Seagate Technology Holdings plc (STX) Earnings Call Transcript & Summary

Good afternoon and welcome to the Seagate Technology Fiscal First Quarter 2021 Results Conference Call. My name is Jason, and I will be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. At this time, I would like to turn the call over to Shanye Hudson, Senior Vice President, Investor Relations and Treasury. Please proceed, Shanye.

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 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 Form 8-K that was filed with the SEC. We've not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control and/or cannot be reasonably predicted. Therefore, a reconciliation to the corresponding GAAP measures is not available without unreasonable efforts. As a reminder, this 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. And 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. With that, I'll turn it over to you, Dave.

Thanks, Shanye. Welcome, everyone, and thanks for joining us today. We began fiscal year '21 executing well across several key objectives, keeping us on pace for our full year revenue outlook. First, we delivered on our financial commitments, navigating challenging market conditions to achieve September quarter revenue of $2.31 billion and non-GAAP EPS of $0.93, both exceeding the midpoint of our guidance range. Second, we advanced our innovative product and technology road maps, which position the company for future data growth opportunities, including the introduction of CORTX, an open-source, object-storage software; and Lyve Rack, which offers a simple and cost-effective solution for enterprises to manage their massive volumes of data and in turn unlock data value. And third, to demonstrate Seagate's long-term commitment of returning cash to our shareholders, the Board approved a 3% increase to our quarterly dividend and a $3 billion increase to our existing share repurchase authorization. These actions exemplify our confidence in the business potential and future cash generation capabilities. In my comments today, I will summarize a few highlights from the September quarter and share some perspectives on the current market environment, then I'll outline how we have been positioning Seagate to capture significant opportunities created by longer-term data trends. The results for the quarter reflect good execution against the backdrop of continued macro disruptions that impacted several of our key end markets. These disruptions were most pronounced in the enterprise market as the anticipated slowdown in enterprise IT spending impacted sales of our enterprise nearline and mission-critical drives. Many enterprises reacted to the pandemic by prioritizing funding to support their remote workforce and accelerating their digital transformation plans. Accordingly, nearline revenue in cloud was solid in the quarter, although below the record levels of June. The adoption of cloud services and the rise of new virtual economy, digital remote and intelligent is driving ongoing cloud data center investments. According to IDC, 2020 may be the first year in which cloud infrastructure hardware spending surpasses traditional IT infrastructure hardware spending. However, they also project enterprise IT spending will pick up in calendar 2021, which aligns well with our outlook for gradual recovery in the enterprise on-prem market. Data center investments vary among cloud service provider and internet content customers depending on their respective end market demand outlooks, expansion plans and architectural needs. Responding to these trends, HDD storage investments depend upon mass capacity transition readiness and installed base replacement timing. Taking these factors into account, we currently expect cloud data center demand to improve in the December quarter and throughout the fiscal year, which supports a more elongated cycle than we've seen in the last couple of years. In other markets, recovery is already well underway. For example, we realized solid double-digit revenue growth for our consumer drives, reflecting both the return to seasonal patterns and strength of the Seagate's brand among prosumers and gamers. And in the video and image applications or VIA markets, revenue doubled quarter-over-quarter, following a resurgence in on-prem security and smart video projects. Recall these markets were heavily impacted in the first half of the calendar year by COVID-related restrictive measures that precluded installations from taking place. Over the long term, the use of AI and other data analytics continues to drive new VIA edge use cases that extend well beyond security, including smart cities, smart factories, health care and even frictionless retail, all of which generate massive amounts of data and the need for cost-effective edge storage. We now believe the September quarter marks the bottom of the COVID-related demand disruptions, and we expect a gradual recovery from this point forward, which, along with the existing secular trends we're exposed to, underpin our outlook for flattish revenue in fiscal year '21 and reinforce the relevance of mass capacity storage in both the cloud and at the edge. Seagate is a leader in mass data, and we continue to deliver innovative technologies and secure cost-effective data solutions that address our customers' needs today and in the future. Building on the strong momentum of our 16-terabyte products, we are qualifying our 18-terabyte drives at multiple customers and progressing very well. We are aligning our volume production ramp to customers' timings and HDD capacity transition readiness. We also remain on track to ship 20-terabyte HAMR drives starting in December, which is an important milestone as we believe HAMR technology will be the industry's path to scaling aerial density and increasing drive capacities. Seagate will be the first to ship this crucial technology with a path to deliver 50 terabyte HAMR drives forecast in 2026. Higher capacity drives not only enable data centers to cost effectively store more data in the same footprint, but also to do so in an environmental and sustainable way. The power consumed by an 18-terabyte Seagate drive is actually lower than a 10-terabyte HDD on a per bit basis. That means by replacing 110-terabyte drive with our latest 18-terabyte product, customers can securely store 80% more data and do so more efficiently. However, the challenges for mass data storage posed by data growth extend beyond capacity cost and sustainability. Increasingly, businesses are challenged by data sprawl and data security, which impact their ability to harness the value of their data. Last month, Seagate hosted its inaugural datasphere event during which customers, partners and other industry thought leaders joined our team to discuss strategies for attacking these data management challenges. If you haven't had the opportunity yet, you can still catch the videos on our website. Seagate's Lyve platform leverages our deep knowledge of data storage and architectures to help enterprises address the complexity of securely managing data across a distributed enterprise. Lyve Mobile is a series of seamlessly integrated edge arrays and data shuttles designed to cost effectively and securely move data between endpoints, edge and into core cloud environments. CORTX is an open-source, object-sourced software with a growing community of developers. CORTX enables enterprises to easily and efficiently manage massive pools of storage resources across their distributed enterprise. Finally, Lyve Rack is a simple and easy to deploy solution, preconfigured with CORTX software and up to 1.5 petabytes of storage in a 4U rack. Lyve Rack helps enterprises build their own mass capacity, optimize private storage clouds with less cost and complexity than ever before. We see multiple use cases across a diverse range of edge-centric vertical markets that all have a common need for mass data management. For example, Raytheon Technologies is using CORTX to develop large-scale secure storage clouds with their federal and commercial customers. And 2 of the world's top automakers are evaluating this platform to efficiently move data across their fleets of autonomous vehicles. While Lyve is still in its infancy, customer reception has been tremendously encouraging, which, together with our outlook for mass capacity storage, makes me excited by the future prospects for Seagate. With that, I'll now turn the call over to Gianluca and have him walk through the September quarter results.

Thank you, Dave. We achieved what we set out to do in the September quarter, delivering financial results consistent with our expectation in face of a dynamic and challenging market environment. Revenue was $2.31 billion, above our guidance midpoint and down 8% sequentially. This performance reflected strong recovery in the video and image applications or VIA market. The strength in the VIA market, along with healthy demand from cloud data center customers, partially offset the anticipated weakness in the enterprise market, which impacted our nearline, mission-critical and system sales. Total hard drive capacity shipments were 114 exabytes in the September quarter, down about 2% sequentially. Mass capacity shipments were 87 exabytes compared with 91 exabytes in the prior quarter and 64 in the year ago period, representing strong year-over-year growth. Our outlook for the December quarter supports calendar year 2020 exabyte shipment growth that is well ahead of the long-term demand CAGR of 35% to 40% forecasted for this market. On a revenue basis, mass capacity storage represented 58% of September quarter revenue and 63% of hard disk drive revenue, no change from a percentage basis with the June quarter and up from 47% and 51%, respectively, in the prior year period. As anticipated, nearline revenue declined sequentially but remained healthy and within its historical range, centered around 70% of mass capacity sales. Nearline shipments were 64 exabytes, down from record levels in June, but up 36% year-on-year, reflecting broad market demand for our high capacity nearline drives. We estimate that about 15% of nearline capacity shipments are to replace existing drives, which equates to about 10 exabytes in the September quarter. We consider this a reliable revenue stream, and it should grow over time, along with the installed base. Average capacity per nearline drive increased 8% sequentially to 11.6 terabytes, supported by sales of our highly successful 16-terabyte drives, which have been the company's highest revenue product for 3 consecutive quarters and the highest nearline product for fourth consecutive quarter. We continue to shift our 18-terabyte drive and make positive progress on qualification plans at multiple cloud customers with volume rent aligned with their timing. Revenue for VIA increased sharply in the September quarter as new security and smart video installation resumed following the COVID-related pause we described in the first half of the calendar year. We anticipate healthy VIA sales over the near term, and VIA's application is a long-term growth driver for mass capacity storage, particularly as new use cases for smart camera system and analytical software emerge. IDC forecast revenue from video security camera is growing at a compound rate of nearly 13% through 2025, which is a strong indication of the increasing storage needs at the edge. The legacy markets represented 34% of total September quarter revenue, the same percentage as the prior quarter and down from 46% in the year ago period. Increased sales for consumer drives partially offset the decline in the enterprise mission-critical market and sub-seasonal demand for PCs. Exabyte shipment into this market increased 5% sequentially to 28 exabytes, supported by the uptick in the consumer product, which had have a capacity of 2.7 terabytes per consumer drive. We currently expect consumer demand to remain stable in the December quarter with some improvement in the mission-critical market, consistent with the gradual enterprise recovery that Dave described. Our non hard disk business made up the remaining 8% of September quarter revenue, flat on a percentage basis with the prior quarter. Non HDD revenue is still below our pre-COVID levels. Sales of our SSD products trended lower due to a challenging pricing environment, while we saw a slight improvement in the system business. I would point out that many of our system customers are small to midsized enterprises, which are still being impacted by the pandemic. Accordingly, we expect it will take a couple more quarters before demand fully recovers. In the September quarter, non-GAAP gross profit was $614 million, which includes $25 million of COVID-related cost. We are taking steps to partially offset costs associated with airfreight by using more ocean freight. Our result in non-GAAP gross margin was 26.5%, including a 110 basis point impact from this COVID-related cost as well as a less favorable product mix and underutilization of the factories. Consistent with our expectations. Non-GAAP operating expenses came in at $320 million, reflecting ongoing benefit of working from home, along with savings from our previously announced restructuring activities. Looking ahead, we now expect operating expense to normalize at approximately $330 million within the next 1 to 2 quarters as we continue to assess market position and investment. Our result in non-GAAP operating income was $294 million, and non-GAAP operating margin was close to 13% of revenue, which is the low end of our long-term target range. Based on a share count of approximately 259 million shares, non-GAAP EPS for the September quarter was $0.93. Capital expenditures were slightly lower in the September quarter at $111 million, which represented around 5% of revenue. Based on the investment made over the past several quarters, we believe the industry has sufficient capacity in place to address near-term market demand growth. As a result, we are focusing our investment to support technology transition rather than further capacity expansion. We have been successful in transitioning more of our shipments to ocean freight, which, as I mentioned earlier, decreased the COVID-related impact cost on gross profit. We have also built strategic inventory for some critical components to protect against potential future supply chain risk. As a result, inventory increased sequentially to $1.3 billion, which was in line with our plan. We expect inventory levels to decline as we consume this component over the next few quarters. We generated about $186 million of free cash flow in the September quarter, which includes the onetime impact of restructuring cost. While these levels are still relatively healthy, we expect free cash flow to return to historical levels over the next few quarters, supported by our focus on operational efficiency and an improving demand environment. In the September quarter, we utilized $68 million to retire approximately 1.5 million ordinary shares, exiting the quarter with 258 million shares outstanding. We also used $167 million to fund our dividend. As Dave mentioned earlier, the Board approved a 3% increase to our quarterly dividend, raising the quarterly payout to $0.67 per share. The Board also approved an increase to our share repurchase authorization of $3 billion, which brings the total amount available to $4.2 billion. The share repurchase authorization has no specific expiration date. Timing of execution on our authorization is dependent on several factors, including our financial position, available cash, distributable reserves and capital requirements. Reduction illustrates the confidence in our business strategy and long-term cash generation abilities. We have cash and cash equivalents, relatively stable at $1.7 billion. As we approach the end of calendar year 2020, we are encouraged by emerging signs of recovery in the larger enterprise market and improvement in VIA demand. We expect solid cloud data center demand to continue in the December quarter, supportive of our view for a more elongated cycle. While we are still facing headwinds from COVID-related costs, we expect this will gradually decrease over the next couple of quarters. Taking all these factors into account, our outlook for the December quarter is as follows. Revenue is expected to be $2.55 billion, plus or minus $200 million, up 10% sequentially at the midpoint. Non-GAAP operating margin is expected to improve sequentially and be in the lower half of our target range of 13% to 16% of revenue. And non-GAAP EPS is expected to be $1.10, plus or minus $0.15, an increase of 18% sequentially at the midpoint. In closing, Seagate has continued to execute well during this prod of prolonged uncertainty. We are navigating the current market and executing a strategy to capture the significant opportunities associated with the secular demand growth for mass capacity storage and the emerging need to manage massive volume of data from the endpoint to edge to cloud core. I will now turn the call back to Dave for final comments.

Thanks, Gianluca. As we conclude the first quarter of fiscal year '21, we are encouraged by the recovery trends we're seeing in key end markets but still expect macro uncertainty to persist near term. We have demonstrated the ability to manage through challenges in the past. And with our team's strong execution and resilient financial model, I remain confident that we will emerge stronger from this current situation. Our improving December quarter outlook suggests we are on track to do it again. I'm proud of our pace of innovation and how we are attacking the critical customer needs posed by data growth, data sprawl and data security. We are delivering on our technology road map and developing cost-effective solutions that address the secular demand growth for mass capacity storage and data management. I am confident in our business outlook for fiscal year 2021 due in part to the tremendous momentum we have built with our highly successful HDD business. And I believe our new initiatives, including our Lyve platform, position us for even greater opportunities in the future. As a result, I'm more excited than ever about Seagate's growth opportunities, ability to generate cash and enhance shareholder value over the long term. Our performance would not be possible without the tremendous efforts of our employees and the ongoing support of our customers, partners and shareholders. Thanks to all of you. With that, Gianluca and I are happy to take your questions.

[Operator Instructions] Your first question comes from the line of Karl Ackerman from Cowen.

Perhaps one on Luca. You spoke during your prepared comments about shipping 20-terabyte HAMR drives revenue this quarter. First, could you quantify the number of design wins you won to date for HAMR? And second, your earlier comments seem to suggest you won't materially ramp 20-terabyte HAMR perhaps because it's cost prohibitive on a dollar per terabyte basis versus your existing CMR offerings. I guess is it possible to achieve 35% to 40% exabyte growth for calendar 2021 if the plan is to leapfrog to 24-terabyte HAMR drives? And how do we think about the margin mix associated with that?

Karl, like you said, it's a new platform out there in the world, and so we're going to introduce it this quarter, and we'll be watching the customers that we are qualified with, which is pretty highly competitive, so we don't talk about that. But we'll watch the performance and dial that knob accordingly. I would say that until -- to your point, until we get to 24 terabyte, there's not really a compelling transition, and so we have to continue working that drive, and we'll work that over the course of the next calendar year.

Yes. I would say that the important for us is the technology milestone that we are achieving in the current quarter with the full shipment of HAMR. It's not so important right now how many units we ship, the important is that the technology is working, and we are doing exactly what we said and start shipping 20-terabyte HAMR ever before the end of the calendar year 2020.

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

Dave, given the higher-than-average margins in the markets that are recovering, enterprise and video markets, why wouldn't gross margins improve materially in the second half of your fiscal year? And then just a follow-up for Gianluca. How do we reconcile the modest share repurchases in September relative to the new $3 billion share repurchase authorization? Why not be more aggressive buying back the stock, given the signs of recovery you see in the business?

Yes. Thanks, Katy. I'll take the gross profit and gross margin points first. We do still have some COVID overhang. And then obviously, last quarter, the factories were relatively empty compared to what we can do from a demand perspective. So we're pivoting some of the capacity over from some of the legacy markets that are still challenged and into the mass capacity, exactly to your point. So over the course of many quarters, we will see that recovery in gross margins, if that helps you think about it. I'm very confident of the product portfolio that we have. It's just a matter of re-equilibrating all the supply -- or the demand against our existing supply.

Yes, and maybe before answering to the capital allocation and share buyback, we said that last quarter and even the quarter before that calendar 2020 was going to be impacted by the additional cost of COVID in terms of gross margin and operating margin. So we think that when the COVID situation will improve our gross margin because of our mix and because of the reduction of the COVID, will start to improve. So we expect some improvement in the second part of the fiscal year. In terms of share buyback this quarter, as you know, we discussed that even during the last earnings release, during COVID, we want to be a little bit more conservative in terms of cash preservation. But the Board authorization is -- it is a more strategic long-term authorization. It's not something for the very short term. We will think about how to use and how to maximize the impact of this new authorization, and with Dave, we will decide in the next weeks and months.

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

Yes. On -- back on maybe the gross margin. I know in the prepared remarks, you had alluded to taking on some strategic supply inventory. I think there's been a little bit of questions out there around some of the component pricing dynamics that maybe you guys have been seeing, be it in spindle motors or also maybe on the substrate side. So can you help us understand exactly what you are seeing in the component supply chain and whether or not you're seeing some inflationary pressure and how you're managing that?

Yes, Aaron, thanks. Certainly, through COVID, where factories were so strained, there were people that needed help, and so we were out aggressively addressing that to make sure we had continuity of supply. And that's the comments that we made in the prepared remarks about the strategic inventory buys that we've done, just to make sure that we have the right inventory placement. Relative to the management, I think that's -- of the supply chain, I think that's really starting to equilibrate now, and I'm fairly happy with where we are. We've got our suppliers in line with our capacity planning again, and they're not getting turned off because of some of the COVID-related stuff, and I think it's very manageable from here. That's the way I look at it.

Yes, and you have seen from our guidance in the current quarter and how we guided the full fiscal year. We expect this quarter and the next couple of quarters to be a strong quarter, so we don't want to be limited by one component or 2 components. So we decided to beat a little bit of strategic inventory, but we will use in the next 2 or 3 quarters.

Great. And just as a quick follow-up, can you just give us an update on how we think about the capital expenditure plan, whether or not you're going to have to increase some of the wafer capacity? Or just any update on CapEx spending as we move forward?

Yes. So mass capacity has such strong growth for many, many quarters now and probably many years to come as well. We'll be continuing to pivot more of our capital allocation against that. We'll watch the legacy markets very carefully. Some, like we mentioned, consumer markets were still fairly strong. Others may be reaching a new normal as they continue to ramp down. We're not investing in those, and so we can pivot the capacity, whether it's wafer capacity or media capacity or drive capacity or whatever, we can pivot that capacity over that. And by the way, that goes against the supply comments or the suppliers' comments that you made as well, making sure we work all the way upstream in our supply chain with the suppliers to do that also. What we said specifically in the script is that we believe the industry has enough capacity in aggregate for that. We make those pivots. We'll still be needing to invest in what we call technology transition capacity, so the ability to make the new 18-terabyte and the HAMR drives and things like that. But that's not adding capacity, if you will. That's just investments in that technology transition.

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

Two, if I could. I'll ask them at the same time. Dave, I believe last quarter, you talked about fiscal year '21 nearline growth of -- I believe it was at least 35% exabyte. Is that still the case? You're reaffirming the flattish revenue guide for the year? And then also just on mass capacity, just so this is quick calculation. I don't know, and I'd love some context on this. This is like kind of like a dirty count, but the difference between overall mass capacity exabyte ships and nearline ships was the largest ever, and it tied for the largest ever and the largest delta this December quarter. And you're talking about pretty substantive growth, anecdotally, I think, coming quarters, and then you said kind of years. Any context around sort of what's going on with that market? Obviously, there is sort of supply chain stuff and China-related stuff, so there is congestion, a pent-up demand. But is that something that can -- are we talking about potentially 35% sort of nearline exabyte growth and then plus meaningful mass capacity growth sort of through fiscal year '21? I just would love some context because it clearly came back super strong.

Yes. Thanks, Ananda. So the first premier we're on was the 35% to 40%. We believe we're still on track to outstrip that this year. We've been talking about that, even as mass capacity was struggling earlier in this year because of surveillance market and so on. These VIA markets came back really strong, and that's the answer to the second part of your question. So that was definitely back in its normal traditional representation, maybe even a little bit greater, given all the disruption that's going on. The VIA markets were quite strong last quarter. We expect that to persist as well going on. It's logical recovery, I would say. And it's some of the new applications that are coming there, whether it's smart city applications or hospital applications, things like that. So we see a fairly healthy demand profile for that segment of mass capacity throughout the remainder of the fiscal year as well. So that's why we have a lot of confidence in those mass capacity numbers being so high.

And so just a quick clarify, Dave. So is it nearline growth, sort of greater than 35% fiscal year? And then mass capacity will be -- whatever it is, is coming back but that -- I'm sorry, not mass capacity, video-related, it's going to be something in addition to that. So we could see much more significant mass capacity growth in addition to the 35% to 40% nearline growth?

Yes. Sorry. So I wouldn't say nearline right now because of -- remember the on-prem discussions that we had last quarter. And so on-prem is still recovering, but it's just not strong. So yes, the 35% to 40% is mass capacity all in, to your point.

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

Just to follow-on those questions real quick. Can you just sort of go into why you think we're at a bottom in terms of the enterprise on-premise spending that you talked about in the prepared remarks and how strong that comes back, say, over the next few quarters to get to your full year outlook? And then in a similar manner, can you talk about the video markets? Obviously, they came back strongly. Like what's -- is it a different shape of business that you're doing now post COVID versus pre COVID? How would we compare sort of mix now versus then?

Yes. Thanks, Steven. So on-prem, I think, in hindsight now, which is -- we have really good visibility. I would say what happened with the early COVID supply reactions by a lot of customers caused pull-ins, and then the demand reality came later than that when people couldn't get back on-prem. So that's the bowl dipping, if you will, that caused a little bit too much inventory in the chain. We're still recovering from that, frankly. I don't expect it to recover to the prior levels because some of those markets, some of those on-prem markets like mission-critical, were actually in decline anyway. So we think they'll come back to maybe the prior declining run rate, if that helps you think about it. The nearline piece of the on-prem will actually come back because that's moving up in exabytes as well, and there's still a lot of value in nearline on-prem storage. Relative to the VIA markets and how they recovered so strongly, I think when people could -- generally speaking, when people could get back on-prem, they were looking for new applications. Some of them may have been facial monitoring, but some of them may have been temperature monitoring and some things like that. And when you do those installs, those upgrades, if you will, you don't have to install, you don't have to upgrade your entire network, you're upgrading typically the box that's the brain in the back room, and that has hard drives associated with it. So that's why we think that, that was so strong. Very global as well. So it all happened at the same time. And we -- again, we expect these kind of smart building, smart city applications to be continuing to be a good investment theme, such that if I look back year-over-year, we'll definitely get back to where we were year-over-year. We did last quarter, and we probably will going forward as well. The muted front end of this calendar year, just we don't know perfectly about the back end of the year, but we think that the VIA markets will be significantly stronger than that muted demand.

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

Dave, maybe just following up some of the comments you made earlier about capacity expansion and how you're transitioning to the nearline drive capacity demand that's out there. I know typically, CapEx is looking at a longer period of time on demand where your products are going. As you begin transitioning to HAMR, one, how do you feel about the capacity in place as the 20-terabyte HAMR drive gets released? And then secondly, over the next 2 to 3 years, do you believe you'll need capacity expansion to meet the demand for HAMR over the next few generations?

Yes. Thanks, Patrick. So a couple of things. We have quite a bit of capacity that is part of our installed base. And we've been thinking for many years about those tools, those tools that have been needed to make the HAMR transition. There are not too many incremental tools. So we feel like we can manage the transition quite well. We do need a little bit of, what we call, technology transition capacity to do that. To the first part of your question, the bigger issue is really how we forecast what's going on in legacy markets and how much we pivot to mass capacity. So we're going to be watching those legacy markets and what they'll do over the course of the next year. And it also started wafer, which is relatively long lead time, so we'll approach this judiciously. I do think, over time, we will need more technology transition capacity as HAMR continues to ramp. So I think that's a fundamental limiter, if you will. And then the market goes bigger than we can react very quickly, I think, on CapEx and especially with back-end test capacity or media capacity to react if the market goes big.

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

On the video and image market, you say that's coming back strong. Can you say geographically which area of the country -- world is it coming in?

Yes, Kevin, I would say the areas that -- almost everything was depressed, and almost everything is coming back. The distribution channel came back quite nicely in Asia, Southeast Asia and India and a little bit less so in Europe just last quarter based on timing. But we are seeing it come back everywhere. And I think it was a fairly healthy quarter for us widespread geographically.

Okay. Great. And going forward, you're expecting it to continue to grow. And can you give an estimate of how much of a capacity it is or how much of your exabytes?

Well, we talk about the max capacity volume, and we also informed the state about the nearline. I would say the difference between the 2 is mainly video and image applications.

Yes. There's a little bit of mass in the non nearline, if you will. But we said, I think 70% is nearline on the call. So if you think about that, of the 30%, it's the bulk of that 30%, although mass is a nice contributor as well and growing in exabytes.

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

Great. Maybe 2 questions. First question is relates to Huawei. I just want to confirm that, can you talk about whether you are continuing to ship to Huawei? And what is included in your December quarter guidance? It looks like your competitor may have stopped shipping maybe back in middle of September. And do you think you're seeing some benefits of that in your December quarter?

Well, I would say, Sidney, we don't talk about individual customers. I think if I go back 5 or 6 quarters now, we've been talking about how demand has been fairly disrupted, and particularly in China. And there's a lot of reasons for pulling in or pushing out demand, different projects that people are doing, financial planning they might be doing. We really focus on the end market demand, and that's how we construct our guide. I do think that relative to some of the products that we're talking about, there's a fairly healthy supply inventory in the chain, if you will, and that gets to the mission-critical question and whatnot. We're a global tech company. We have a broad network of suppliers and customers. We continually monitor and remain in compliance with all the rules and regulations around. I think relative to some of the legacy markets, I think we're just watching too much inventory out there. So I don't think it's material, but it's all factored into our guide about what's going on in the end markets. And then our long-term view is that mass capacity storage will find multiple routes to market, and that's what's growing, and that's the way we're positioning ourselves.

Okay. And maybe switching gears to talk about the nearline side. Dave, you talked about the timing of 18-terabyte drives that it will really depend on the customers' ramp. Do you have any insight as to when you will see maybe a unit crossover with 16 terabytes? And maybe going forward, when I start thinking about beyond 18 terabytes, do you think -- do you expect the market to do from 18 terabyte next year going straight to the 24-terabyte HAMR? Or do you think there is somewhere in between, let's say, the 20 terabyte a period where 20-terabyte is picking up? And how do you address that opportunity?

It's interesting. Our 16 terabyte is a very, very strong platform for us. So the unit crossover, we don't really think about it as units. It's actually such a similar bag of parts, as we've talked about before, that it's really a transition slightly in head capacity from our wafer fabs and some -- a little bit of media turns and a couple of other piece parts. So it's not a hard transition for us to make. We've been saying for multiple quarters now, we really like our 18 terabytes. It's a good quality drive. It's sailing through the qualifications at the right level. So it's really about aligning with what the customers need from a volume perspective, and I don't think it's going to cross over the next couple of quarters. We could drive it harder if we want to, but there's no real reason to do that, especially against the demand certainty that I think everybody needs. So the other point, I do think that ultimately, 18 terabytes becomes a big volume. I don't think people will wait for 20s. Although if an individual customer wants to do that, we'll go there with them. We're not going to talk about what our plans are there competitively, but I think there will be 20 terabytes in the market. I don't think everyone will wait from 16 to 24, though. I think the TCO proposition about requalifying an 18 or 20 or something like that is significant, and I think people will do that. So we're in deep conversations with all of our customers about this. These qual cycles take a long time. So we're locked and loaded with them on all this stuff and making sure we get them what they need at high volume.

Yes, I would say, for this calendar year, 16-terabyte is for sure the leading product in high capacity. And we expect in calendar '21 to transition more and more to 18 terabyte. And then, as you know, we are developing the first generation and the second generation of HAMR, but it will take it a bit longer time to transition, but we think we have a very strong road map.

Your next question comes from the line of Mark Miller from The Benchmark Corporation.

I'm just wondering, what's your outlook for gaming in terms of sales in the gaming application? Solid state memory has been showing up more and more. And what's your feelings about that?

Yes. Thanks, Mark. So gaming has been very strong as part of our consumer business for the last 2 quarters now. I think that's part of the work from home, learn from home and play from home, too. The interesting thing that's happening there is that not just the PC space, where some of the some of the interesting titles are getting -- the maths are getting bigger and bigger, but also the refreshes that are coming in the consoles, which we're tremendously excited about, we've been talking to customers for quite some time about. It says that the consoles are going to get bigger, faster, more powerful, the experience is going to be awesome. We're very supportive of that. I think when it comes to porting information from the old generation to the new generation, we think that we have a tremendously relevant role to play there. And then helping the architecture of a lot better performance and a lot higher capacity, we have a lot to offer there as well. So we're super excited, always have been. Admittedly, I've heard people talk about this segment before and not really know where it's going, and so maybe say, come to the wrong conclusions. That's starting to become a little bit more obvious as people are going through these transitions, but we're super excited about gaming, obviously, and I think it's a representative of what's going to happen to the edge over the next 5 years. Data has to get bigger, faster to be able to satisfy all the applications, and we believe this is kind of one of the lead dogs on that hunt, and so we're very active in participating in it.

You talked a little about the inventory. Inventories were up, but you say they're going to be coming down. Can you give us a little more color about what's going on with inventories in your belief?

Yes. Like we said, we've said in the prepared remarks that we've done some -- at a time when the market was relatively low, we wanted to make sure we didn't get into any situations where we had any losses in our factories because we didn't get parts. And a lot of suppliers, I think we need to appreciate that a lot of suppliers and sub-suppliers were having issues in their supply chain because of COVID and things like that. We didn't want to get into any of that. So we pulled a little extra inventory, and we'll bleed that out over the next couple of quarters, reequilibrate.

Your next question comes from the line of Jim Suva from Citigroup Investment.

As many of the questions were asked and you gave great details on, I'll pivot and ask one more about the stock buyback. It's kind of interesting to note the timing of it when you still had over $1 billion, if my math is right, about $1.2 billion left. And I believe in your prepared comments, you mentioned you'll kind of do it opportunistically or kind of as you go. So I'm just kind of thinking about that comment about why announce a big $3 billion in addition to the $1.2 million you have left. Or are you meaning to imply you're going to put the capital to use a little bit sooner because of the current cadence you have, it would still be well over a year to exhaust the $1.2 billion in that you have? So I'm just kind of triangulating about the timing and what you meant and the size of it, which is very impressive.

Yes. Just referencing our past authorizations. Our last one was in October of 2018. By the way, it phases up with our October Board meetings. That's part of our process to address these things, the dividend as well. Our last one was $2.3 billion of new authorization in October of 2018. The previous one before that was April of 2015. I think we -- to your point, we had $1.2 billion left. We wanted a little bit more flexibility to that, so we look out over the long term and make those decisions.

Your next question comes from the line of Mitch Steves from RBC Capital Markets.

I kind of want to turn back a little bit to the gross margin discussion there. It sounds like the higher-end companies or customers are starting to purchase more products. So I guess why isn't there going to be a year-over-year improvement in gross margin, particularly in calendar year '21, assuming that some of these operational issues kind of fade away due to COVID and all that stuff that happened this year, plus a mix shift to the high end? I guess why aren't we seeing that kind of flow through more next year?

Well, I think we'll flow through more next year. I think we're just in -- to your point, we're in the -- still in the throes of having factories that are underutilized and moving a lot of capacity from some of the legacy markets, which are under representative into mass capacity. We just can't do that, that fast. So we've got a little bit of overhang of what we've just been through. But I have confidence that we'll fill up the factories with the right product after that and be able to get solidly back into our margin range.

Yes. When we talk about COVID cost and the impact, we just communicate the direct impact, right? There are a lot of other negative impact that we have. For example, the underutilization that Dave is mentioning is not for sure including what we communicated as COVID-impacting total. So it's just a small part of that. So we think in the next 2 or 3 quarters, that will improve. And this is also not aligned to our CapEx discussion that we just said. So we expect gross margin and operating margin, which is more important to us, to improve in the next 2 or 3 quarters, hopefully.

Okay. And then just as a follow-up on that, just assuming that you're able to operate as usual, meaning that there's no distancing or any like that at the factory, et cetera, can you maybe help us understand what type of margin bridge you would normally see? So what I'm trying to get at here is you probably found some operational savings just given the work-from-home environment, and it could probably make some reductions there and adjustments there. So how do we think about the, I guess, organic gross margin number if we didn't have this kind of onetime impact?

Yes. I suppose organic gross margins, we'd be in our range, I think, based on the full utilization, if you will. We focus more on operating margin, and we've been tending towards the high end of our range. The reason we're at the low end of our range right now really is, to your point, it's the gross margin issue with the under absorption of the factories. But I think we'll continue to manage the operating margin range, try to get back to the high end of our range as quickly as we can. It will happen as a function of the footprint that we need from an OpEx perspective, which we benefit from no travel and everything else, everybody else, everyone else is talking about, just spending control, but also the gross margin that you're asking about.

The last quarter before COVID impact, we were actually above our long-term range of 13% to 16% in terms of operating margin. So the mix today is even slightly better, I would say, in terms of profitability. So we expect to go back to that level and even higher than that when the pandemic impact will start to decline and go away.

Your next question comes from the line of Nick Heisler from SIG.

Yes. And this is actually Mehdi Hosseini from SIG. I have one follow-up question, and I want to go back to your nice capacity, excluding nearline. It did double on a Q-over-Q basis. Is that driven by surveillance, especially in the APAC region?

Yes. Maybe it is. I mean especially APAC, I'm not sure I'd say especially APAC because I think it's picking up around the world. But it was so underrepresented around the world the quarter before because to our point, before, nobody could get back on-prem. Surveillance came back quite nicely. We reacted well to it. Some of that we were predicting, and some of that we had to react to. It's -- there's recovery in every market. Some markets are recovering faster than our projections, some are not as fast as our projections, but we had such confidence, especially later in the quarter. That's why we kind of we're communicating that, and surveillance was a strong part of it.

And I have a question on the object experience efforts. I could see why it would fit into your long-term strategy, but maybe you can help me better understand how you can avoid alienating your existing customers as you pursue this strategy. And essentially, it seems like moving up the stack.

Yes. I don't look at it as alienating simply because there really isn't an object store that's designed specifically for mass capacity. So many object stores, they're fantastic object stores that are out there. Some of them are very proprietary, others have come and gone, but a lot of them have been purposed for many other reasons, not just mass capacity. And so we're the ones designing the drives, we're the ones designing this object store. We're opening up the community so other people can help us. And that -- we've been getting great response for the communities, so thanks for pointing it out. I look at it as a great opportunity for mass capacity storage, whether it's on-prem or in a cloud or something like that. And we want partnerships. And we think if that's tailored to all the features that we need for our drives, whether it's MACH.2 drive or HAMR drives or any other features that we want to go develop. I think this will be the fastest route to market, the fastest, the best TCO proposition for people using it. And we're open to any partnership with anyone. I don't think it's going to be a threat to anyone.

Your last question comes from the line of Nikolay Todorov from Longbow Research.

Dave, I think in your last Analyst Day, you guided to CapEx to grow as a percent of revenue. And I believe at the time, the understanding was that your capacity mix between legacy and mass capacity was optimal. Now you're alluding that there's some underutilization because of access legacy capacity. I guess can you give us some color on what inning are we in that transition? I mean I understand that this is a continuous dynamic, but when can investor expect for you to optimize that capacity mix?

That's -- it's a good question. And what inning are we in? It's kind of hard to say because we're going to have to wait a little bit longer until we see the recovery out of COVID of all the representative markets. But it's exactly the way we're thinking about it, what you described. Before we could have said these markets will transition according to some game plan, these legacy markets will go out in 5 years or 4 years or whatever we were expecting. There's been some changes to that because of COVID. We either have to know if we get back on that curve or maybe that curve is a permanent downshift and then we can transition the capacity. So we're making that investment. And I think the key point is that from our perspective in the industry, I think everybody is going to have to go through this relative to the footprint, and we like our chances relative to that. We're just telling you that we'll probably be below our 6% to 8% range that we would have talked about in that Analyst Day because of the impact of COVID.

Okay. And related to that, I think you guided to mass capacity exabytes growing that 35% to 40% for fiscal year '21. I guess are you willing to give us a number for total capacity for fiscal year '21 growth, including legacy?

Yes. No, we've never just really done that before. I mean we've been very focused on the growth market of mass capacity. And now that it surpassed legacy significantly, I think that's the growth driver. The legacy markets, to be very frank, we're still studying them because, like I said, things like consumer were maybe ahead of where we thought they would be because of COVID and other markets may be underrepresented. So...

Okay. And if I can just squeeze one more. You mentioned different demand profile by cloud customers. Can you maybe talk about that in terms of geography, particularly interesting hearing your take on the China cloud demand? And maybe where is the volume in terms of capacity with those customers?

It's a very complex question. It's a very good question. It's something that we struggle with as well. There's many different types of applications. There's not just one kind of cloud service provider, one kind of application, one kind of drive, if you will. So from our perspective, the investments that the cloud customers are making depend upon all these different strategies they might have. From our perspective, we have a great portfolio lineup. We can transition from products that in our factory and from one customer to another given enough lead time, and we have good relationships with all those customers. So I do think that there's some things in the cloud depending on where you are geographically, where there are logistics challenges to grow. I mean we said this a little bit last quarter. You can't build data centers or you can't get people on-prem to build them. So there are priorities being made for service level agreements, where people in the cloud may have a real strain on them at the front end with compute or networking or something like that, and that may push off some of the mass capacity install. We're working with customers on that, too. So we know the demand is coming. We just have to make sure we're tight with the customers about what they need, exactly when.

June quarter was a record quarter for cloud. September was not at the same level but was very healthy, and we expect December quarter to be still very strong.

There are no more questions. I'll turn the call back to management for closing remarks.

Thanks, Jason. Seagate continues to execute well through the current business environment. We're very encouraged by the improvements that we're seeing in some of the end markets, and we expect gradual recovery throughout this fiscal year. Longer term, we see no change to the secular growth in mass capacity data, and we're very excited by the opportunities that we can foresee ahead. I'd like to once again thank all of our customers, suppliers, business partners and our employees for their ongoing support of Seagate. Thanks, everyone, for joining us today.

Thank you, everyone, for joining today's call. That concludes the conference call, and you may now disconnect.