Seagate Technology Holdings PLC

Seagate Technology Fiscal First Quarter 2020 Financial Results Conference Call. My name is Denise, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. As a reminder, this conference is being recorded for replay purposes. At this time, I'd like to turn the call over to Shani Hudson, Vice President, Investor Relations. Please proceed, Shani.

Thank you. Good morning, everyone, and welcome to today's call. Joining me today 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 2019 quarter on the investor section of our website. During today's call, we will refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and Form 8K 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, reconciliation to the corresponding GAAP measures is not available without unreasonable effort. 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, and general market conditions. These statements are based on management's current views and assumptions and should not be relied upon as of any subsequent date. Actual results may vary materially from today's statements. Information concerning our risks, uncertainties, and other factors that could cause results to differ from these forward-looking statements are contained in our most recent Form 10-K filed with the SEC, and the supplemental information is posted on the Investors section of our website. Following today's prepared remarks, we'll open the call for questions. And with that, I'll now turn the call over to Dave.

Thanks, Shani. Good morning, everyone. And for those of you here in Europe, good afternoon. Thanks for joining us. I will start today's call by summarizing key highlights from the September quarter, sharing our views on the market and their relevance to Seagate, and outlining the progress we've made on our key priorities. Afterwards, John Luther will provide further details on our financial results and our outlook for the December quarter. Following the prepared remarks, we will open the call for questions. We've had a solid start to the fiscal year, increasing revenue, non-GAAP operating profit, earnings per share, cash flow quarter over quarter. Our focus on optimizing profit dollars is driving strong and sustainable operating cash flow to fund our future growth, extend our technology leadership, and sustain our strong capital return program. Over the past 12 months, we have returned a total of $2 billion to our shareholders through a combination of dividends and share repurchase, reflecting our ongoing commitment to enhancing shareholder value. Our board approved an increase to our quarterly dividend demonstrated their confidence in our future growth and cash generation capabilities. This marks the first time in four years that we've raised our dividend. Moving forward, we plan to review the dividend payment consistently over time. Let me now share some perspectives on the near-term market environment, starting with mass capacity storage. This market is growing, both in terms of dollars and exabytes, and is comprised of nearline, video and image applications, including surveillance, and NASDAQs. The mass capacity storage market supports cloud and edge applications that are data-centric and require reliable, cost-effective, high-capacity storage best suited to HDDs. In the September quarter, we delivered strong double-digit revenue growth in Nearline, supported by improving demand across cloud and hyperscale customers. We are aggressively ramping our 16-terabyte Nearline drives to fulfill strong customer demand for these products. more than a dozen cloud and OEM customers qualified and several others underway, we are executing very well and are tracking to plan against our product maturity and customer qualification timelines. Based on our current outlook, we expect to ship more than 1 million drives in the December quarter, which would make 16 terabytes the fastest near-line product ramp in Seagate's history. Revenue from video and image applications declined in the September quarter following an unusually strong June period. Geopolitical tensions and regulatory hurdles continue to disrupt customers' typical buying patterns across multiple markets, including surveillance. We expect some demand volatility to persist over the near term. With the transition to IT 4.0, we see the emergence of edge storage applications, which, like surveillance, utilize high-definition video and image processing. For example, smart factories, smart cities, and IoT all require large, amounts of data which can benefit from low-cost, high-reliability disk drives. We believe these video and image processing applications continue to represent meaningful growth opportunities for Seagate over the long term. In our legacy markets, which include mission-critical, desktop, notebook, DVR, gaming, and consumer applications, we saw a seasonal uptick in revenue in the September quarter. As we've shared in the past, these markets contribute to Seagate's cash flow while requiring little additional investment. Importantly, many of the enterprise customers and OEM partners that we are supporting in the legacy markets are the same ones we expect to create new storage growth opportunities at the edge and in private clouds, along with other new customers. With the trend toward the multi-cloud world and the build-out of the private cloud, customers are seeking to follow the same economical disk-centric storage architectures as the large public cloud providers. Low cost, High-density storage platforms are an integral part of the solution to address data-rich workload requirements, and Seagate's high-density, scalable system solutions are ideally suited to these big data applications. We believe Seagate's strong technology roadmap, broad product portfolio, and deep customer relationships make us well-positioned to capitalize on the significant opportunities we foresee ahead. We forecast the mass capacity storage revenue TAM will more than double from current levels by 2025 supported by ongoing demand from the public cloud, the build-out of the private cloud, and emerging edge storage applications. To capture this growing demand, we are executing our strategy to be first to introduce new product solutions to the market and consistently deliver cost and performance benefits to our customers. Today, Seagate is the only company mass producing 16 terabyte drives, which are the capacity benchmark for the industry. We are preparing to ship 18 terabyte drives in the first half of calendar year 2020 to maintain our industry capacity leadership. We are also driving aerial density leadership with our revolutionary hammer technology, which enables Seagate to achieve at least 20% aerial density over the next decade. We remain on track to ship 20 terabyte hammer drives in late calendar year 2020. As drive densities increase, Multi-actuator technology is required to maintain fast access to data and scale drive capacity without compromising performance. We generated revenue from our Mach 2 dual actuator solutions for the first time in the September quarter. We are working with multiple customers to qualify these drives, including a leading U.S. hyperscale customer who is qualifying the technology to meet their rigorous service level agreements without having to employ costly hardware upgrades. We expect to see demand for dual actuator technology to increase as customers With that, I'll turn the call over to Gianluca to go into more depth on our September quarter results and share our outlook for the December quarter.

Thank you, Dave. We executed well in the first quarter, growing revenue, operating income, and operating cash flow to support strong return for our shareholders. Compared to the final quarter, revenue increased 9% to $2.58 billion. above our guidance midpoint. Non-GAAP earnings per share were $1.03 at the high end of our guidance range. Our performance was underpinned by improving demand for mass capacity storage. Total exabyte shipment increased 16% quarter-over-quarter to 98 exabytes, driven largely by our near-line products. Revenue for the enterprise market which includes near-line and mission-critical drives, represented 45% of total September quarter revenue, up from 41% in the June quarter. Exabyte shipments into the enterprise market increased 34% sequentially to 51 exabytes, with near-line drives representing the vast majority of that total. Average capacity per near-line drive increased 10% quarter over quarter, reflecting the ongoing transition to higher capacity points. Our 16 terabyte drive was the fastest growing near-line product, both in terms of revenue and exercise. We anticipate strong demand for these products across cloud, hyperscale, and OEM partners, and expect 16 terabytes to be our highest enterprise revenue product in fiscal Q2, and our largest company revenue contributor in fiscal Q3. ahead of our prior expectation to meet this milestone in the fiscal Q4 timeframe. Revenue indexed by Siemens for our mission-critical drives was sequentially higher in the September quarter. We continue to service customer demand for these performance drives, which have remained fairly consistent over the past several quarters. Revenue for the edge non-compute market represented 31% of total September quarter revenue, compared with 34% in the June quarter. Exabyte shipments remain flat at 33 exabyte quarter over quarter. Edge non-compute is comprised of surveillance, nulls, scanning, DVR, and consumer applications. As noted on our prior call, a few surveillance customers accelerated demand into the June quarter, which resulted in slightly lower revenue in the quarter. As Dave mentioned earlier, applications such as surveillance, which utilize high-definition video and image processing, continue to be a meaningful growth opportunity for Seagate moving forward. Revenue from the edge compute market, including desktop and notebook drives, contributed 17% of total revenue, compared to 18% in the June quarter. Extra bag shipments increased 7% sequentially to 15 extra bags, reflecting seasonal demand for both desktop and notebook drives. Aligned with what we presented during our recent analyst day, we will change how we present our HDD business. Starting in the December quarter, we will break out revenue and extra bag shipments in two primary categories, mass capacity storage and legacy markets. Mass capacity is made up of near-line, video and image applications, and maps. This represents a growing market that supports data-centric applications requiring high-capacity, low-cost storage while suited to HDDs. Our other HDD products are sold into legacy maps. Mass capacity storage has been increasing as a percentage of our total revenue and contributed 47% of September quarter revenue, compared with 35% just two years ago. We expect this growth trend to continue over the next few years. The legacy market made up 46% of total September quarter revenue. Our non-HDD business made up the remaining 7% of revenue, with growth from both system and SSD solutions. and this drive revenue up 12% quarter over quarter. We continue to gain traction in our system business with OEM and other customers. Within our SSD business, the pricing environment has been challenging for multiple quarters. Our main focus has been on enterprise SSDs, which complement our mass capacity HDD solution to provide our customers with a more complete storage solution portfolio. We remain focused on servicing those areas of the market where Seagate can deliver value to our customers. As a reminder, we extend the useful life of our capital equipment from a range of three to five years to a range of three to seven years, which resulted from a more efficient use of capital. This change lowered September quarter depreciation by approximately $23 million. a majority of which was included in cost of goods sold. Accounting for this change, non-GAAP gross margin for the September quarter was approximately flat with the prior period at about 27%. On top of the challenging industry conditions we discussed over the last few quarters, we encountered higher than expected costs associated with the initial ramp of our new product. which impacted gross margin by approximately 50 basis points. Looking ahead, we expect margins to improve as production scales and 16 terabyte drives become a more meaningful part of our total revenue. Non-gas operating expenses for the 14-week quarter came in lower than planned at $359 million. Discretionary costs and costs associated with extra weeks were both lower than our original outlook. We are continuing to efficiently manage expenses and optimize profitability. In the September quarter, we expanded non-GAAP operating income to $329 million for approximately 13% of revenue. We expect to see financial leverage as we grow revenue and execute our roadmap to reduce cost per terabyte. We deliver non-GAAP EPS of $1.03, which was at the high end of our guidance range. Capital expenditures for the quarter were $147 million, representing about 6% of September quarter revenue. We expect CAPEX for the fiscal year to be near the midpoint of our target range of 6% to 8% of revenue to support our Exabas capacity expansion plans and prepare for the ramp of our AMR technology. We deliver LP-free cash flow of $309 million, up 4% sequentially. We utilize $450 million to retire 9.2 million ordinary shares, exiting the quarter with 263 million shares outstanding, down 8% from the prior year. Through a combination of opportunistic share reports and dividends, we returned $620 million to shareholders in the quarter. As we highlighted during the Annals Day, our board approved a 3% increase to our quarterly dividend payment to $0.65 per share, available on January 8, 2020. This increase reflects our positive long-term demand outlook, as well as our confidence in sustainable cash generation. We have also been focused on further improving our balance sheet. During the September quarter, we successfully marketed a $500 million six-year term loan to restructure a portion of our debt. Through this effort, we extended the average debt maturity profile, lowered annual interest expenses by $13 million, and reduced total debt to $4.1 billion. As of the end of September, cash and cash equivalents were $1.8 billion, with access to up to $1.5 billion available through our revolver. Looking ahead to our outlook for the December quarter, we expect total revenues to be in the range of $2.72 billion, plus or minus 5%. Non-GAAP operating margin is expected to be above the midpoint of our long-term target range of 13% to 16% of revenue, driven by top-line growth and improved gross margin. And Nonga PPS is expected to be $1.32 plus or minus 5%. Overall, we are executing very well. And while we continue to face geopolitical challenges, we believe improving industry demand with the name of our 16 terabyte drive, the third foundation for revenue and profitability growth in the fiscal year 2020. I will now turn the call back to Dave for final comments. Thanks Gianluca.

In summary, Seagate is consistently delivering solid performance and advancing our key business initiatives. We are generating sustainable cash flow and and directing capital towards areas that provide the greatest return for all of our stakeholders. We are successfully scaling exabyte capacity and executing the company's fastest ever production ramp on a nearline drive at 16 terabytes. We are on track to introduce AMR and Mach 2 dual actuator technologies to drive aerial density and scale performance with capacity to deliver lower total cost of ownership to our customers over the next decade. While we are mindful of global macro uncertainties and the recent industry dynamics, we remain focused on delivering value for all of our stakeholders by executing our technology roadmap and optimizing profitability and free cash flow. We continue to expect revenue and profitability to grow in fiscal 2020, with the second half projected to be somewhat stronger than the first, supported by our 16 terabyte ramp and improving mass capacity storage demand. Through our ongoing execution, leading technology roadmap, and deep customer relationships, Seagate is well-positioned to capitalize on the significant opportunities in mass capacity storage. Before opening the call for questions, I would like to take a moment to thank our customers, suppliers, business partners, and employees for their contributions to the ongoing success of our business. Gianluca and I will now take your questions.

Ladies and gentlemen, to ask a question, please press star, then the number one on your telephone keypad. To withdraw your question, press the pound key. We ask that you limit yourself to one question and one follow-up. Your first question comes from Carl Ackerman with Cohen. Your line is open.

Hey, good morning, everyone. Thanks for letting me ask a question. Two, if I may. You know, there's been much investor debate whether you are better positioned among peers to regain share in their line. As you win one peer out of 16 terabytes today, another one is in the lead on 14. But are there any other attributes that you'd like to call out that we should be aware of, aside from just capacity per drive, that would enable you to gain share over the next few quarters? Now the follow-up, please.

Yeah, thanks, Carl. I think, simply put, the demand is increasing in Nearline, and we also see that the 16 terabyte is latched with customers, and so we have fairly good relationships. Predictably, getting into their architectures, I think we feel pretty comfortable that we'll be able to hit this volume ramp. I can't really speak to what other people might do on their capacity points, but being that that's the leading exabyte point that's right in front of us, and probably a significant portion of the next calendar year as well, we'd feel pretty strong.

Got it. That's helpful. If I could ask a question on gross margins, which I know the message today and on your analyst day has been around operating margins, but one of your competitors this week alluded to some pricing pressure in your line. Do you think that pricing pressure will get worse before it gets better? Do you think pricing is the main reason why maybe we haven't seen an inflection yet in your margins, gross margins, that is, despite higher levels of enterprise mix? And maybe more importantly, though, you know, as we continue to push the aerial density curve, you know, and you certainly can leverage the additional capital required to pursue this greater complexity of heads and disks in the high capacity points, you know, why can't margins push toward that forehandle?

Thank you. They certainly can. I'll let John Luke elaborate on the impact of the ramp cost that he mentioned in the script. But first, just let me say that in our business, to your point, gross margin is a function of supply and demand. It's very specific to the demand for the products that you have. And for the last few quarters, Exabyte demand was relatively weak. I mean, if I go back three quarters ago, we sensed that this was happening. We made conscious decisions to throttle bills, manage cash, inventory really carefully and also start converting production to the new platforms. By the way, the new platforms are not just the 16 terabyte, but we have continued ramp of various cost reduction for other products across the portfolio. So demand's definitely picking up. That's one of the reasons why we're confident. The strength of the demand will go through the back half of this fiscal year, I think, and potentially even further than that. We feel like calendar year 20 is a lot stronger than calendar year 19, and with the new products, I'm confident we'll get into that op-inc modeled range that we talked about quite quickly. That's why John Luca mentioned that we'd be above the midpoint of our long-term operating range in Q2. Ben, we'll be driving to your point. I think gross margins will rise with all those dynamics, and John Luca, I'll let him elaborate here.

Yeah. Hey, Carl. Thank you for the question. So as we discussed in the previous earning release call, we didn't run all the production at full capacity in the last two or three quarters. And that was generating underutilization charges that was higher, let's say, three quarters ago and then starting to reduce. During this period of time, we were still adding capex, giving us the opportunity for even higher capacity when we were ready to take benefit from that. Right now we have strong demand, so we are ramping hard, especially our 16 terabytes, but also other products on lower capacities. When we ramp so fast, sometimes you have additional cost, a little bit lower yield, a little bit of additional scrap. We had a little bit of those impacts in SQ1. We don't expect that to happen again in SQ2 and after that. So we expect margins in general, so gross margin and operating margin, to improve starting SQ2.

I think one other point we'd make is that, to your point, we have to make sure we make the investments. So we've been investing in CapEx for the heads of media that we need to stage for the X-Men growth. We have to make sure we make those investments and get paid for those investments.

So we're mindful of that over the long term as well. Your next question comes from Stephen Fox with Cross Research. Your line is open.

Thanks. Good morning. I had two questions. First, a follow-up on the gross margin question. I know you're not providing guidance beyond the current quarter, but is it safe to assume that as you ramp capacity down, The yield issues and scrap issues that you mentioned are less than the incremental margins that you would garner from the new products. If you could just sort of elaborate on what that path might look like, and then I had a follow-up.

Yes, Stephen, that's exactly the right way to think about it. And it's not just one capacity point, which we all tend to fixate on. There's other cost refreshes, as we talked about, through the rest of the portfolio. So we feel pretty good about that strength going into next year.

And in... We are saying that we expect the second half of the fiscal year to be stronger than the first half. So, of course, this is part of our confidence in the results.

Great. That's helpful. And then just a question on the surveillance drives. I understand what you said in the prepared remarks about, you know, the tougher comparisons and some of the changes that you saw this quarter. What does the recent demand say, though, for surveillance drive prospects for the, you know, the next few quarters? Are you lowering those, or do you see different mix of capacity points, et cetera? Can you just give a little bit more view on that? Thanks.

It's a really interesting question. If I go back about a year to 18 months, the box demand was actually higher. The exabytes have grown, certainly, in surveillance and some of the other mass capacity markets, but we started talking about three quarters ago about demand disruptions. And, you know, it's kind of Interesting that people want to focus that on just one locale, but really that can be much more broadly based, and it could have to do with people pulling stuff in because they're speculative. Maybe they think they can gain share or something like that. So that demand has been disrupted for quite a while. The end demand, the end market demand is strong for exabytes, and we believe it will continue to grow strongly next year. It's exactly how we satisfy that end demand is still in question, and What's interesting about some of the global markets is they're really more what we call white van markets. There's the people making the final buy decision out there is actually doing integration in a business or in a home or something like that where it's a fairly small lot size. We don't think that in demand is slowing down at all. As a matter of fact, we think it's growing.

Great. That's helpful. Thank you.

Your next question comes from Katie. Hubbardy with Morgan Stanley, your line is open.

Thank you. A couple questions. First, enterprise price per exabyte fell much more this quarter than in the recent history. Can you just talk about, is that mixed or like-for-like price aggression in the market?

I don't think ours fell too much. I mean, we're still... analyzing what just went on, but I don't think ours fell too much. You know, I think, Katie, what I would say is a few quarters ago, demand was soft, and so therefore there may have been some behaviors like that. I think as we feel going forward, we feel very confident about where we are, and that's one of the reasons why we think we can get back into our gross margin range.

And then last quarter, you talked about some different behavior and buying in the China market. Intel gave an actual revenue attribution to some pull forward of demand ahead of tariffs. Any dynamic in your business this quarter as it relates to a benefit from early buying around trade negotiations?

I would say that it's still disturbed, to your point. That's kind of what we discussed not only last quarter but the quarter before, I think, as well. To Steven's question, those disturbances are still present. I think we said something like that in the prepared remarks as well. I think that the end demand is still that strong, and I feel like calendar year 20 will be better than calendar year 19. Certainly going into January quarter last year, we were signaling that we saw the softness. So the end demand is still there, I think, and it's just a matter of how do we exactly fulfill that end demand.

Thank you. And going back to your question for pricing per terabyte in near line, as you know, we also increase our average capacity per drive in that segment, and usually when you have this increase of average capacity, you have a little bit of decrease in price per terabyte.

Okay, understood. Thank you.

Your next question comes from Aaron Rakers with Wells Fargo. Your line is open.

Yeah, thanks for taking the question. I have two as well, if I can. I guess going back a little bit to the gross margin line, you know, obviously the yield ramp on 16 TVs, and then I guess as we look forward, you know, the progression of Hammer into next year. But I'm just curious, as you kind of add capacity, how should we think about, you know, the level of capacity shifted? as kind of, you know, your kind of full utilization level here as we look out over the next couple of quarters. I'm just kind of curious, you know, relative to where we stand this last quarter at 98 exabytes.

Yeah, I think the exabyte capacity will go up very strongly over the next few quarters. I'll let John Luca talk here in a second. But, Aaron, the way I would say it is 16 terabytes is some of the driver for that. There's other products across the portfolio that are driving as well, the margin improvement. We think we've positioned things well. It's a subtle point, but a lot of the capital positioning is actually in heads and media, so it's different than drive capacity, if you will. And so what we're really responding proactively to is that exabyte growth, making sure we have the right products ramped at good yields and everything else for when the demand gets bigger.

Yeah, we are still not at full capacity, and we are still adding some capex. We have a huge expectation for volume increase demand in the next, I would say, two or three quarters. So we are preparing to satisfy that demand, and we should be at full capacity, I would say, maybe in two quarters from now. But, of course, it depends on how much capex we want to add in the future.

And over the very long, you know, that's long lead time capital as well, but over the very long haul, I think to one of the earlier questions, we need to make sure we have that capacity in place because we do believe there will be constraints.

Okay. And then just as a quick follow-up, as you know, there was not necessarily a competitor of yours, but a company last night alluded to, you know, basically a notable pause at one of the hyperscale guys. They also talked about you know, hyperscale, you know, companies moving, you know, moving to almost a more real-time procurement cycle. How would you characterize your engagement with the hyperscale guys as far as visibility in demand for the near-line drives? Has that changed at all over the past few quarters as we kind of think about this recovery that seems to be, you know, you're confident kind of continuing to last over the next couple quarters?

I would characterize our engagement as very strong, and their problems, depending on who they are, they're different, but their problems are very complex. So it's not a one-size-fits-all answer. And I think part of the issue that you might see with other companies, I don't want to speculate too much, but the issues you might see if you're qualified on one part of an architecture and all of a sudden that architecture gets delayed for whatever reason, it can be impactful. I think, generally speaking, some componentry, and hard drives are in there as well, tend to be fairly broad-based, although, for example, we may have an eight-terabyte drive qualified on one architectural point, and that doesn't move as fast, so it's not like the entire fleet transitions at the same time. These customers have complex, not only supply chains, but also problem sets themselves, and I'm speaking globally as well. The bigger the world gets, the more there's some of these inherent inhibitions complex sets. So it's not surprising to me that, you know, from time to time that you can see one architecture affecting you. But I think, you know, most of the demand that we see across ExaBytes is broad-based across architectures. That's what drives our confidence. Okay. Thank you.

Your next question comes from Christopher Muse with Epicor. Your line is open.

Yeah, thanks for taking the question. First question, as you think about the 16 terabyte ramp, really celebrating it in the first half of the year, how should we think about seasonality into your March quarter versus what typically, at least over the last five years, has tracked down 10% sequentially?

Yeah, good question. Thanks. There will be seasonality in some of the legacy markets that we always talk about, but I think The exabyte demand in the mass capacity markets is strong, and there are obviously dynamics in one quarter with Chinese New Year coming, and then the quarter after that is the seasonally weakest quarter, but we think that there's such strength. That's why we're so confident on our back half revenue numbers that I made reference to earlier. a fairly large transition that will happen between people who, exactly to the earlier question, that people who were on 8s or 12s or 14s and may transition to 16s or 18s sometime way late next year. As all those transitions go up, the exabytes growth is very good, and so getting our stuff staged is our top priority.

Very helpful. As my follow-up, considering you had the extra week in the September quarter, Is the math just simply removing that week, so roughly 350 million OPEX? And as part of that, how should we kind of model the trajectory of OPEX beyond the December quarter into 2020?

Yeah, OPEX for SQ1 was actually a little bit better than what we were planning. But you are right, so it's one extra week. I would model fairly flat for the next maybe quarter or two.

We think we can support all the customer transitions that we need to without raising OPEX. You know, we could always trim if we had to, depending on macro conditions, but we don't really see that need right now. So I think flat is a good way to model it.

So to be clear, so flat at 378, even though you had the extra week in September?

I think your 378 is probably including share-based compensation, so you should take that out. Just look at what we reported, yes. Okay, good.

Your next question comes from Ananda Baro with Loop Capital. Your line is open.

Yeah, thanks for taking the question, guys. I was going to say good morning, but good afternoon for you guys. Two, if I could. The first is a clarification on gross margin. Gianluca, you had mentioned... one or two items that could be adjusted back to get a sense of structural gross margin. You mentioned 50 basis point headwind from new product ramp costs, and then there was mention of a 23 million impacted gross margin as well. Are those separate items? And I guess my question, if they are, is an accurate way to think of kind of structural gross margin costs I get 50 basis points impact from each of those. So it would actually be 100 basis points higher for the quarter. And walk us through that if that's not accurate. Thanks. And I have a quick follow-up.

Sorry, Ananda. We couldn't hear your second part of the question. So the 50 basis points, we got it. What is the second one?

The other one was there was a mention, you made mention of a $23 million impact And the question is, is that separate from the 50 basis points from the new product cost ramps?

Yeah, so, yeah, the 50 basis points that are related to, let's say, lower yield and higher scrap related to the ramp, we don't expect that to happen in FQ2, so you should count that as an improvement. I think the $23 million that I mentioned in the prepared remark was a depreciation change, or the impact of the depreciation. Now, in FQ2, you will have a little bit higher impact, so you should consider also this one. The timing when you start the change, part of the impact is in inventory. So Q1 was the P&L impact was $23 million. Max Q2 will be a little bit higher. Not much higher, but a little bit higher.

Got it. Got it. Understood. And then the second question is just with regards to where the hyperscale cycle is right now. Dave, is it accurate that you mentioned in the prepared remarks that it's a little bit ahead of expectations where you guys thought it would be? And then... You know, I guess, like, you made comments in the past about what you think potential for this cycle could be with regards to growth. Do you still feel those are valid? Could you give us an update there, how you feel, you know, sort of what you're thinking in terms of growth potential?

You know, from a demand perspective, it's about where we thought it would be. It doesn't mean that it ticks and ties completely. everywhere we thought it would be, but it's about relative to where we thought it would be. There is some indication that there's, to the point I made earlier about the complexity that some of the global partners have to qualify new products and things like that, we think that there's a little bit of inertia around that, but I actually suggest that even though it might be later, it suggests a higher demand. To get back to the point of 18 months ago when the demand was very high, So that's one of the reasons we feel comfortable about the demand cycle. I think what we talked about was the 16 terabytes on plan to slightly ahead of plan, so happy with the qualifications across more than a dozen OEMs now. We shipped those first drives in April, remember, so there's been a lot of work to get here. The qualifications have run very well. Customer demand's high, and that's where we get more bullish.

Okay, that's great. That's helpful. Thanks a lot.

Your next question comes from Mitch Steeves with RBC Capital Markets. Your line is open.

Hey, guys. Thanks for taking my question. I've got two. The first one is just to kind of splash out a bit on the data center side. So am I hearing this right that the data center piece is probably going to be one of the faster-growing end markets for you guys in kind of December and March? Is there any way to directionally help us out in terms of what markets you guys are seeing do better over the next couple quarters or so?

Yeah, I think definitely data centers are the strength that we're seeing. We call it all near-line to your point, but globally different people are building out different types of data centers, but we call it all near-line strength.

Yeah, the second one I had is your competitor kind of talked about 30% gross margins for hard disk drives in December. So how long should we expect kind of the product transition? I kind of understand the the investment cycle out there, but how long do we wait until you guys think you can hit maybe 30% on the HCD side?

Well, we don't guide gross margin. As I said, we expect FQ2 to be higher than FQ1, and you can probably model based on our revenue and EPS guidance. But as we said, we expect an improvement quarter over quarter.

Yeah, OpBank will be above the midpoint of the range as well. So we'll just continue to look at the value that we provide. And, you know, the customer's demand, like I said, is strong. So we'll continue to work that. Our cost reductions are good. So all the vectors are pointed in the right direction, but we don't want to get specific on guidance.

Yeah, let me ask you a different way. Is 30% attainable for the company for gross margins?

Certainly, if the demand is The picture's high enough, yeah. I mean, we've, you know, intentionally driven the operations to be sized for Exabyte growth, and, you know, if the demand picture goes there, then we have the right products to get it, sure.

Perfect. Thank you so much.

Your next question comes from Mark Delaney with Goldman Sachs. Your line is open.

Yes, good morning. I have two questions as well. Thanks for taking them. First is on the fiscal 20 revenue outlook. I think at the analyst day, the company talked about the potential for revenue to increase in fiscal 20. And on the comments today, we talked about having some good backlog and expecting strength in the second half fiscal 20. So as you said today, do you still think that's achievable and any more quantification you may be able to provide around fiscal 20 revenue?

Yes, that's the right takeaway, Mark, and that's where the confidence comes. The one thing I did mention earlier was as some of the transitions that are going on globally from one platform to another inside some of these different customers, there's more opportunity, I think, for us to have a better product portfolio in there, whether it's a lower cost portfolio you know, lower capacity drive, or whether it's the 16 terabyte, you know, kind of marquee point, that provides us opportunity to get more revenue than we have.

Okay. My second question is a follow-up on some of the prior questions on gross margins. Understanding there's been some near-term headwinds around costs and yields, but if we look at gross margins for both Seagate and your main competitor, they're down cycle to cycle compared to where they had been in past points when your line was doing well. And I'm I understand maybe pricing has gotten a bit more difficult, but is there anything else beyond pricing that is maybe more structural? I don't know if as near-line mix increases more towards hyperscale compared to being more balanced in the past between OEM and hyperscale. Is that having an effect or anything else that may be more structural versus temporal in near-line gross margins? Thanks.

Yeah, I can only really speak to us. So what I would say is that demand is not as strong as it was 18 months ago, to your point, the peak of the last cycle, Q4, Q1, a year ago. Demand was quite strong then, so it's not been as strong, but we think the strength is building. That's what we've been talking about. And then having the right products available. in the market that we feel comfortable to ramp and, you know, high volume against that. That's what gives us the confidence. Thank you.

Your next question comes from Vijay Rakesh with Mizzou. Your line is open.

Yeah, hi, guys. I was just wondering, as you look at the next hammer transition, when do you expect that to ramp? What do you expect the mix would be end of 20 or mid-21? And if you would give us some margin profile or cost profile on that. Thanks.

Yeah, I think that's, thanks for the question. There's the highest capacities, which depending on where you're shipping them, the qualification cycles can be long or short. There's also opportunities for even lower capacities built off that same platform. So, you know, we'll ramp that to your point as the yields make sense and as the cost makes sense to insert into the market. As time goes on, we gain confidence because we keep solving the engineering problems. So we're pretty confident pretty happy about that. I think there's, you know, there's 18 TB before there's 20 TB as well. So I think that's going to come to the market. But the hammer transition is ultimately something that's going to drive us forward into 21 and 22, and we'll continue to ramp there.

Got it. And I think you mentioned in your line, overall you're seeing a little softness As you look through 21, do you expect overall data center spending, year-line spending to be more back-up-loaded or middle of the year? Any sum of color if you can give? Thanks.

Are you talking about fiscal year or calendar year?

Calendar year, sorry.

Oh, sorry, calendar year. So, yeah, calendar year 19 was relatively muted, especially in the first two quarters. counteryear 20 will be stronger year over year, and it's more broad-based exactly to your question. Not only the exabyte transitions that are going on, but the demand picture as well.

Thanks.

Your last question comes from Jim Suva with Citi. Your line is open.

Thanks very much. Earlier in the call, you mentioned you'll be fully loaded or higher utilization rates. Can you remind us of that time period and was that calendar or fiscal year? And then as a follow-up, as Hammer ramps up, will there be much of an impact to operating or gross margins as we go about that? I know certain technology changes do have a meaningful impact to margins like short-term headwind and then longer-term positive, but I just didn't know with Hammer ramping if it's going to be material to your company-wide margins. Thank you.

In terms of capacity, I said we would be close to full capacity in the next couple of quarters, so let's say in the first half of calendar year. And Dave may be taking the hammer question.

Yeah, I think on hammer we'll do the right thing. As time goes on, we'll continue to manage for operating income and free cash flow and continue to work the cost to the earlier question. I don't expect it to change the model. Obviously, we want to drive the model as hard as we can, and if we can drive to the high end or drive the model up, that's great too. But I don't expect Hammer to change the model.

Thank you so much for your clarifications. It's greatly appreciated.

Thanks. And now I'd like to turn the call back over to Dave Mosley for closing remarks.

Thank you. I want to once again thank all of our employees, customers, suppliers, and business partners for all their contributions to our third quarter performance, and thanks to our shareholders for their ongoing support. We'll talk to you all next quarter. Thanks.

This concludes today's conference call. You may now disconnect.