early, but when do you anticipate reaching the unit or exabyte crossover for HAMR drives? Finally, to clarify, will you continue to offer PMR products in the 30-terabyte range alongside HAMR drives? I have a follow-up question as well.

Thanks, Sidney. I appreciate all the positive momentum that’s happening. There are many individuals, both within and outside our company, who deserve recognition for making this technology a reality, having believed in it for the past 20 years. It's exciting that the world will have the opportunity to double nasty points and similar advancements over time. I feel confident about our current position. While we aren’t specifying the exact launch schedule, we plan to be as proactive as possible. Regarding your question, I believe the first drives will likely be distributed through a few different channels, some of which we can manage, like our systems business mentioned earlier. Additionally, some major customers are eager to be early adopters to better understand the technology and how to utilize it. At the peak capacity point, integration can be challenging because these technologies are new to the world. If we can create midrange capacity points with fewer heads and disks, that will be beneficial for us as well. Once we release the heads and disks, I’m confident we will find suitable applications for them and will aggressively ramp up production in the coming years.

Okay. Maybe a follow-up question. You and your competitors have both indicated quite a bit regarding production cost in this down cycle. I'm curious if you're seeing any less rational behavior in terms of pricing given the high level of inventory in the channel and the customers in the December quarter, but more importantly, going forward, do you think the pricing environment will still be okay? Thanks.

I believe that to effectively manage long-term outcomes, it’s best to reduce production and avoid releasing too much of the less desirable products. I find it encouraging how the industry is responding to this challenge. Regarding your question, I don't currently focus on market share or individual deals as indicators of long-term trends. Instead, I consider the level of discipline within the industry. For Seagate, I am optimistic that we can provide a stronger value proposition, reduce costs, and use these factors to help us return to our desired margin range or exceed it.

Great. Thank you.

Hi, Dave, and Gianluca. Great quarter and good control on the inventory side. Just a quick question on how you see broad inventories in the channel. Like if you look at China and U.S. enterprise hyperscale, any thoughts on where inventories are broadly?

Yes, from our perspective, inventories at hyperscalers generally decreased, which we found encouraging. Naturally, we would prefer to see a more rapid decline to help us ramp up our factories more quickly. This would be beneficial for us. Additionally, regarding our owned inventory, we've managed not to release much into the market, particularly from our legacy capacity points in the nearline space, which is also encouraging. While weeks of inventory on hand are relatively high, they are not unusually so compared to historical levels. Depending on the measurement period, whether it's 4 weeks or 13 weeks, it can vary based on the baseline used. This baseline has shifted in light of current macroeconomic conditions. We are beginning to observe some signs of macroeconomic recovery in certain regions like Europe and Asia. The overall inventory value isn’t extremely high, indicating there aren't excessive weeks on hand, which allows us to respond effectively. Therefore, I’m not overly concerned about the inventory situation.

Great. And you mentioned HAMR ramping here. Good to see that. A exit the year, any thoughts on what that mix would be of your mass capacity at nearline revenues or units?

Yes. We haven't really talked about it. I think this year, it will probably still be relatively low. And then the faster we can get the yields and scrap and all the costs that we can control down on the heads and media then the faster will be accelerating. I think that will happen in calendar year '24 and calendar year '25 will just continue to accelerate. The highest capacity points will be addressed, but also these midrange capacity points. And how successful we are with all that stuff will determine how broadly we can penetrate all those different individual markets.

Hi, thanks, guys, for taking the question. Two quick ones, if I could. Just going back to Aaron's question, Dave and Gianluca on the utilization. So Dave, you said you're 30% below peak your gross margins are actually down 30% from that same peak. Is that a coincidence because pricing has been stable? Or is it really sort of that simple? And then I guess the ramp back up kind of higher-cap drives sort of takes up more capacity. And so is it really as simple as on sort of the ramp back up sort of the same indexing on capacity ship, is like a little bit more of a slope up, just given the mix? And I have a quick follow-up after that.

The majority of the decline in our gross margin is attributed to underutilization charges due to lower production levels. In the previous quarter, we discussed some pricing pressures on low-capacity drives, which persisted a bit in December. However, we generally view the current pricing stability positively, especially considering the strong downturn we are experiencing. We anticipate that once we return to the production and revenue levels we had last year, our gross margin will either reach those levels or improve even further.

Gianluca, can we model the gross margin in alignment with our expectations for capacity increases moving forward?

I would say capacity mix, of course.

Okay. Cool. And then just a real quick follow-up. $300 million OpEx through the June quarter, how do you want us to think about modeling out past that, the puts and takes? Thanks.

But we are staring to discuss about the next fiscal year, but I would say part of the lower OpEx is coming from variable compensation that is very low in the current fiscal year. So you will have to think about adding some cost for variable compensation in fiscal '24.

Yes, I think Ananda, we reacted, obviously, very early on some of this when we saw it. And I think we're going to be asking the same kinds of questions throughout the course of this year, what's the new trajectory, the new normal, if you can. When some of the normal demand cycle comes back, where is the world from an economics perspective and we'll address factory footprint and things like that when those times come.

Cool. Thanks, guys.

Thank you.

Hi. Yes. Thank you so much. Apologize, jumping across calls if this has already been answered. But I'm wondering if you could talk a little bit about the trajectory that you see in exabyte growth. It's kind of been a little bit all over the place given so many moving pieces with both demand slowdown as well as inventory and if you could maybe calibrate for calendar '23, that would be great?

Yes, it also depends on where you reset to. We’ve taken significant steps down, and while we could discuss the 30% growth target, it might be too soon to determine that. However, with our introduction of 24 terabytes and 30 terabytes, we believe this will contribute significantly to exabyte growth. A couple of years ago, we achieved over 80% from nearline drives, which highlighted not only a strong value proposition tied to capacity increases, but also the fact that many were investing at that time. I believe the demand for data remains strong, driven by AI, machine learning, and new applications emerging. Currently, businesses are adjusting and figuring out their investment strategies. Our role is to present compelling value from an exabyte standpoint to encourage that investment. We expect the latter half of this year to show improvement in exabyte growth, although it may still be too early to provide an exact figure.

And maybe you already covered this, but if you wouldn't mind, if you have covered it, then we don't need to go in. But I was wondering if you could address if there's anything abnormal that you're seeing within pricing in the competitive environment, is there especially within the channel, anything that you're seeing that might be abnormal? And when do you think if there is something when that would normalize?

At a macro level, I believe everyone is experiencing a similar demand environment. Companies are responding in much the same way by conserving cash and hesitating to invest in uncertain market opportunities. The industry has effectively reduced our production capacity over the past several months, which has been quite challenging for us and our suppliers. However, our customers are aware of this situation. Overall, I don't observe a tendency for companies to manufacture excessive amounts of incorrect products in an attempt to enter the market. There might be minor exceptions, but in the grand scheme, I don't think that issue is particularly significant.

Okay. Thank you so much.

Hi. Thank you very much for taking the question. Maybe just first, within the context of recent export restrictions and macro headwinds in China, I'm curious if you can share any color on your TAM assumptions for the VIA market, both in the near term and longer term, which I believe you previously said the longer-term market outlook remains intact, but just curious on those dynamics?

Yes, I'll start and then Gianluca can add his insights. The VIA market is undergoing significant changes globally. There are many applications emerging; a few years back, we focused on surveillance, but now there's a greater emphasis on consumer behavior and inventory management. Many people are concerned about inventory levels. Hence, there's an innovative use of new smart edge applications. Overall, it's an exciting market worldwide. In China, the drivers have been quite muted for the past year, and we were anticipating a recovery that hasn’t materialized yet. I believe recovery will happen, but it will be gradual. Additionally, there are new opportunities arising in various regions across the globe.

In the very short term, we see possibly a decline in the March quarter, mainly because of seasonality. March is always the quarter where we have the lower revenue from VIA and from some of the legacy markets also. So not a lot of increase in the short term. But in our view, the rest of the calendar year, we should see sequential improvement. And VIA is an important segment for us. And in a segment that is also generally generating a very good gross margin.

Great. That's very helpful. Thank you. And then maybe just a follow-up. Within the context of the operating margin target that you outlined last year, 18% to 22%, assuming this is still the right framework, can you just walk us through some of the levers and the timeline for reaching that range and maybe thoughts on medium- to longer-term OpEx growth or intensity within that context?

Yes. I think we're still evaluating the long-term demand, so I won't make any predictions just yet. However, I can say that this management team's goal is to return to our previous models as quickly as possible. Demand is certainly the key factor in that. We've made operational improvements through cost reductions, and unfortunately, we've had to eliminate some projects we were working on. This suggests that we have a bit more flexibility than we did before, but demand will still be the main driver. One of the reasons we're pushing to transition our products rapidly is that we believe it will help us meet that demand with a more appealing value proposition that benefits us quickly. We're also focusing on our internal operational metrics to secure the best costs at the moment, which contributes to our efforts.

Great. Thank you very much.

Hi. Thank you for taking my questions. Gianluca, could you discuss how you're thinking about working capital for the second half of the year? Our inventory days came down pretty substantially. Obviously, if you took production down. But they're still above the year ago levels. And then as you launch HAMR, is there anything we should consider within that number? And then I have a follow-up.

Yes. In the December quarter, our working capital was positive by about $50 million. We decreased our inventory by a lot, but we also paid a lot to our suppliers. So I think that is part of the positive working capital that will actually impact the March quarter. And after that, probably is fairly stable for at least a couple of quarters.

Okay. And then, Dave, you kind of touched on this in a prior question, but AI has become a much more common topic in the last few weeks. And I'm wondering how Seagate thinks about that opportunity, not just from data creation, but your product lineup? And is this coming up in customer conversations? Is it something that they're asking for your help on? Thanks.

Thank you, Ashley. Underlying the demand for data growth we are seeing is a major trend that we are closely monitoring, as it impacts both cloud and edge computing. I believe we are optimistic about this trend in the long run. In the early phases of AI, training models required access to large data sets. However, as we move forward, these data sets need to be real-time to support timely decision-making. At times, information must be processed at the edge, particularly when dealing with video data that can inform consumer behavior or inventory management, as I previously mentioned. There is considerable excitement among our customers regarding this. The positive aspect, as I have pointed out recently, is the strong wave of innovation occurring in this space. Given the uncertainty in current macro conditions, many are hesitant to fully engage, but I eagerly anticipate the time when more applications are implemented, significantly boosting data growth.

Thank you.

Hi. Good afternoon. Just following up on some of the questions on pricing. I understand that controlling production is a way to get back over time to your utilization rates and gross margin target. But is the price decline in NAND that we've seen recently impacting some of the pricing that you're looking at for HDDs? Or is there basically a possibility of share shift toward demand given the pricing that NAND is undertaking currently? And how do you react to that?

Tristan, I think that back in the day that the legacy markets obviously went through some transitions because of this. There may be some happening in the consumer markets, that's relatively small. The impact is relatively small. We still have a pretty good value proposition in the consumer markets as well. In the mass capacity markets, not really. I mean I think the people running big mass capacity rigs either they understand both technologies and they use both technologies. They're not really making a trade-off of one versus the other. I think NAND, we can all see that the business is tough over there. I think everybody is in tough shape and I feel for some of those guys because the world needs their technology. I think we need their technology as well to make sure that they do their part and the layers they're relevant in, but I don't think it affects mass capacity long term.

Great. Thank you.

Thanks, Cole. As you heard today, Seagate is acting with speed and agility to manage through a tough near-term market environment. At the same time, we're executing our strong mass capacity product roadmap that makes us well positioned to enhance customers' value and Seagate's financial performance. I'd just like to close by thanking all of our stakeholders for their ongoing support, and thanks for joining us today.