Seagate Technology Holdings PLC

NASDAQ:STX

Earnings Call Analysis

Seagate Outlines Strategic Vision Amid Market Recovery

Seagate delivered solid Q2 results with $1.56 billion revenue, a 17% year-over-year non-GAAP operating income increase, and introduced the Mozaic platform, a significant innovation for mass capacity storage. There is a gradual market recovery, with U.S. cloud demand stabilizing and Chinese demand expected to improve post-Lunar New Year. The company is confident about reclaiming a non-GAAP gross margin minimum of 30% on lower revenues and holds a positive outlook for increased U.S. IT budgets and server growth in 2024. Shipments of new high-capacity drives have begun, projecting 1 million units in H1 2024 and broader customer engagements in the year. However, the transition to the new HAMR technology may be slower than previous transitions due to longer cycle times.

Revitalizing Innovation and Rebounding Performance

As we unpack the latest from this earnings call, the narrative begins with the unveiling of a technology marvel, the Mozaic platform. This innovation signifies Seagate's tactical fusion of next-gen techniques, particularly their unique spin on Heat-Assisted Magnetic Recording (HAMR), propelling the company into a leadership position in areal density. Areal density, a critical metric for data center operators to scale storage efficiently, promises lower Total Cost of Ownership (TCO) and advances sustainability goals.

Financial Resiliency in Down Cycles

It's heartening for investors to see how Seagate weathered the down cycle with a stewarded balance sheet, reflected in their latest revenue of $1.56 billion. Notably, their strategic cost control paid off with non-GAAP operating income tripling and a 17% yearly increase. This careful navigation has built investor trust, fostering the expectation that the September quarter marked the downturn's nadir.

A Steadfast March Toward Margin Recovery

Crucial to Seagate's story is their commitment to reclaiming a minimum 30% gross margin benchmark, even with revenues trailing 20% behind the previous peak. This confidence is fostered by rigid cost discipline and supply chain prowess, setting a stage for profitability improvements.

The Clouds Begin to Part

Optimism peeks through as the U.S. cloud market shows signs of revival, coupled with stabilizing demand in enterprise Original Equipment Manufacturers (OEM). This rebound is bolstered by anticipation of enhanced IT budgets in 2024, hinting at a potential upswing in HDD demand across the year.

A Watchful Eye on Global Markets

While a slower recovery in China is recognized due to lingering economic uncertainties, local governmental initiatives are forecasted to spur demand in mass storage markets by the latter half of the year, showcasing Seagate's global market acumen.

Driving Profitability Through Product Leadership

The strategic focus on a mass capacity product portfolio underpins both technological prowess and a path towards better profitability. Early signs are positive, with the company on track with their product qualification and ramp plans, aiming to ship around 1 million units of new iterations in the first half of the calendar year.

Mozaic's Areal Density Breakthrough

The Mozaic platform is a watershed moment in areal density, aspiring to scale up to 5 terabytes per disk. This groundbreaking platform, poised to be plug-and-play with conventional drives, stands ready to handle a broad spectrum of mass capacity workloads, promising attractive economics and improved TCO for Seagate's enterprise, NAS, and cloud customers.

Cost-Effective Innovations on the Horizon

With the promise of driving down material costs, a prospective 20-terabyte drive using only half the heads and disks than current constructions is already in the works. This innovation is slated for revenue generation in the latter half of 2025, providing a glimpse into the future of Seagate's product advances.

Tailoring Advantages for Diverse Customer Needs

Seagate's adoption of a novel laser manufacturing process aims to reduce expenses further while offering a compelling TCO narrative for an assortment of clients, illustrating the company's commitment to tailored cost benefits for a broad customer base.

Transformative TCO and Sustainability

In a bid to revolutionize data center economics, Seagate illustrates the profound benefits of Mozaic, where a single 32-terabyte drive may replace three 10-terabyte units, achieving more capacity with just a third of the power and space requirements, an offering that may well expedite the replacement cycle in data centers.

Uplifting Financials with an Eye to the Future

As Gianluca Romano unveils, Seagate ended the December quarter on a robust note with improved revenue and tripled non-GAAP operating income. Non-GAAP gross profit soared, with margins broadening considerably. These fruits of fiscal discipline signal an upward trajectory likely to continue into 2024. With expectations of a steady rise in demand, Seagate projects their March quarter revenue to range around $1.65 billion, forecasting an operating margin entering the low double digits and a non-GAAP EPS of approximately $0.25. The company stands well-primed to optimize financial performance, honoring capital returns, and aiming to attain projected profitability levels over time.

HAMR Technology: A Glimpse into the Future

Seagate gives a forward-looking perspective on their HAMR units, with a goal to scale up exabyte production aggressively into 2025. This tech transition aligns with their emphasis on financial predictability and supply-demand equilibrium.

Earnings Call Transcript 2024-Q2

[Operator]

Welcome to the Seagate Technology Fiscal Second Quarter 2024 Conference Call. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Shanye Hudson, Senior Vice President, Investor Relations. Please go ahead.

[Shanye Hudson, executive]

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 posted our earnings press release and the detailed supplemental information for our December quarter 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 8-K. We have not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control and/or cannot be reasonably predicted. Therefore, a reconciliation to the corresponding GAAP measures is not available without unreasonable 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 the information available to us as of today, and should not be relied upon as of any subsequent date. Actual results may differ materially from those contained in or implied by these forward-looking statements as they are subject to risks and uncertainties associated with our business. To learn more about the risks, uncertainties and other factors that may affect our future business results, please refer to the press release issued today and our SEC filings, including our most recent annual report on Form 10-K and quarterly report on Form 10-Q as well as the supplemental information, all of which may be found in the Investors section of our website.

As always, following our prepared remarks, we'll open the call for questions. I'll now turn the call over to Dave for his opening remarks.

[William Mosley, executive]

Thanks, Shanye, and hello, everyone. I am going to focus on 2 key topics in my remarks today. First, we delivered solid fiscal second quarter results, with revenue at the midpoint of our guidance and non-GAAP earnings of $0.12 per share, exceeding the upper end of our guided range.

And second, last week, we marked a major inflection point in mass capacity storage with the launch of our groundbreaking Mozaic platform. Mozaic is intentionally named to describe the fusion of innovative technologies, including Seagate's unique implementation of HAMR that collectively enable us to extend our areal density leadership. As we shared in the past, growing areal density is the most efficient way to enable data center operators to scale mass capacity storage to lower their TCO and to advance their sustainability targets.

I'll discuss the platform in more detail shortly and also share progress towards qualification and volume ramp of our first HAMR-based Mozaic product, which lays the foundation for products boasting 5 terabytes per disk and beyond.

Let me start by highlighting our fiscal Q2 performance. Revenue of $1.56 billion was led by sequentially improving cloud nearline demand and a seasonal uptick in consumer drives, offset partially by the decline in VIA sales that we anticipated. Strong cost discipline and execution on pricing adjustments resulted in non-GAAP operating income tripling quarter-over-quarter and increasing roughly 17% year-over-year despite lower revenue levels. These performance and demand trends affirm our expectation for the September quarter to be the bottom of this prolonged down cycle.

The enhanced discipline we've built into the business, including strict cost controls, management of supply and strengthening of our balance sheet gives us an excellent foundation to build on as we move into a broader recovery. Additionally, execution of our product road map is expected to structurally improve profitability and return us to our targeted financial model, which supports healthier industry economics. We enter calendar 2024 with increased confidence in our non-GAAP gross margin trajectory, including our ability to reclaim 30% minimum benchmark level at quarterly revenues that are at least 20% below our prior cyclical peak.

From a demand standpoint, gradual recovery within the U.S. cloud market has started to take shape, reflecting solid progress in consuming excess inventory, along with more stable end market behavior. Enterprise OEM demand trends have also stabilized within the U.S. markets. Customer feedback still points to macro-related concerns, although IT hardware budgets are projected to modestly improve in calendar 2024 and traditional server growth is expected to resume, trends that support incremental HDD demand growth in the calendar year. We were also encouraged to see incremental demand among certain non-U.S. cloud and enterprise customers in the December quarter.

Across the broader China markets, we project a relatively slower pace of recovery given the ongoing economic challenges within the region. However, some local governments announced further steps to support the region's economy, which our customers believe will bolster local demand across mass capacity markets in China in the second half of the calendar year. These efforts support our view for demand in the VIA markets to pick up sometime after the Lunar New Year.

Against the dynamic market environment, Seagate has continued to execute on a mass capacity product portfolio that further advances our technology leadership and serves the breadth of our customers' unique workload requirements while also supporting our objective of improving profitability. I'll outline the execution path for our latest product launches and the relevance of the new platform and then share how we believe our mass capacity solutions deliver economic value both to our customers and to Seagate.

Our product qualification and ramp plans are on track with what we've been articulating over the past several quarters. We began shipping initial volumes of our 24-terabyte CMR, 28-terabyte SMR drives in the December quarter. Customer reception has been positive, as illustrated by the numerous active qualifications underway across multiple cloud and enterprise customers.

Our 3-plus terabyte per disk product is the first major release of the HAMR-based Mozaic platform and we are rapidly nearing qual completion with our initial hyperscale launch partner. The qual has gone very well, and we are working with this customer at their request to fully transition future Seagate demand to the 3-plus terabyte per disk platform. Volume ramp is starting in the March quarter according to plan, with a goal to ship about 1 million units in the first half of this calendar year.

We then expect to continue to ramp through the balance of the calendar year, and we are currently broadening our customer engagements. Based on their planned time lines, we expect to complete qualifications with a majority of U.S. hyperscalers and a couple of global cloud customers during calendar 2024.

Starting at 3 terabytes per disk, Mozaic delivers a quantum leap forward in areal density innovation with a well-defined path that extends to 5 terabytes per disk and beyond. This transformative platform is the culmination of decades of development and numerous technologies pioneered by Seagate, including our superlattice platinum alloy media that enables higher bit density. The revolutionary plasmonic writer with integrated laser capable of reliability writing each bit and an advanced reader technology that boasts one of the world's smallest reading sensors. While Mozaic represents groundbreaking technology, the platform is fully plug-and-play with existing conventional drives and addresses the breadth of our customers' mass capacity workloads. These drives can also be deployed with SMR technologies for the few customers able to integrate SMR to take advantage of the additional capacity gains.

As I noted earlier, areal density gains are the most efficient way to scale storage capacity. Let me offer a few clear examples. First, as we execute our product road map, we can deliver increasingly higher capacity drives with minimal changes to the Bill of Materials. This results in a better TCO value proposition for our customers and attractive economics for Seagate. Second, as we scale areal density to 4 terabytes per disk, this enables extremely cost-effective product offerings in the low to midrange capacity points used by a majority of our enterprise via NAS customers. With 4 terabytes per disk, we used half the number of heads and disks to produce a 20-terabyte drive. Prototypes are already working in our labs, with revenue planned for the second half of calendar 2025.

As we ramp production to expand to other end markets, we gained tremendous manufacturing efficiencies, adding to the attractive margin opportunities that I just described. We continue to build on our technology and operational innovations with each successive product generation. For example, we are executing plans to vertically integrate the laser manufacturing process, which enhances supply flexibility, provides greater control of the technology and provides opportunities to lower production costs. Collectively, we believe these actions underpin our mass capacity cost reduction road map while also providing a very strong TCO story for a broad range of customers.

While TCO remains a key driver for mass capacity storage, data center operators are also focused on power and space consumption, particularly as investments in compute-intensive infrastructure proliferates to support generative AI applications. For context, the latest AI GPUs consume up to 700 watts, which is roughly 100x more power-intensive than a hard drive operating at maximum performance.

Our products can help data center operators store more exabytes using less power and space. To quantify this, a single 32-terabyte Mozaic drive can replace 3 10-terabyte drives storing more capacity at 1/3 of the power and footprint. TCO and sustainability gains of this magnitude are decision-altering when architecting a new data center and offer a highly economical path to modernizing existing infrastructure. We believe that this dynamic can potentially accelerate the replacement cycle.

As we move into the early stages of demand recovery, Seagate's strong focus on maintaining our product and technology road map through this past down cycle position us to return to profitable growth and address data center operators most important challenges: cost, power and space. We believe we've got the right product at the right time heading into a gradual recovering mass capacity market.

With that, Gianluca will now cover details on our financial performance and outlook.

[Gianluca Romano, executive]

Thank you, Dave. Seagate's December quarter financial results reflect solid operational execution. Revenue was $1.56 billion, up 7% quarter-over-quarter. Non-GAAP operating income more than tripled sequentially to $127 million, leading to non-GAAP operating margin expanding to 8.2% of revenue, up 540 basis points quarter-over-quarter. And non-GAAP EPS was $0.12, improving $0.34 sequentially and exceeding the high end of our original guidance range, reflecting both improving demand trends and our focus on profitability.

As these trends continue, we expect our results to improve and reach the target financial model over time. Within our hard disk drive business, exabyte shipments grew 6% sequentially to 95, with revenue growing 7% to $1.4 billion. Revenue performance was mainly driven by an expected improvement in cloud customer demand, along with seasonal improvement in the consumer market.

Within the mass capacity market, revenue increased 4% sequentially to $1.1 billion, driven mainly by strong nearline cloud demand, offsetting the expected decline in the VIA market. Mass capacity shipments totaled 83 exabytes, compared with 79 exabytes in the September quarter. Mass capacity shipments as a percent of total HDD exabyte was 87%, which is comparable to the prior quarter 88%.

For nearline products, shipment of 65 exabytes were up quarter-over-quarter from 56 exabytes. Average capacity per nearline drive continue to increase sequentially, reflecting modest demand improvement among both U.S. cloud customer and China cloud customers. We believe that inventory among many CSP customers is reaching more normalized levels and anticipate continued nearline demand improvement in the March quarter and beyond.

VIA market revenue was down sequentially in the December quarter, consistent with our expectations. Looking ahead, we expect VIA to reflect more typical seasonal patterns through calendar 2024, with the March quarter representing the low point. Legacy product revenue was $324 million, up from $278 million in the prior quarter, driven by higher seasonal demand in the consumer market. We expect the legacy market to be sequentially lower in the March quarter following typical consumer demand trends post-holiday season. Finally, revenue for our non-HDD business increased to $171 million compared with $159 million last quarter, primarily driven by improved SSD demand.

Moving on to the rest of the income statement. Non-GAAP gross profit increased sequentially by roughly $80 million in the December quarter to $367 million, ahead of our original expectations. Non-GAAP gross margin of 23.6% expanded nearly 400 basis points compared to the previous quarter, due in part to pricing adjustment and cost savings from earlier restructuring activities as well as lower amortization costs, which were about $40 million, consistent with our view for ongoing demand recovery. However, we expect amortization cost to marginally increase for the next couple of quarters as we transition some of our production line to Mozaic.

Accounting for this [ happening ], we still expect to see margin expansion every quarter in calendar 2024 as nearline demand continues to improve gradually and we ramp our latest products along with continued execution of price adjustment across the entire portfolio. Non-GAAP operating expenses totaled $240 million, down from $248 million in the September quarter and reflecting ongoing spending optimization.

With the benefit of diligent expense management and higher margins, adjusted EBITDA improved more than 50% sequentially to $216 million. Non-GAAP net income turned positive in the December quarter, resulting in non-GAAP EPS of $0.12 per share, based on diluted share count of approximately 211 million shares and tax expense of $17 million.

Moving on to cash flow and the balance sheet. In the December quarter, we had the inventory flat at just below $1.1 billion. Capital expenditures were also flat sequentially at $70 million. A majority of planned capital expenditure were completed in the first half of fiscal '24. Consistent with prior commentary, we still expect fiscal '24 CapEx to be down significantly compared with fiscal '23, although still sufficient to support our innovation-driven product road map. We generated about $100 million in free cash flow and returned $146 million to shareholders through the quarterly dividend, exiting the quarter with 210 million shares outstanding.

We closed the December quarter with $2.3 billion in available liquidity, including our undrawn revolving credit facility. Our debt balance was $5.7 billion at the end of December quarter, with more than 90% of our long-term debt obligation beyond 3 years. Non-GAAP interest expense were flat quarter-over-quarter at $84 million, and we project similar expense levels in the March quarter.

Turning to our outlook. We expect incremental improvements in mass capacity demand from both cloud and enterprise customers to more than offset seasonal related decline in VIA and the legacy markets. With better context, March quarter revenue is expected to be in the range of $1.65 billion, plus or minus $150 million, an increase of 6% sequentially at the midpoint.

We are planning for non-GAAP operating expenses of approximately $260 million as our temporary pay reduction ended late in the December quarter. At the midpoint of our revenue guidance, we expect non-GAAP operating margin to expand to the low double-digit percentage range, including underutilization cost of approximately $50 million.

We expect our non-GAAP EPS to be $0.25 plus or minus $0.20, based on a diluted share count of approximately 212 million shares and a non-GAAP tax expense of $27 million.

I will now turn the call back to Dave for final comments.

[William Mosley, executive]

Thanks, Gianluca. Heading into calendar 2024, we have increased confidence in a gradual nearline demand recovery that coincides with the launch of Mozaic. We believe this platform delivers sustainable areal density leadership with compelling TCO advantages, enabling data center operators to satisfy their increasing workload demands while conserving both power and space. This combination of capabilities is significant, and our timing is fortuitous. We've navigated the last 7 quarters with discipline and focus while maintaining our product and technology execution plans. As a result, we emerge well positioned to drive optimized financial performance to support our capital return commitments and return to our targeted profitability levels over time.

Our strong execution is only possible through the tremendous efforts of our global team, and I would like to thank them for their resiliency and dedication through this dynamic period. I would also like to thank our suppliers, customers and shareholders for your ongoing support of Seagate. Operator, let's open up the call for questions.

[Operator]

[Operator Instructions] And today's first question comes from Wamsi Mohan with BofA.

[Wamsi Mohan, analyst]

Dave, you alluded to the progress that you've made on Mozaic. Given what you know now, how would you characterize the outlook for maybe HAMR units in the second half of '24 or perhaps into '25? And I think you mentioned your first customer looking to transition to 3-terabyte HAMR. What kind of exabyte installed base opportunity is that? And maybe you could address it even more broadly across hyperscalers. That would be very helpful.

[William Mosley, executive]

Yes. Thanks, Wamsi. So we were very quantitative and prescriptive on the last call about the front half of this year. I think we won't be as much on the back half of this year, but the ramp is continuing on at a healthy pace. And we're continuing to look at all what customers need on the last generation platform, next-generation platform, trying to balance supply and demand really well. I think that's the primary metric that we're focused on, make sure we get financial predictability. We'll drive the HAMR transition aggressively this year. And then Mozaic really gets into when we get to 4 terabytes of platter and how are we populating that chain. I mean we expect to drive as many HAMR exabytes into 2025 as we can.

So we're off to a good start, I think, and we're going up the ramp and trying to work the yields and get everybody qualified like we talked about. Nothing really changed in the last 90 days, I would say. Problems are tough problems, but the team is knocking them down. So I'm pretty happy with that.

[Wamsi Mohan, analyst]

Okay. And Gianluca, maybe could you help us just think about the margin ramp? I think you noted some headwinds that will continue from underutilization charges, but you're also expecting the margins to increase all through calendar '24. Could you maybe also help us think through in that margin commentary, how -- what the margin differential is between HAMR and CMR mass capacity drives and how that might change over time?

[Gianluca Romano, executive]

Yes, good question. Well, first of all, our December quarter showed a good improvement in profitability. Our gross margin was up about 4%. Operating margin was up more than 5%, so I'll say this profitability recovery already started. Part of that is, of course, coming from Mozaic cost actions that we have taken in the last almost 2 years. And of course, the mix improvement and of course the pricing action also that we have taken in the last several quarters. So this will continue to be reflected also in the future quarters.

Mix will continue to go through more mass capacity volume and those cost actions are, of course, continuing to be very effective. In terms of the underutilization, depending a bit what we ramped during the quarter. In the December quarter, we ramped a little bit more of the wafers, but of course, has high cost in our manufacturing to get ready for the shipment of the current quarter and next quarter in terms of HAMR. And then now we can mediate use it to be the wafer and trend more on the media and, of course, having more drive in the final test. So depending a little bit on the mix inside our production. So we said underutilization charges could be slightly higher, a little bit higher, but not very much higher, which is a little bit higher. So I expect that for the next few quarters to see mix going in the right direction, meaning more high-capacity drive and starting to see the impact from some volume of HAMR. So March will not be particularly high volume, but we will have more in June. And as Dave said, we will have even more into the second part of the calendar year.

With the business improving, demand improving, we go into possibly higher revenue, and we are, of course, targeting to bring back our gross margin into the target range of 30% to 33%, as we said in the prior quarter at a much lower level of revenue compared to the prior upside.

[Operator]

And our next question today comes from Erik Woodring with Morgan Stanley.

[Erik Woodring, analyst]

Dave, I was wondering if you could just double-click again on some of the dynamics behind the hyperscalers and where their inventory is. How long do you see any more pain or what their behavior is, what your conversations look like? And then again, how they're responding to any pricing actions and production changes that you've been making over the last -- relative to 90 days ago.

[William Mosley, executive]

Yes. The dynamics for them is very interesting, and it has affected us quite a bit over the last year or so. I do think the inventory situation is much, much better than it was 6 months ago. So I'll say, it's basically cleaned up at this point. And it's going into the inventory changes going out and being consumed by the data centers again. So we're much happier with that. The rate of consumption isn't what it was 2 years ago. And -- but I do think it's going to accelerate a little bit. And this is where we get into the forecast numbers of what the CAGR is, the exabyte CAGR.

In 2020, we were in the high 50s and then we stayed in the 30s for 2021 and 2022. And then for the first time ever for the last year, 1.5 years, we've seen negative exabyte growth, which doesn't make any sense. We're forecasting still in the mid-20s right now. And it may be a little bit higher as people get into some of these replacement cycles that we talked about. The interesting dynamic as I look back on the last 1.5 years was the push for AI and how it consumed a lot of compute dollars for the compute infrastructure that was going on in the data centers. And that's critical for most of our customers. They have been raised up to get as much compute memory for that compute online as they could to be able to handle all these AI applications everyone's talking about. I do think ultimately, there's a data back end piece of that. And then also, there's the fact that they were -- as they were prioritizing that, they were letting the drives that they had in the data centers just continue to run. So there's the replacement cycle for power and space and just overall cost benefits.

We're all -- we're definitely having those conversations with our customers, and then factoring that into what exactly our volume plans are for the next 3 years and saying this is what we're intending to build. This is the economics that you could get it to -- and we've talked about this build-to-order before and I think we're getting a lot of good reception. There's a lot of other supply chains that are actually managed this way by these people. So they understand it fairly well, and they see the TCO benefits of the higher capacity drives, so they want to reach for that, plan it well and they'll get it. And we have to be careful, of course, because the factories have been so decimated by this downturn that we need to make sure that as we grow back, we grow back in a smart way.

[Operator]

And our next question today comes from Aaron Rakers with Wells Fargo.

[Aaron Rakers, analyst]

I wanted to maybe just ask about the income statement, just the P&L trajectory from here. This guidance that you've given looks like it's the first kind of sequential increase in OpEx that we've seen, and I can appreciate improving fundamentals, et cetera. I'm just curious, how do we think about the pace of quarterly OpEx and maybe a normalized level of operating expenses looking out over a couple of quarters. And then kind of building off of that with free cash flow generation returning, just remind us again how you think about the capital structure and possibility of coming back into the market in terms of share repo?

[Gianluca Romano, executive]

Thanks, Aaron. Well, in terms of OpEx, if you look our trend has always been very positive in terms of OpEx control, cost control. Just a few quarters ago, we were at well above $300 million. So we went fairly low, especially in the last quarter, now at $240 million. As I said in the prepared remarks, we have little bit of higher costs expected in this quarter because we took some extraordinary action on salary that ended at the end of last quarter. So we have a little bit of higher labor cost. As usual, we will focus on OpEx control. It's still a very, very good number. And I think in the next few quarters, we will stay around this level of OpEx until next fiscal year. As you know, in the current fiscal year, we don't have any variable compensation overall in our COGS and OpEx, but a big part is in OpEx. So I think this level is probably reasonable for fiscal Q3 and fiscal Q4. And then next fiscal year, probably a little bit higher cost in OpEx. Still, I think well below the $300 million, probably between $270 million, $280 million a quarter is probably a reasonable way to model it.

Free cash flow. We had another positive free cash flow quarter. Of course, always very important for us to generate positive free cash flow. Revenue is increasing, profitability is increasing and therefore, we expect free cash flow also to improve sequentially through the next few quarters.

[Operator]

And our next question today comes from Krish Sankar with TD Cowen.

[Hadi Orabi, analyst]

This is Eddy for Krish. Congrats on the HAMR launch. It's an exciting opportunity for you guys. I have a question regarding the customer value you are providing with these 32-terabyte HAMR drives. Will customers be enjoying lower price for terabyte versus 22 and 24 terabytes CMR drives, for example? Or because HAMR yields haven't matured yet, this benefit will be more about power and space and the lower price per terabyte to take place in the future.

[William Mosley, executive]

Yes. Well, it's a good question. We will balance everything, of course, what our yields are and our costs are and then try to get the customers incentivized. But there is some incentive business provided by their power and space reductions as well. We call that their TCO proposition. So all things in balance. I do think that the price per terabyte, if you will, is nominally the same. It may be just slightly lower, but there's definitely going to be a TCO incentive for the customers to move off of the lower capacities and under guidance.

[Hadi Orabi, analyst]

That's great color. And if we juxtapose the HAMR transition to the transition from LMR to PMR that took place back in 2006, 2008, you guys went from like 0% PMR mix to 100% within 5 to 6 scores. Do you think the HAMR transition will be as quick or you see some reasons why this trans may be a little bit slower transition from LMR to PMR, in that sense...

[William Mosley, executive]

The cycle times are a little bit longer now. So I don't think it will be as fast. I mean I'd like it to be as fast and we'll continue to drive it as quick as we possibly can. The one thing I will say is that our last generation PMR product, if you will, the 2.4 terabytes platter drive that we've just talked about has a remarkably similar kit of parts as the HAMR drives do. So relative to what we're making one versus the other, it's not a big deal and we can get through customer transitions easier.

I think as we gain more confidence in a year over the 4-plus terabyte Mozaic platforms, then we'll definitely want to accelerate. Because by the time you get to say, 5-plus terabytes, then it's such a great replacement on every legacy product that you have that we want to drive the whole portfolio there because utilization is much better in the factories and the costs come way down.

[Operator]

And our next question comes from Thomas O'Malley with Barclays.

[Thomas O'Malley, analyst]

I appreciate it. So I just wanted to understand the move from qualification to revenue recognition. It sounds like with your largest customer, you're finishing qualification right now and you're obviously pointing to some big units in the first half. You mentioned on the call that you're expecting quals with the majority of the U.S. cloud guys and a couple of others in calendar year '24. Would you expect a similar time frame between qualification and revenue recognition? Aka, like if those are getting qualified in the second half of this year, you could see revenue from a large number of additional customers. Just wanted to understand the timing.

[William Mosley, executive]

Thanks, Thomas. It's complex. There are some customers that are relatively shorter qualifications. And that -- some of that's because of feature set, making sure we get the feature set checked out. If they're on a generic feature set that we're already shipping versus their own unique feature set, we have to make sure we're doing all those things right. That's normal in any nearline transition. And I will say that a lot of people are seeing the TCO benefits. So they're asking and trying to speed these qualifications through, right, because they want that benefit to flow through as well. We will also be limited on our ramp as to what we can do and the cycle times are quite long. So we're going to balance all these things together, if that helps you.

[Thomas O'Malley, analyst]

Yes, that's helpful. And then I just wanted to ask one on the margin side. So you guys have talked about 20% below peak, but still getting back to that 30% gross margin target or at least at the low end. If you look at what you're saying for mass capacity growth for the industry, mid-20s, if you just assigned that to kind of your revenue ramp over the next couple of years, it takes probably 1.5 years to kind of get to that $2.5 billion, $2.6 billion mark, just using like a linear growth rate. Is that the time frame we should be thinking about until you get back to that 30% to 32% gross margin? Or can you get there before? And what are the levers that get you there before revenue gets back to that $2.5 billion, $2.6 billion?

[Gianluca Romano, executive]

Thank you, Tom. Well, the major lever is HAMR. So the more we ramp up HAMR, the better will be the margin. So we are becoming more and more positive on, of course, the timing of the continuous improvement in our margin. I would say, we gave an indication last quarter in terms of the level of revenue, what we think we need to achieve in order to get a certain level of gross margin. That is probably I'm getting a little bit more optimistic right now. So probably we can do at even lower level of revenue.

As you said before, qualification of customers is important, but we are working hard on qualifying more and more customers. So assuming we can continue our ramp on HAMR, now I'm fairly positive we can do earlier than what you said and also at the lower level of revenue.

[Operator]

And our next question comes from Karl Ackerman with BNP Paribas.

[Karl Ackerman, analyst]

Gianluca, it's encouraging to see an improving gross margin trajectory, but it doesn't appear to be driven by price yet. Given our mass capacity suggests that price per terabyte did fall low single digits sequentially and year-over-year, could you perhaps address whether we should expect previous actions to raise prices across the channel may occur over the next couple of quarters? I have a follow-up, please.

[Gianluca Romano, executive]

Well, I would say, you can see the good improvement in our profitability. A good part of that is actually coming from pricing. Of course, you need to check into the like-for-like pricing. The mix is, of course, always a major impact on the average. We are very happy with what we are doing, both on pricing and on cost. This quarter show a fantastic improvement in profitability, both gross margin and operating margin. And if you look at our guidance, this imply another strong improvement in profitability. So pricing is a good part of that. Mix is another part of that improvement. And we will continue to do exactly execute the strategy, and we are very glad with the outcome so far.

[William Mosley, executive]

Yes. I would say, Karl, the raw demand is still not what it was 2 years ago. And so -- and we have a supply chain that's not entirely healthy yet. We have to go continue to work on those actions. But I do think over time, especially incentivizing transitions to newer mass capacity drives. And then if there's price raises, it tends to be more on legacy and to the extent that everyone is under the same strain throughout the entire ecosystem, this is the trend that we're seeing. I think we'll probably take advantage of it.

My sense is that in the next year or 2, we'll get to the point where we get high enough of the ramp that we can be very predictable. And then I think things will stabilize quite a bit. But we're not at a place where the industry has enough demand relative to the capacity that has online yet.

[Operator]

And our next question today comes from Kevin Cassidy of Rosenblatt Securities.

[Kevin Cassidy, analyst]

Congratulations on the great results. You implemented a build-to-order program with your customers. Can you give an update on that? Is that still active? And how is it giving you visibility?

[William Mosley, executive]

Yes. Thanks very much. It is, and it's transitioned from my last comments as well because the industry just at the levels that we're at, to build on my last comment is just can't fund the investment to make an areal density and exabyte growth over time with the revenue and margins where it was. And what helps us is -- to run factories is the improved visibility and the predictability towards that in demand. And so I think that's why the HDD industry has changed fairly dramatically through this cycle, these last 6 or 8 quarters, because capacity did come at the same time that people were -- that demand was down.

And the industry is, therefore, underinvested in capital and lead times are going up, as we've talked about before. So we need this build-to-order framework to just get back to a healthy industry. And we are rewarding predictability with our customers, and we're incentivizing that predictability and where the people aren't predictable, and they come in at the last minute for product that either we don't have it or they have to pay for our flexibility. I think that's the way we're thinking about it. And then making sure that we stabilize the supply base as well because it's not just ourselves as the HDD supplier, but we have numerous upstream supplies that need to be stabilized as well. So it's still going to take some time.

[Kevin Cassidy, analyst]

Okay. Great. And you mentioned vertical integration of your laser technology. Is that a cost savings? Or is it more controlling the supply chain?

[William Mosley, executive]

Yes. I think at this point, it's been a long time coming, and we definitely value the suppliers that have helped us get HAMR products to market. We also feel like given how intricate this silicon photonic circuitry is, is that we needed our own capability to control. But right now, it's more of a technology second sourcing, if you will. And so we're going to continue to run with a few sources.

I think over time, there should be the opportunity to go drive the cost down and balance all things with multiple sources and the ability to control the investments that we make in capital, for example, and things like that. But it's been a long time coming and part of the reason we're talking about it as part of Mozaic because it's very relevant as we get to 4-terabyte platter and 5 terabyte platter. I think also there's been some noise out there in the industry about, well, as goes the ramp of that supplier so goes the Seagate ramp, and that's clearly not true.

[Operator]

And our next question today comes from Steven Bryant Fox with Fox Advisors LLC.

[Steven Fox, analyst]

Dave, I was just wondering if you could zoom out a little bit, without putting any kind of time frame on it, to get to the 30% gross margins. It seems like you can almost get there from here on just the typical incremental margins from volumes. But based on everything you said, it doesn't seem that easy, especially early stage with HAMR versus later stage. So can you sort of walk through some of the puts and takes, say, over the next 2 to 3 quarters versus, say, when you hit that volume crossover where it becomes more smooth to get to the margin? It's just -- there's been a lot of comments around this. Maybe you could just sum it up.

[William Mosley, executive]

Yes. And Gianluca can share some insights as well here. I think that first of all, we're ramping HAMR according to some prescriptive schedule. We can deploy it into certain mass capacity hyperscaler markets. We can also deploy it in other markets, depending on how we choose to do things so we can put it in VIA markets, for example, over time. And the rate at which we are able to transition and our yields and scrap and things like that, especially once we get to 4 terabytes per platter, then I think that becomes more and more accretive in margin. Fundamentally, though, I still think the demand picture actually is going to shape the next few quarters from a margin perspective.

My sense is the demand has still not come anywhere close to where it was 2 years ago. We may see with the growth of data and with investments that people need to make in data around all these AI applications, we may see demand pick back up again, and that will be the fundamental driver.

Gianluca, go ahead.

[Gianluca Romano, executive]

Yes. No, I said that before, I think the combination of stronger demand through the cycle and our very good products based on HAMR technology will drive further improvement in gross margin, sequential improvement. Now I think we will have a sequential improvement through the entire kind of '24. And this is, of course, based on our view of the ramp of HAMR and also the recovery from the prior down cycle that we expect, especially in the mass capacity to continue through the entire kind of '24 and actually even kind of '25 in it.

[Steven Fox, analyst]

That's helpful. Just can you fill in one other blank, which is back-end testing capacity? How does that sort of help hurt margins as this ramp happens?

[William Mosley, executive]

Based on where we were from legacy products years ago on desktop and so on and even just the volumes we were at a couple of years ago, I think we have plenty of back end test capacity.

[Steven Fox, analyst]

But is it a longer test cycle though? Is it going to be a long test cycle as you did before...

[William Mosley, executive]

It is. It certainly is. The bigger the drive, the longer the test cycle, but we still have plenty of capacity to cover the demands at this level.

[Operator]

And our next question comes from Timothy Arcuri with UBS.

[Unknown Analyst]

This is [ Leo ] on for Tim. Just one for me. Now you don't report orders, but perhaps you could give us some color on book-to-bill and just some idea of where orders are relative to revenues and where that -- how that book-to-bill has been trending and where you think that's going over the next couple of quarters. That would be helpful.

[William Mosley, executive]

Thanks. Yes, that does get into our build-to-order plans. We are definitely, like I said before, very prescriptive on what we're building for people 2, 3, 4 quarters out. And as long as we all stay on that plan, I think that's predictable economics for our customers as well. So it's going better and better every quarter. I think when we first launched this, there were questions that I was getting on these earnings calls about supply is so far below -- or sorry, since demand is so far below supply today, how can you do something like this? But we need that predictability in order to run the supply chain and reward everyone upstream of the supply chain. So far, the progress has been fairly good and we're getting better visibility in the next quarter and beyond.

[Operator]

And our next question comes from Vijay Rakesh with Mizuho.

[Vijay Rakesh, analyst]

Dave and Gianluca, just on the enterprise hard disk drive side, on the hard disk asset, do you see, given the 25% exabyte growth and recovery on the TC side this year, do you expect those revenues to get back to that $2 billion run rate exiting '24 , I guess, calendar '24?

[Gianluca Romano, executive]

No, we don't guide after this quarter. So we just gave a good guidance for the March quarter in terms of revenue increase and profitability increase. And as we said, no, we are ramping HAMR volume. We are seeing better demand environment. So we expect sequential improvement through the quarter, but we don't give specific guidance on revenue for the end of the calendar year.

[William Mosley, executive]

Yes. I would say that obviously we're watching nearline demand, CSP demand, on-prem enterprise demand continuing to build strength but not nearly be as big as it was a couple of years ago, but that's very good and we're being very careful building into it.

The one point that you just raised, which was the whole AI PC demand, which I think it's still very early innings in this, but we do see opportunity there. High-end workstations, if you will, that are running AI applications may actually be an interesting opportunity.

[Vijay Rakesh, analyst]

Got it. And then on the gross margin line, sorry to belabor that, Gianluca, do you see you guys getting back to that target window 33% exiting this year? And especially on the HAMR side, I think Dave mentioned you can do with 4-terabyte-plus 5 disks for a 20-terabyte drive versus 7 to 10 disks now. What are the gross margins on HAMR versus where you see your corporate margins today, I guess?

[Gianluca Romano, executive]

We know we said in the past amortized gross margin is, for sure, accretive to the corporation. So it's always above our average. Right now, as you know, there is no HAMR drive in our results. But now we see starting in the March quarter, and you already see some improvement in our guidance. It will be, I expect, more when we go into the June quarter and through the rest of the calendar year. So we are positive on the profitability from that product. And we need to take our time to qualify big customers and then to start ramp because, as Dave said, we take a little bit of time to ramp high-volume production for the new product.

[Operator]

And our next question comes from Ananda Baruah with Loop Capital.

[Ananda Baruah, analyst]

Really appreciate it. I guess for Dave, and Gianluca can jump in here, too. The hyperscalers are sort of having some conversation about data center redesign over the coming years, a lot of this is around GPU compute. But they are referring to it as data center [indiscernible]. And I guess would there -- if that occurs, do you have any opinion on if there would be incremental opportunity for nearline drive that would, I guess, substantively be like in addition to whatever data growth is going on? So really I just wanted to -- if you have any thoughts on that in any context. And that's it.

[William Mosley, executive]

Yes. Ananda, it's a real complex topic. What I would say is that the compute infrastructure is changing dramatically and the memory architectures will change to support that computer architecture very dramatically as well. So there is a lot of redesign discussion going on. There are different types of applications and things that are being branded AI. There's stuff that's very focused on text or large language models. And then there's image recognition and video creation. And so there's a lot of different types of applications that are propagating. And I think this is just normal application development that's been going on for years and years and years. But I do think there's different types of hardware. So I think there are some now AI data centers being discussed that are largely compute.

I also think that some of these applications are spinning off a lot of data and they're requiring data to be stored for a certain period of time and then brought back up to the higher levels to be reprocessed. And so that's just normal data growth as well. So I think the net of it is there's a lot of architectural redesign going on, probably not affecting the tiers that we're in. If anything, and we made reference to this in the prepared remarks, there's cost power and space at a premium. There's many AI applications from what I'm hearing that there's just not enough power for and our infrastructure is going to be critical. But to the extent that you can do your part to buy transitioning to higher capacity drives that net-net gives you the same exabyte capacity with less power. I think that's a good thing. It may be an opportunity for us.

[Ananda Baruah, analyst]

So that would be in addition to like the 25% kind of data run rate driven -- that sort of power as a catalyst, Dave?

[William Mosley, executive]

It's hard to say. It depends on the bills and how much people are having to pay for it. Again, I think in the AI applications that are really exploding right now, power is going to become one of the limiting factors. And so to the extent that there may be a really good payoff in not only cost savings, space savings and so on, but also just freeing up that power infrastructure to go do other things. I mean that might actually help us get above the 25%.

[Operator]

And our next question comes from Mark Miller of The Benchmark Company.

[Mark Miller, analyst]

Congratulations on the launch of Mozaic. I'm just wondering, you mentioned it briefly. What kind of traction are you seeing from AI-related opportunities? And what do you -- how do you see that ramping throughout the year?

[William Mosley, executive]

Yes, Mark, me, I'm pretty cynical sometimes on these things, and I'm looking for POs that actually say AI on them. And they are starting to happen, but it's still fairly small. And again, I'll go back to my previous comments. These are really applications that have been developing on a lot of fronts over many years anyway. So say, for example, image recognition, whether it's at the edge or in the cloud, that application space has been developing over time quite a bit. When we get into specific things like large language models where people talk about, I think the data infrastructure impact piece is still secondary to the compute piece even at this point. So at some point, there will be compute enabling all these really cool applications and efficiencies that people and businesses like ours were taking advantage of and then the data will continue to grow on the back side of that, but we're still early innings on that.

[Mark Miller, analyst]

So that's more 2025, you think?

[William Mosley, executive]

For large language models, I'd say maybe. I don't know exactly.

[Operator]

And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to management for any closing remarks.

[William Mosley, executive]

Thanks, Marco. Seagate is focused on executing our product road map, leveraging the advanced technologies in our Mozaic platform, which we believe positions us well to enhance profitability over the near term and capture long-term opportunities for mass capacity storage. I'd like to close by once again thanking all of our stakeholders for their ongoing support of Seagate. Thanks for joining us today, and we look forward to speaking with you during the quarter.

[Operator]

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.