Good afternoon, and welcome to the Seagate Technology Fiscal First Quarter 2021 Results Conference Call. My name is Jason and I will be your coordinator for today. 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 would like to turn the call over to Shanye Hudson, Senior Vice President, Investor Relations and Treasury. Please proceed, Shanye.

Thank you. Good afternoon everyone and welcome to today’s call. Joining me are Dave Mosley, Seagate’s Chief Executive Officer; and Gianluca Romano, our Chief Financial Officer. We posted our earnings press release and detailed supplemental information for our September quarter on the Investors section of our website. During today’s call, we 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 8-K that was filed with the SEC. We’ve not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control, and/or cannot be reasonably predicted. Therefore, 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, possible effects of the economic conditions worldwide resulting from the COVID-19 pandemic and general market conditions. These statements are based on management’s current views and assumptions and information available to us as of today and should not be relied upon as of any subsequent date. Actual results may vary materially from today’s statements. And information concerning our risks, uncertainties and other factors that could cause results to differ from these forward-looking statements are contained in our most recent Form 10-K and 10-Q filed with the SEC, our Form 8-K filed with the SEC today and the supplemental information posted on the Investors section of our website. As always, following our prepared remarks, we’ll open the call up for questions. With that, I’ll turn it over to you, Dave.

Thanks, Shanye and welcome everyone, and thanks for joining us today. We began fiscal year 2021 executing well across several key objectives, keeping us on pace for our full year revenue outlook. First, we delivered on our financial commitments navigating challenging market conditions to achieve September quarter revenue of $2.31 billion and non-GAAP EPS of $0.93, both exceeding the midpoint of our guidance range. Second, we advanced our innovative product and technology roadmaps, which position the company for future data growth opportunities, including the introduction of CORTX, an open-source, object-storage software; and Lyve Rack, which offers a simple and cost effective solution for enterprises to manage their massive volumes of data, and in turn unlock data value. And third, to demonstrate Seagate’s long-term commitment of returning cash to our shareholders. The Board approved a 3% increase to our quarterly dividend and a $3 billion increase to our existing share repurchase authorization. These actions exemplify our confidence in the business potential and future cash generation capabilities. In my comments today, I will summarize a few highlights from the September quarter and share some perspectives on the current market environment, and then I’ll outline how we have been positioning Seagate to capture significant opportunities created by longer term data trends. The results for the quarter reflect good execution against the backdrop of continued macro disruptions that impacted several of our key end markets. These disruptions were most pronounced in the enterprise market as the anticipated slowdown in enterprise IT spending impacted sales of our enterprise nearline and mission-critical drives. Many enterprises reacted to the pandemic by prioritizing funding to support their remote workforce and accelerating their digital transformation plans. Accordingly, nearline revenue in cloud was solid in the quarter, although below the record levels of June. The adoption of cloud services and…

Thank you, Dave. We achieved what we set out to do in the September quarter, delivering financial results consistent with our expectation in face of a dynamic and challenging market environment. Revenue was $2.31 billion, above our guidance midpoint and down 8% sequentially. This performance reflected strong recovery in the video and image application or VIA market. The strength in the VIA market, along with healthy demand from cloud data center customers, partially offset the anticipated weakness in the enterprise market, which impacted our nearline, mission-critical and system sales. Total hard drive capacity shipments were 114-exabytes in the September quarter, down about 2% sequentially. Mass capacity shipments were 87-exabytes compared with 91-exabyte in the prior quarter, and 64 in the year ago period, representing strong year-over-year growth. Our outlook for the December quarter support calendar year 2020 exabyte shipment growth that is well ahead of the long-term demand CAGR of 35% to 40% forecasted for this market. On a revenue basis, mass capacity storage represented 58% of September quarter revenue and 63% of hard disk drive revenue, no change from a percentage basis, with the June quarter and up from 47% and 51% respectively, in the prior year period. As anticipated, nearline revenue declined sequentially but remain healthy and within its historical range, centered around 70% of mass capacity sales. Nearline shipment was 64-exabytes, down from record levels in June, but up 36% year-on-year, reflecting growth massive demand for our high capacity nearline drives. We estimated about 16% of nearline capacity shipments are to replace existing drives, which equates to about 10-exabytes in the September quarter. We consider this a reliable revenue stream, but it should grow over time, along with the installed base. Average capacity per nearline drive increased 8% sequentially to 11.6-terabytes, supported by sales of our highly…

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

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

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

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

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

Great color, thank you.

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

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

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

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

Thank you.

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

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

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

And I know you’ve seen from our guidance in the current quarter and how we guided the full fiscal year. Now, we expect this quarter and the next couple of quarters to be a strong quarter, so we don’t want to be limited by one component or two components. So, we decided to beat a little bit of strategic inventory, but we will use in the next two or three quarters.

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

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

Perfect. Thank you.

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

Hi, good afternoon, guys. I appreciate you guys taking the question. Yes, two, if I could. I’ll ask him at the same time. Dave, I believe last quarter talked about fiscal year 2021, nearline growth of I believe it was at least 35% exabyte. Is that still the case you’re reaffirming the flattish revenue guides for the year? And then also just on mass capacity, just had this quick calculation. I don’t know, and I’d love some context on this, this is like kind of get dirty count. But the difference between overall mass capacity exabyte chips and nearline chips was the largest ever, and it ties to the largest ever and the largest Delta for the December quarter. And you’re talking about pretty substantive growth anecdotally, I think, coming quarters, and then you said, kind of years, any context around sort of what’s going on with that market? Obviously, there’s sort of supply chain stuff, and challenge related stuff, and there’s congestion and pent-up demand. But is that something that can – we’re talking about potentially 35% year sort of nearline exabyte growth, and then plus meaningful mass capacity growth sort of through fiscal year 2021, just with less than contacts, because it clearly came back super strong?

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

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

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

Got it. Got it. Thanks.

Your next question comes from the line on Steven Fox from Fox Advisors. Your line is open.

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

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

Great. That’s very helpful. Thank you.

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

Thank you very much. Dave, maybe just following up some of the comments you made earlier about capacity expansion and how you’re transitioning to the nearline drive capacity demand that’s out there. I know, typically, CapEx is you’re looking at a longer period of time on demand, where you’re – where your products are going. As you begin transitioning to HAMR 1, how do you feel about the capacity in place as the 20-terabyte HAMR drive gets released? And then secondly, over the next two to three years, do you believe you’ll need capacity expansion to meet the demand for HAMR over the next few generations?

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

Great. Thank you.

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

Thank you for taking my questions. On the video and image market, you say that’s coming back strong. Can you say geographically which area of the country world is it coming?

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

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

Well, we’re talking about as our capacity volume. And we also informed to stay to above the nearline. So, I would say the difference between the two is mainly video and image application.

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

Okay, great, thank you.

Your next question comes from the line of Sidney Ho from Deutsche Bank. Your line is open.

Great. Thanks for taking my question. Maybe, two questions. First question is related to Huawei. Just want to confirm that, can you talk about whether you are continuing to ship to Huawei, and what is included in your December quarter guidance? It looks like a competitor may have stopped shipping, maybe back in middle of September? And do you think you’re seeing some benefits of that in your December quarter?

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

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

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

I would say for this calendar year, 16-terabytes is for sure the leading product in high capacity and we expect that in kind of 2021 to transition more and more to 18-terabytes. And then as you know, we are developing the fourth generation and the second generation of HAMR, that will take a little bit longer time to transition, but we think we have a very stronger roadmap.

Okay. Thanks, Dave. Thanks, Gianluca.

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

Thank you for taking questions. I’m just wondering, what’s your outlook for gaming, in terms of sales in the gaming application, solid state memory has been showing up more and more, and what’s your feelings about that?

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

You talked a little about the inventory – inventories were up, which you say they’re going to be coming down, if you could just put more color about what’s going on with inventories and your belief?

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

Thank you.

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

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

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

Okay, thank you very much.

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

Hey, thanks for taking my question. I kind of wanted to turn back a little bit to the gross margin discussion there. It sounds like the higher end companies or customers are starting to purchase more products. So I guess why isn’t there going to be a year-over-year improvement in gross margin, particularly in calendar 2021, assuming that some of these operational issues kind of fade away due to COVID all that stuff that happened this year, plus the mix shifts of the high-end and it gets away, we’re seeing that kind of flow through more next year?

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

Yes. When we talk about the COVID costs and the impact, we just communicate the direct impact. And I bet a lot of other negative impacts that we have, for example, the underutilization that Dave is mentioning, is not for sure including what we communicated at COVID impact in total, so that is more parts of it. So we think in the next two or three quarters debt will improve. And this is also aligned to our CapEx discussion that we just said. So we expect gross margin and operating margin, which is more important to us to improve in the next two or three quarters hopefully.

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

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

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

Okay, perfect. Thank you so much.

Thanks.

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

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

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

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

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

Got it. Clear. Thank you.

Thanks.

Your last question comes from the line of Nikolav Todorov from Longbow Research. Your line is open.

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

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

Okay. And related to that, I think you guided to mass capacity exabytes growing that 35% to 40% for fiscal year 2021. I guess, are you willing to give us a number for total capacity for fiscal year 2021 growth, including legacy?

Yes. We’ve never really done that before. I mean, we’ve been very focused on the growth market of mass capacity, and now that it’s surpassed legacy significantly, I think that’s the growth drivers. The legacy markets, to be very frank, we’re still studying them, because like I said, things like consumer were maybe ahead of where we thought they would be because of COVID and other markets may be under represented.

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

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

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

Got it. Thank you.

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

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

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