Seagate Technology Holdings PLC

Welcome to the Seagate Technology fiscal third quarter 2023 conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Shani Hudson, Senior Vice President of Investor Relations. Please go ahead.

Thank you. Hello, everyone, and welcome to today's call. Joining me are Dave Mosley, Seagate's Chief Executive Officer, and Gianluca Romano, our Chief Financial Officer. We've posted our earnings press release and detailed supplemental information for our fiscal third quarter 2023 results on the Investors section of our website. During today's call, we'll refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and included in our Form 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. Before we begin, I'd like to remind you that today's call contains forward-looking statements that reflect management's current views and assumptions based on information available to us as of today and should not be relied upon as of any subsequent date. Actual results may vary materially from today's statements. Information concerning our risks, uncertainties, and other factors that could cause results to differ from these forward-looking statements are contained in our most recent Form 10-K and 10-Q filed with the SEC. Our form 8K filed with the SEC today and the supplemental information posted on the investor section of our website. As always, following our prepared remarks, we'll open the call up for questions. With that, I'll now turn it over to you, Dave.

Thanks, Janie, and hello, everyone. Seagate's March quarter revenue came in at $1.86 billion, just above the low end of our guidance range, while we reported a non-GAAP loss of $0.28 per share. These results reflect rising economic uncertainties and an elongated inventory correction that impacted demand among a few large customers late in the quarter. As a result, we've altered our outlook regarding the timing and trajectory of recovery to now begin later in the calendar year. In response to the current market environment, we are taking aggressive actions to further reduce costs and right-size the business to navigate this downturn. and position Seagate to thrive when recovery ultimately comes. Beyond this cycle, we remain excited about the long-term opportunities presented by the secular growth of data and the relevance of mass capacity storage as new data-centric applications emerge and more workloads migrate to the cloud. We continue to make strong progress on our industry-leading technology roadmap, including launching hammer-based products this quarter, which we believe put us in outstanding longer-term positions In my remarks today, I will share some perspectives on the current market dynamics, provide greater context on our restructuring initiatives, and update you on our product plans. First, let me address the settlement we announced with the U.S. Department of Commerce Bureau of Industry and Security, or BIS. The agreement resolves BIS's allegations regarding Seagate's sales of hard disk drives to a certain customer between August 2020 and September 2021. Under the terms of the settlement agreement, Seagate has agreed to pay a total of $300 million in $15 million quarterly installments that will take place over the course of five years. I want to emphasize that Seagate maintains its strong commitment to export compliance, and we believe that we complied with all export regulations at the time we made the shipment. However, in working toward a mutually acceptable solution with BIS, we balanced factors such as the risks and cost of protracted litigation involving the U.S. government, the size of a potential penalty, which could have been a significant multiple of the settlement amount, and our desire to focus on current business challenges and our long-term business goals. We believe the outcome we have reached and putting this matter behind us is in the best interest of our customers, shareholders, and other stakeholders. Turning now to the near-term business environment, for the past year, Seagate has been navigating a complex market shaped by a few primary factors. Inventory digestion among our large cloud customers that is impacting our near-line business, lower economic activity in China owing to the country's COVID lockdown policy, and weakening macro conditions that initially impacted consumer demand and is now affecting all end markets. These pressures have been compounded recently and weighed on our end-of-quarter dynamics. In the near-line markets, CIOs are now facing constrained IT hardware budgets, which has raised the bar for projects to get funded and resulted in efforts to optimize existing workloads both on-prem and in the cloud. In turn, cloud service providers have focused on maximizing utilization of their existing infrastructure rather than deploying new capacity. The combination of these factors dramatically slowed the pace of cloud customer inventory consumption and led to the pronounced slowdown in cloud and enterprise storage demand that we experienced exiting the March quarter. However, we don't foresee a strategic shift in customer spending patterns or a change to what remains a robust long-term outlook for cloud storage. Digital transformation trends will continue as enterprises realize significant cost benefits and operational efficiencies by transitioning workloads to the cloud. Industry analysts have observed that once applications and workloads are moved to the cloud, they generally stay there and grow. Digital workloads rely on data, which bodes well for mass capacity storage as the number of new cloud workloads multiply every year. Within the China markets, customers remain constructive on their end market demand outlook as the economy continues to reopen. However, rising macro uncertainties are pushing timing for recovery to begin later in the calendar year. Despite the push out, we are seeing some positive demand movement in the consumer and service sectors after COVID lockdown restrictions were lifted. These trends support a digital economy growth that bodes well for China cloud demand, as growth in consumer demand has historically led to revenue growth for regional cloud customers. Within the VIA markets, future demand pickup is based on two factors. First, you will recall that several existing VIA projects were delayed during COVID lockdowns. Customers expect these projects to gradually resume as the economy reopens in the coming months, which will consume the existing HDD inventory that was earmarked for these projects. Second, we expect new smart city and smart manufacturing initiatives to build momentum as government funding and enterprise budgets free up when the global economy improves. In this dynamic environment, we are continuing to manage what is within our control. In late March, we extended the first phase of our restructuring efforts to adjust our factory headcount to align with lower production volumes, realize efficiencies across various operational support functions, and reset our live edge to cloud business plans. We are scaling back new investments in live cloud as we focus on filling our existing infrastructure. We expect to drive operational and cost synergies across all platforms to accelerate time to profitability while growing the business over the long term. Since fiscal Q1, we've taken more than $150 million out of our cost structure, lowered debt by 5%, and significantly reduced manufacturing capacity. Given the prevailing market conditions and our reduced near-term demand outlook, we are undertaking the next phase of restructuring actions targeted to yield at least an additional $200 million in annualized savings from both COGS and OPEX, as well as implementing temporary cost savings measures, including salary reductions. We are taking a programmatic approach focused on three key areas. First, We are reassessing the levels of production output and functional support required to meet both near and long-term business needs. These actions are intended to ensure that supply and demand are appropriately balanced. Second, we are simplifying our product roadmap to create operational efficiencies. We plan to reduce the number of drive configurations and major capacity node transitions to lower supply chain and manufacturing costs and complexity. We're taking these actions in concert with our customers who can also capture cost benefits from fewer product qualifications. Finally, we will continue prioritizing resources towards higher return products and end markets while rationalizing support levels and investments aimed at non-core businesses. Our goal is to emerge a stronger, more agile company able to navigate well in all demand environments, return to profitable growth, and preserve our technology leadership momentum. To that end, we have not let up on executing our hammer-based product roadmap to preserve our significant time-to-market advantage. We are tracking well to our stated plans and achieved the key milestone last week of shipping initial qualification units to a cloud launch partner. And we expect to recognize initial revenue from 30-plus terabyte platforms this quarter as part of our core vault system solutions. The decades of development that have led us to Hammer productization are even more important today, as highly cost-efficient mass capacity storage will be a competitive enabler in a world where data is rapidly growing and increasing in value. We believe Hammer will further extend the large and sustainable cost-advantage multiple compared to other storage media, even with current market prices. Additionally, Seagate's ability to service this growing demand through aerial density gains by increasing capacities from three to four to five terabytes per disc or more provides far greater capital efficiencies compared with current PMR technology over time. We're confident in Seagate's ability to translate aerial density leadership into the most advantaged TCO across a broad range of customers, from the highest capacity drives used in cloud data centers to lower and mid-cap drives more typically used by enterprise and VIA customers. We currently expect the high-volume ramp to begin in early calendar 2024, depending on customer qualification timelines and prevailing macro conditions at that time. Tactically, we're very focused on realizing our targeted savings, which along with an improved demand environment should create the foundation to move towards our targeted financial model. And as we transition to our strategically vital hammer platform, we believe that we are positioning the company to drive differentiated financial performance for Seagate over the long term. Thanks, and now I'll turn the call over to Gianluca.

Thank you, Dave. Amid intensifying economic uncertainties, we saw a rapid decline in demand in certain parts of the business over the last couple of weeks of the quarter, pressuring supply-demand balance. These factors, along with underutilization charges and tax expenses, weighed unfavorably on profitability. For the March quarter, we reported revenue of $1.86 billion and non-GAAP losses of $0.28 per share. Despite these conditions, we generated free cash flow of $174 million, demonstrating our ability to maintain disciplined and strong cost control measures. In response to the near-term business environment, we have, and we will continue, to evaluate and take steps to improve our cost structure and strengthen our balance sheet, as evident by the expansion of our restructuring efforts, which we announced in the late March. Exiting the June quarter, the actions that we committed to and taken charges for are expected to deliver cost savings of $40 to $45 million annually. with roughly 60% realized in cost of goods sold. As Dave described in his comments, we are taking additional actions to further improve our cost structure, targeting at least $200 million of annualized savings exiting fiscal Q1 2024. Now, turning to the end markets. Total artist drive revenue declined 4% sequentially to $1.6 million. Mass capacity revenue remain essentially flat quarter over quarter at $1.2 billion, but lower than our expectation due to more prolonged cloud customer inventory adjustment and slower demand recovery in China. Achievements into the mass capacity market total 104 exabytes compared with 97 exabytes in the December quarter. Consistent with the prior quarter, roughly 83% were derived from Nearline products shipped into cloud and enterprise OEM customers. Nearline shipments of 87 exabytes were up 9% sequentially, driven by growth in 20 plus terabyte drives. As percentage of our Nearline exabyte shipments, 20 plus terabyte capacity drives have grown from high single digit to approximately two-thirds of our Nearline Exabytes year over year, reflecting our customer pursuit of higher density storage for their data center needs. Looking ahead, we expect Nearline Exabytes shipments to decline over the next couple of quarters as cloud customers intensify their efforts to reduce inventory and improve the productivity of their existing infrastructure. Specific to the VR market, revenue declines sequentially largely as expected. As we outlined earlier, based on interaction with customers, we expect gradual recovery in the second half of the calendar year. Within the legacy market, revenue was $371 million, down 12% sequentially, reflecting a steeper-than-anticipated decline in mission-critical sales amid a more cautious spending environment and weakening server demand, while the client and consumer markets reflected typical seasonal demand patterns. Finally, revenue for our known HDD business increased 14% sequentially to $256 million, a bright spot for the quarter. As anticipated, we grew sales for our enterprise system as component supply constraints continue to improve, and we expand our market coverage. Moving to our operational performance, non-GAAP gross profit in the March quarter was $347 million, reflecting lower revenue and a less favorable mix than what we anticipated. Underutilization cost of approximately $75 million, similar to the prior quarter, but higher than we were originally forecasting, as we delayed restarting production two later in the quarter, as noted at a recent investor conference. Accounting for this underutilization cost, which translates into more than 400 basis points of margin headwind, we recorded non-GAAP gross margin of 18.7%, compared with 21.4% in the prior quarter. Based on our current outlook, we expect underutilization cost to improve in the June quarter, even if production output remains well below the year-ago level. We expect both gross profit and gross margin to move higher as demand recover toward the end of calendar year 2023, and our cost structure improvements are fully realized. We reduced non-GAAP operating expenses to $282 million, down $63 million year over year, and $12 million sequentially. The year-on-year decline reflect our cost structure improvement actions to date, lower variable compensation, as well as disciplined cost management. We expect non-GAAP OPEX in the June quarter to be similar to the March quarter. I would point out that our GAAP operating expenses for the March quarter included the $300 million reserve associated with the BIS settlement agreement and will be paid in quarterly installments of $15 million over the course of five years. starting in fiscal Q2 of 2024. We incurred non-GAAP tax expenses of $36 million in the March quarter. Our tax expense is largely based on a full year GAAP forecast by geography and allocated between the quarters based on expected profitability. We expect total non-GAAP tax expenses for fiscal year 23 to be approximately $45 to $50 million. Based on diluted share count of approximately 207 million shares, gap loss per share for the March quarter were $2.09, which reflects the reserve that I mentioned earlier. No gap loss per share was $0.28. Moving to balance sheet and cash flow. We ended the March quarter with liquidity level of approximately $2.5 billion, including our evolving credit facility. Inventory was relatively flat, sequentially, at $1.2 billion, consistent with our plan. We reduced capital expenditure to $54 million in the March quarter, down 32% sequentially. We expect CapEx to remain relatively flat in the June quarter. Pre-cash flow generation was $174 million, up slightly quarter over quarter, and reflecting our ongoing focus to optimize free cash flow. We currently expect to generate positive free cash flow through calendar year 2023, dependent on the timing of restructuring costs. We used $145 million for the quarterly dividend and exited the quarter with 207 million share outstanding. We are not currently planning to repurchase any share in the next several quarters, consistent with our near-term focus on optimizing cash balances. Our debt balance exiting the quarter was just below $6 billion, down $71 million quarter over quarter. Adjusted EBITDA for the last 12 months totaled $1.3 billion, resulting in gross debt leverage ratio of 4.5 times. Since fiscal Q1 of 23, we have reduced debt by approximately $290 million. In fiscal Q4, we plan to further reduce debt by approximately $560 million. Interest expense in the March quarter was $81 million and is expected to be similar in the June quarter. Turning to our outlook, in the context of the market challenges that we have outlined today, we expect June quarter revenue to be in a range of $1.7 billion plus or minus $150 million. We project incremental decline in the mass capacity business, mainly driven by customer focus on inventory drawdowns in our near-line cloud market. As a midpoint of our revenue guidance, we expect non-GAAP operating margin to be in the low to mid single-digit range, which includes between $50 and $60 million in underutilization costs. and we expect a non-GAAP loss in the range of 20 cents plus or minus 20 cents. I will now turn the call back to Dave for final comments.

Thanks, Gianluca. The past year has presented a set of challenges that have impacted Seagate and our industry to a degree not seen for more than a decade. As our outlook and commentary today demonstrate, we believe that we are still a couple of quarters away from seeing a positive turn in demand for data storage. However, there are a few key takeaways that underpin our confidence in the business and our long-term potential. We are aggressively managing through this environment and taking appropriate actions to generate positive free cash flow, strengthen our balance sheet, and enhance future profitability, all the while executing our technology roadmap. To that end, we have continued to prioritize investments on our Hammer product roadmap. These drives offer the highest density, most cost-efficient mass capacity drive storage, which we believe translates into a competitive advantage for our customers, and we are focused on driving appropriate returns for the value we are delivering. And we continue to receive indications from our customers that demand will pick up as the global economy improves. The secular drivers powering long-term demand for storage are intact, and this fact is at the root of the conversations we're having with customers across our key markets and geographies. I'd like to thank and recognize our global team for your resilience and perseverance through this challenging period. We are keeping our heads down and aim to make continued progress towards our goal as we move closer to market recovery. Thanks again for joining and let's open up the call for questions.

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble the roster. And our first question will come from Eric Woodring of Morgan Stanley. Please go ahead.

Thank you so much. Good morning, guys. You know, Dave, can you maybe help us understand kind of as we sit here today what gives you the confidence to kind of talk about a recovery towards the end of the calendar year? I guess, you know, what I'm hearing from you is a worsening of demand in the last few weeks of the quarter, greater macro concerns amongst customers. obviously challenges in the near line market. And so what data points are you seeing today or what are customers saying to you that gives you the confidence that the recovery will happen towards the end of the year as we sit here today? And then I have a follow up. Thanks.

Yeah, good. Thanks, Eric. You know, as you allude to, we've been anticipating return to X by demand growth in near line for a few quarters. But what we saw coming out of the last quarter still reflects that there's too much inventory against just a very slow near-term mass capacity demand. I would say that the customers are spending money. They're not necessarily spending money on mass capacity storage right now. They may be spending on compute or other investments that they're choosing to make. And as we look through into their data center behaviors, if you will, we're somewhat encouraged that the data continues to grow. So, you know, in the data centers, The drives that are in there are being strongly utilized. There are some drives that are living a little bit longer in data center applications, but there's also really compelling value propositions we're putting in front of them with higher capacity drives like 30 plus terabytes and new features that are coming that should drive adoption and we should get a refresh. So, as all these things need to be factored into our planning, they're all important. But the most important thing right now is, this reflects kind of our sentiment coming out of last quarter, is we don't want to push too much in, especially the older technology products. We want to really stage ourselves for the new technology products and make sure that that inventory flows through. Timing is everything, exactly to your point. But I do think with the way data is growing, the evidence that we have that data is growing, Even anecdotally, I could talk about Seagate's IT. We can see the data growing in the cloud much further than our projections were a long time ago, and this is fairly consistent with discussions that I have with CIOs and other fellow travelers. I do think that we're not at peak cloud or anything like that. I think the cloud applications are growing tremendously in data size, and it's just a prioritization issue that we're in the middle of right now. So we just focus on taking actions to further manage the downturn, like cost and footprint, and still keep driving the technology leadership so that we're there when markets recover. That's how we think we can create the best foundation to quickly move back into the targeted financial range when the demand resumes.

Okay. Thank you for that color. And then I guess, Luke, I know you mentioned talking about paying down the $540 million maturity in June, but can you maybe just help us understand some of your sources and uses in cash over the next, let's call it six to 12 months, how you're thinking about your liquidity situation, just given your leverage is kind of quickly kind of creeping up towards that five times number. And then For example, how are you thinking about the stability of your dividend, any potential drawdown of your revolver, adjustments to covenants? Maybe if you could just unpackage that a bit, that would be helpful for us. Thanks so much.

Thank you, Eric. We renegotiated our covenants in the December quarter. We have paid down already a big part of our debt between December and even the March quarter. As you said, we already discussed about the repayment coming in June. about 560 million, so we are very focused on reducing the debt to help with the leverage. We are generating positive free cash flow every quarter until now, so part of that free cash flow is also going to help with the repayment of the debt. We have other sources that we are looking at. One of those that we discussed in the past is some sales and leaseback of non-manufacturing buildings that we are working on right now. So all this will help with our debt covenants, and if we need to do more, we can do more.

Thank you for the call. Thank you.

The next question comes from Tom O'Malley of Barclays. Please go ahead.

Hey, guys. Thanks for taking my question. I just wanted to dive a little bit into the dynamics of the full year. I think you just said that you expect some declines in near line for the next several quarters. Just given the size of how big that end market is for you guys, do you expect any sequential growth for the remainder of this calendar year? And if so, are you getting that with about a via market or a recovery in legacy? Could you just walk through the puts and takes of total revenue and when you may see that inflection given the new outlook? Thank you.

Sure. Thanks, Tom. So, a few points. I would say that the next quarter will be fairly muted as what we just described. I do think that there will be exabyte growth as we, I'll say late in this calendar year, as we get towards the end of the calendar year. That comes from many cloud service providers of the world that are getting through their digestion phase, if you will. Because, again, there's a lot of data that we get from them about utilization rates being high inside the data centers and data continuing to grow. So I do think this is going to be over at some point. Relative to the VIA markets and maybe the broader macro, we're not really calling the end of any macro uncertainty as part of this, but we do think that some of the investments that have been put off and put off for quite some time may actually come back towards the back half of the year. So there's There's positive sentiment. It hasn't translated into POs yet, but that's the way we're feeling about it. And only one other point that I would make there is that inside of the cloud workloads that we see, the data growth is actually fairly profound. So I think people can make trade-offs with older drives that they have running, throwing data away and things like that. But at some point, the world runs out of gas. We all know we're creating more and more data all the time in the form of videos and communications and AI and things like that are all going to need the data. So we're just really focused on making the space for it. I don't think the world can deal with this kind of supply and demand imbalance for very long. But we need to take the actions that we are taking on the supply side to make sure that we're not waiting too long.

Got it. And then the second one is for Gianluca. Just on the gross margin side, underutilization charges went up slightly quarter over quarter, and you kind of laid out what the charges would be for the guided quarter. But in terms of the impact of gross margin, gross margins are down substantially more than the impact on the math that I'm doing underutilization. Obviously, there's some revenue impact as well, but could you talk to, is it just mixed with VIA being a bit higher in mass capacity? Is there any pricing pressure that you're seeing from the near-line customers? Could you just walk through why you're seeing more gross margin pressure than just the underutilization charges? Thank you.

Yeah, thanks. So I would say the March quarter, of course, has some mixed impact also. For example, mission critical was sequentially down, and as you know, that has a good gross margin generation. The year was also sequentially down. So we had a couple of segments that are, let's say, above average gross margin in March because of seasonality were down. So we see that recovering actually in the June quarter. As you said, there is also some pricing pressure, especially through the end of the quarter with no certain customers. we decided to not take some of those deals and we decided not to take other deals. And so this is what we are focusing on, trying to keep a supply-demand balance where we can. This is why we are doing another restructuring action. We want to keep the capacity that we have internally aligned to the short-term demand. And then, of course, in the longer term, keeping that balance in a way that there is not too much pricing pressure to Seagate and to the industry in general.

Tom, I would add on to that. You can see the pricing stress fairly readily in the dollar per terabyte trends. And so that's where we have to be very discerning about what deals we're taking. But I think it's reflective of a world where manufacturers are just trying to convert inventory back to cash as quickly as they can. And our answer long term has got to be don't build too much so that we don't get ourselves into that position and then focus on a transition to a more substantial value proposition like higher capacity or lower cost like via the aerial density gains that we might have and we apply that to lower capacity drives just in order to rebuild the margin for ourselves and for the industry.

Thank you.

The next question comes from Wamsi Mohan of Bank of America. Please go ahead.

Yes, thank you. I was wondering if you could just maybe talk about the outlook and pricing as well. It seems like your timeline for near-line demand recovery is kind of late in the year, hammer shipments starting like in volume maybe early next year. In the interim, certainly like memory pricing, NAND pricing has been also under significant pressure. So would you say that as you're thinking about this comment about gross margin improvement as you go through the course of the year, is that predicated on stable pricing, improving or worsening pricing, any color you can share? And do you think that that pricing environment could deteriorate a lot more as you go through the course of the year? And I will follow up.

I'll let Gianluca talk about the restructuring, because I think that's a significant part of your question. But I would say relative to the pricing environment, you know, this is really where we believe we have good products at 20 terabytes to mid-20 capacity points. And, you know, there's not great demand right now, but we have good products that we can yield and so on. The way out of it, of course, is to, you know, continue the aerial density gains into the get the chance to reset things a little bit. From my perspective, the demand environment's so low that the way pricing becomes more strained is when we overbuild. And so that's what we have to make sure we don't do because we can't continue to stress ourselves and our cash that way. So we always have to wait this thing out a little bit. So John, look, if you want to talk about

A good part of the improvement in our gross margin starting fiscal Q1 is related to the restructuring actions that we are taking right now. We said it is about $200 million annualized savings, and it will be fully realized probably through the end of fiscal Q1. The plan is based on the current visibility of pricing. As you know, that can change, and we are trying to reduce our capacity so that we build the right level of products for the current demand, and we take out some pressure from pricing.

Okay, thanks for that, Kolar. And if I could follow up, Gianluca, on the comments around positive free cash flow for the remainder of the year. Your free cash flow and EBITDA levels have the potential to deteriorate from current levels. And when we look at that on an LTM basis, it does get you pretty close to your existing covenants. I know you mentioned certain actions that you can take on, say, leaseback and other elements. But how should investors think about the dividend in this context, given that you have some cash restructuring charges coming up, you do have other... uses of cash as well. I know you are paying down debt, but in the context of dividend, should investors think that's pretty secure as we go through the course of this year or is not going to be another lever to use to balance the cash sources and uses for you? Thank you.

Stigate has always been very focused on shareholder return. As you know, we have suspended share buyback based on the current economic situation, but we have protected our dividend. We think now we can reduce our leverage in the next few quarters or already discussed that leverage level with our banks. But I'll say until now, we have always protected our dividend.

Yeah, I'd say, Wamsi, that I'm Proud of who we've been. If you look just over the last 15 years when we came up with some of the policies that we're talking about, you know, I'm really proud of how we've been able to return value to shareholders. Times are tough right now. We have a lot of levers that we can look at, I think, over time. But, you know, we want to continue to be that company that we have been. So we're factoring this into all of our discussions right now. You know, what our priorities are, you know, trying to keep the exact same priorities that we've always had for shareholders and One of the reasons why we're being really aggressive on the cuts that we are, you know, we're also, you know, as aggressively trying to turn some of the assets that we have into cash. We'll continue to look at all those options.

Okay, thank you so much.

The next question comes from Timothy Arcuri of UBS. Please go ahead.

Hi, thanks. I had two. So, John, Luca, just on free cash flow, so are you implying that it's going to be positive for the June quarter? Because you did extend payables a lot in March, and you probably have to bring that down maybe 25 days or so. So it seems like maybe June free cash flow could be quite a bit negative. So what's the message on June in particular around cash flow?

We see June still as positive free cash flow. Of course, we need also to look at the exact timing of the payment for the restructuring actions. But in our plan, we have positive free cash flow for June. You do. Okay.

Okay. Then I guess I had a bigger picture question. So, Dave, in your prepared remarks, you talked about some evaluation of the longer-term capacity needs for the business, and that's kind of a new angle. You know, we've gone from a year ago thinking that the industry didn't have enough capacity and now we're, you know, thinking about having, you know, too much on a structural basis. So I guess, can you talk about that? And maybe in the context of that, just given how low NAN pricing has gone, we're now basically at cash cost. Is there a risk that there's some cannibalization happening now in Nearline? And sort of what's the, you know, TCO difference in ESSD and, you know, Nearline now and data center. Is that part of what's driving you to talk about maybe, you know, rethinking what the longer term capacity needs are for the business? Thanks.

Oh, okay. Let me address that second problem or the second question first. No is the answer to that question. I think we believe that some of the SSD pricing that we're seeing is unsustainable, fundamentally unsustainable. It might go on for a while, but it's unsustainable. So we're not really factoring that into our calculation for exabyte demand over time. I don't think, you know, even at the rates that we're seeing today, our ability to continue to take costs out and deliver more terabytes over time is going to, you know, keep us with a substantial gap to any competing technology. I will say that your question is super appropriate. You know, over the last year, industry hasn't been putting on capacity. There are suppliers that we have that, you know, Unfortunately, you know, bearing the brunt of this and they're still assessing their own investments or consolidating the factories and things like that. So, you know, from an equipment perspective, there's less capacity than there was a year ago. But definitely from a people perspective, there's less capacity than there was a year ago because of significant people takedowns, which, you know, we know is really hard and nobody wants to do. And that capacity can recover, but not quickly. So if you start staring out a year from now, you know, does the industry have the same amount of capacity that it did a year ago? The answer is no. You know, theoretically it can grow back, but it's a matter of time and investment. And from my perspective, the biggest thing we're focused on is the lead times are so long on some of the starts, for example, wafer starts, you know, that we have for the new products that we're making sure the customers understand that it's not going to snap back and we better have discussions right now about, you know, what the demand that they're going to need fulfilled out there a year from now. In some sense, you know, the kind of consumer behavior where you say, I don't need to buy any for a while and then I can always go to the store and get some, that's the thing that will be challenged because I think that's what a lot of enterprises are kind of assuming to make their models look okay right now. And, you know, that's why the factory workers are getting strained. But, you know, we're going to We're going to have to navigate our way through this and be as communicative as we can. I don't think the industry capacity is what it was a year ago. And I think if you don't tell us now, then it may actually be even more stressful for you a year from now.

Got it. Okay. Thank you.

The next question comes from Erin Rakers of Wells Fargo. Please go ahead.

Aaron, we can't hear you.

Yeah, sorry about that, guys. Can you hear me?

Yeah, yeah.

Yeah, sorry about that. So, thanks for taking a question. I guess I got two real quick. Dave, just on the heels of that last question, I'm just curious if, you know, if you're asked kind of the longer-term growth of near-line capacity shift trends, where do you think that is today? Like, as we come out of this, do you think we – Maybe I'll stop there. What do you think that long-term capacity shift growth trend looks like now?

Yeah, it's an interesting question because I think if we go back a couple years, you remember where there was a stall and then there was an enormous growth pop back. I think it's not going to happen like that again. I mean, from an exabyte perspective, if by that time we're on, you know, mid three terabytes per disk or, you know, even potentially four terabytes per disk, you know, then our exabyte output is going to be significantly higher at better economics for us as well. But will we have enough capacity for everyone all at the time? I think the answer to that is probably no. And I don't think we'll see the magnitude of the swing that we did before. Maybe we can from theoretical demand, but I don't think there's going to be supply right now because of the stresses that are going on in the industry. And the fact that people just can't start materials. They won't have a whole lot of inventory. They won't have a whole lot of materials. They won't be leaning forward into some of those really great value propositions nearly as hard because they just can't do that speculatively on long lead times. So it's actually an interesting problem set versus what it was a few years ago.

Yeah. And then the follow-up question, just trying to think about gross margin kind of normalizing itself, or I guess taking another way, if we kind of think about the progression of lifting out the underutilization charge. Appreciating you're not guiding beyond this next quarter, but as I look back in time, would I look back and say, hey, if this model gets back to total capacity shipment levels of 150 exabytes a quarter, 130 exabytes a quarter, how do we think about that relative to lifting out the underutilization charges in the P&L?

Well, of course, it depends what will be the capacity installed at that point. As you know, we are reducing capacity right now. So gross margin, what we see today for the next several quarters is, despite the short-term declining revenue, we got it in a way that is implying an improvement in gross margin already in the June quarter. So I think that will continue for the next several quarters. And of course, as Dave was saying before, demand will come back and capacity will be at a certain level and hopefully supply and demand will be well balanced and we have to manage this short-term demand decline. But again, we are ready to do it. We have done that in the past and we think we know how to do it.

So underutilization charges continue you know, beyond, you know, the June quarter, you know, through the back half of the calendar year?

We will have some, I think, also in September, but it's declining sequentially.

Yeah, and some of that is preset to fixed and variable cost as well, Aaron. So, you know, I think as we look forward, we have to project what we think the supply that we'll need to meet that demand is, of course, and we'll be adjusting and trimming as need be.

All right. Thank you.

The next question comes from CJ Muse of Evercore ISI. Please go ahead.

Yeah, good morning. Thank you for taking the question. I was hoping to maybe drill down a little bit deeper on the near-line outlook. You know, if you think about your vision three months ago versus today, obviously a change. And I guess was hoping you could kind of isolate between cloud enterprise and China and maybe know rank order you know the change statements there in terms of the slowdown as well as from a uh end demand overall perspective versus just you know realizing that there's just too much inventory uh downstream and and that that's what kind of caught you by surprise so we'd love to hear kind of maybe the moving parts there and if you could prioritize what has really driven the change that would be helpful good thanks cj i i think uh

It is good to break it down into a few different pieces. You know, the most relevant, obviously, is the major cloud service providers around the world. And there are a few different behaviors depending on geography and so on. You know, I think if I think about the big applications in the cloud, they're growing a lot. I think right now there are priorities being made on compute and their priorities being made on other investments. And then there's people questioning business models and all of that just takes time to sort out, but the data keeps growing. So, you know, I think that's largely what we're seeing. We would have forecast six months ago that we would be, you know, coming out of it by now, just based on, you know, all these trends and run rates. And I think people can always hold on for another three months or six months. They can't hold on much longer than that. So, you know, that's the way I think about the major cloud service providers, the subtle difference might be in China where you've got cloud providers there that really have been kind of on a pause for quite a while and are starting to get a little bit more optimistic. Again, like I said, I alluded to earlier, not necessarily purchase orders just yet, but get a little bit more optimistic about their investments. And so that's a watch item for when that might come back. On the enterprise side, I know there's a lot of discussion about servers and other componentry. From our perspective, data does continue to grow on-prem. There are stressed budgets in the CIO's world today, but I think some of the offerings are actually pretty efficient right now. I do think, for totally different reasons, Well, unless you consider macro being the underlying driver of everything, I think the on-prem enterprise is going to take six months probably as well. I do think that there's not too much inventory there. So we've got anecdotal evidence that that inventory has been well managed. And so if there's an opportunity to break north into some of those investments, we could go necessarily quicker.

Very helpful. I guess as my follow-up to Gianluca, thinking about liquidity you know you talked about intention to pay down the debt that's coming due in June curious you know how you're thinking about gross cash and you know is there a plan today to draw on the revolver or that's you know TBD depending on kind of the free cash flow generation into June and September no I think our cash balance will be fairly stable at the end of the quarter compared to the end of March so

I don't think we need to use a revolver. Sometimes we use a revolver during the quarter to cover for a few weeks. But in terms of cash balance, I think it will be fairly similar to what we had at the end of March.

Thank you.

The next question comes from Krish Sankar of TD Cowan. Please go ahead.

yeah hi thanks for taking my question my first one is for john luca just wanted to follow up on hammer how much of a drag is it on margins today and when do you think it'll improve towards the corporate average is the is it just purely a function of volume and yield that can help you improve hammer margins and then um is the long-term gross margins target still 30 to 33 percent baking in hammer then at a follow-up for dave yeah thank you what i would say

Right now, we are very happy with how we are progressing with Hammer. As we said in the prepared remarks, we are shipping products for qual. So right now, we don't have revenue coming from Hammer, so it's not really impacting our gross margin. But we think, of course, in the future, 3 terabytes per disk or 3.5 terabytes per disk and 4 terabytes per disk Those are very interesting propositions for our customers, and we think will be a very profitable gross margin improvement for Seagate. This is why this product is so important to us and in general in the longer term for the entire industry.

Got it. Got it. Very helpful. And then a follow-up for Dave. Sorry, just to come back to this SSD versus HDD dynamic. I agree with you that the NAND prices are unsustainably low. But if you look at like, you know, last down cycle, the SSD prices were almost 8x higher than HDD on a per gigabyte basis. Now it's more like two to four times. So that gap is definitely closing. So I'm kind of curious, when you talk to your cloud customers, is it a bigger, you know, how does that discussion progress? And is that the second part of your, you know, weak pricing per terabyte? Or is it, part of your big demand from cloud customers, or just kind of curious about it? Thank you.

No, I would say when you get into mass capacity, the highest capacity points, I don't subscribe to the notion it's 2 to 4x. I think it's significantly higher than that. And we'll have an ability to continue to drive to better value propositions as we add more capacity per drive through the transitions that we're talking about. What I would say is that, you know, right now demand is low for everyone. And so what you see, the dynamics you see is just manufacturers trying to take some of their cash that they've tied up in inventory and turn it back into cash as quickly as possible. And, you know, if you start to look and say that's below cost or something like that, you know, hopefully people stop doing that and try to look for other options, you know. And that's exactly how we're thinking about ourselves as well, right? You know, to make sure you don't build. So I think in that kind of environment, it's really hard to extrapolate on trends. You know, exactly to your point, Krish, I think, you know, some of these other things that we're comparing against are unsustainable. They're going to have to re-equilibrate at some point. Don't know exactly when that is. The more we push into the value chains, the more we push inventory in there, the more people will build buffers and then continue that. So I think that's one of the reasons why from our not holding the fence, we've decided to really pull back on our builds and reduce our footprint.

Very helpful. Thanks a lot, Dave.

The next question comes from Tshoya Hari of Goldman Sachs. Please go ahead.

Hi, good morning. I had one for Dave and then one quick one for John Luca as well. So Dave, I know it's a bit of a black box, but I was hoping you could give kind of your assessment of near-line inventory or customer inventory in the near-line market relative to six months ago, 12 months ago. What's your view there? And when you compare and contrast what you're selling into the near-line space,

versus what's truly being consumed what's the percentage delta at the moment yeah it's actually an interesting uh thing because you know if i normally talk about inventory like a distribution channel inventory for example i'll look at weeks of supply or something like that but then that's is that based on the last four weeks or 13 weeks i mean if we base things on a couple of years ago the demand is low and there's not too much inventory out there based on the run rates of number of drives that were a few years ago. Even on exabytes, the demand is fairly low, or sorry, the inventory is fairly low. But I will say that most cloud service providers need to have some inventory around based on the data center populations, the new data center build-ups they're doing, and the refresh, the spares that they need, So, they normally need to have a few months of inventory anyway. It's more than a few months right now, but it's not significantly more, and the gross number of drives is not huge, I think. So, that's the way I think about it. The exabyte growth will be substantial coming sometime, and what we've got to do is just make sure we're not pushing any more into those chains. I don't know if a good way to think about it is really, you know, three months or six months, like we might want to say, because if you go back two years historically on the number of drives that were being pulled by people, it's not really six months. It's probably more like three.

Got it. And then any view on sell-in versus end consumption? Or is that too hard to really see?

Yeah. Here's what I'd say, is that We see a lot of the new drives, the higher capacity drives, going into, you know, replacing lower capacity drives, obviously, but the lower capacity drives get put into other purposed applications as well. So, I think drives are living longer, but there's still going to be demand for higher capacity drives, especially just the efficiency that you get out of that in the data centers. And then there's new data center build out as well. So, you know, I actually, think that this is not a problem of not needing any product. This is a problem of reshuffling priorities inside of the data centers and getting ready for the next level of data center expansion.

That makes sense. Thank you. And then, Gianluca, on gross margins longer term, obviously, you've had this target of 30% to 33%, if I'm not mistaken. You're obviously, you know, significantly below that today. But as you think about the path toward your long term model over the next four to eight quarters, given the reduction to manufacturing footprint that you're executing to, what sort of quarterly revenue run rate would you need to be at to be at that, you know, call it 30 percent range? I assume it's lower than, you know, where you were about a year ago, which was three billion, a little bit below three billion.

Yeah, of course, it depends also from the mix and other factors. But as you said, we are taking a lot of cost actions. So what we also said last quarter is when we go back to the prior level of revenue, but now we picked at about $3 billion, we expect gross margin to be actually better than what it was at that time. So we are still confident in the medium and long term. We are taking actions to be even stronger when we come out from this down cycle. And we are executing our roadmap. We are executing all our cost reviews. And we think we are ready for the recovery of this up cycle when it comes. Thank you.

And operator, I think we have time for two more questions.

The next question comes from Sydney Howell of Deutsche Bank. Please go ahead.

Great. Thanks for taking the question. So I have two quick ones, one on the hammer side. Sounds like high volume is starting in early 24 to your plan. Can you give us any goalposts in terms of when you expect to hit a certain unit volume on a quarterly basis, and maybe when you expect hammer to be gross margin accretive, and maybe at what kind of volume level in that follow-up?

Yeah, I think, Sydney, our gross margins are going to come back based on demand. You know, I don't know that we can really break it out, you know, based on hammer transition right now because there's so many other dynamics. But we are aggressively filling the pipeline full of, you know, the product, working on the yields and scrap that we need to get down. Very, very confident in the technology. So thanks for the question. I would say we'll hit what I'll consider a significant volume ramp in early 2024. And then we're going to continue to ramp from there because we have that much confidence.

Okay, that's helpful. Maybe a follow-up question is on the demand side. It seems like you're more optimistic about the enterprise market as compared to the cloud market. Do you expect further correction in the enterprise market or maybe just a U-shaped recovery Considering comments from some of the storage OEM seems to be quite subdued, and it looks like they are just going through their demand correction, and they're still in the early stages for them.

Yeah, I think the only subtlety to your comment is I would say that my comments earlier were about inventory. There's just not too much inventory out there in those chains. So when we did start to see some recovery, I think there's room for the inventory to repopulate. To your point, I know that people are talking about a fairly subdued summer at least, maybe no recovery until the back half in there, and so we are watching that. I do think there's, unlike some of the other markets where we look at maybe too much inventory to be digested, I don't think that's necessarily the case there. It's been managed better.

Okay, thank you.

The next question comes from Ananda Barua of Loop Capital. Please go ahead.

Hey, thanks, guys. Thanks for taking the questions. Just two quick ones. I'll ask them at the same time here. One might be more of a clarification. Dave, when you talk about you believe, and it was just the question about, I think, sort of sequential growth at some point later in the year. When you say towards the end of the year, you think, demand will pick up again. Is that to say you think December quarter could be up sequentially? And I guess, does that also mean the implication is you think September quarter will be down sequentially? Actually, then I'll have a quick follow-up. We'll leave that there. I'll have a quick follow-up.

Yeah, I think, Ananda, thanks for the question. I think it's a little too early to guide. I mean, I think we're still, you know, frankly, digesting. We're just telling people what we're building. I do think at some point exabytes pick up, of course, right? And, you know, if we want to think about the December quarter or something like that, that's fine because I think there should be some pickup, barring any other macro, you know, issues or something. But it's too early to guide, I think, very specifics. What we're doing right now is curtailing the build.

Thanks for the context. And the quick follow-up is on the BIS dynamic, is there a revenue impact? We should take into account now as well with that. And that's it. Thanks.

No, no revenue impact.

Excellent. Thanks a lot.

This concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks.

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

The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect.