Seagate Technology PLC (STX) Q4 2020 Earnings Call Transcript

Seagate Technology PLC  (NASDAQ: STX) Q4 2020 earnings call dated July 28, 2020

Corporate Participants:

Shanye Hudson — Vice President, Investor Relations

Dave Mosley — Chief Executive Officer

Gianluca Romano — Executive Vice President and Chief Financial Officer

Analysts:

Katy Huberty — Morgan Stanley — Analyst

Patrick Ho — Stifel — Analyst

Ananda Baruah — Loop Capital Markets — Analyst

Shannon Cross — Cross Research — Analyst

Kevin Cassidy — Rosenblatt Securities — Analyst

Steven Fox — Fox Advisors — Analyst

Michael Turrin — Wells Fargo — Analyst

CJ Muse — Evercore ISI — Analyst

Karl Ackerman — Cowen — Analyst

Toshiya Hari — Goldman Sachs — Analyst

Dustin Scaringe — Robert Baird — Analyst

Presentation:

Operator

Good afternoon and welcome to the Seagate Technology Fourth Quarter and Fiscal Year 2020 Financial Results Conference Call. My name is Jason and I will be your coordinator for today. [Operator Instructions] Following the prepared remarks, there will be a question-and-answer session. [Operator Instructions]

At this time I would like to turn the call over to Shanye Hudson, SVP, Investor Relations and Treasury. Please proceed, Shanye.

Shanye Hudson — Vice President, Investor Relations

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 June quarter and fiscal 2020 year-end on the Investor Section of our website.

During today’s call, we will refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and Form 8-K that was filed with the SEC. We’ve not reconciled certain non-GAAP outlook measures, because material items that may impact these measures are out of our control and/or cannot be reasonably predicted, therefore a reconciliation to the corresponding GAAP measures is not available without unreasonable effort.

As a reminder, this call contains forward-looking statements, including our September 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, should not be relied upon as of any subsequent date.

Actual results may vary materially from today’s statements, information concerning our risks, uncertainties and other factors that could cause results to differ from these forward-looking statements are contained in our most recent Form 10-K and 10-Q filed with the SEC, our Form 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 will open the call up for questions.

I’ll now turn the call over to you, Dave.

Dave Mosley — Chief Executive Officer

Thanks, Shanye. Good afternoon, everyone and thanks for joining us. I will begin the call by summarizing our June quarter performance. Giving context for the current market environment and then share some perspectives on the longer-term data trends. Before turning the call over to Gianluca to discuss details of our June quarter results and provide our outlook for the September quarter. Following the prepared remarks, we will open the call for questions.

Results for the June quarter came in within our guided range amidst a deteriorating demand environment across several key end markets, coinciding with COVID-19 related economic [Indecipherable]. We delivered June quarter revenue of $2.52 billion and non-GAAP EPS of $1.20. We increased free cash flow by 5% sequentially to $274 million over 80% of which we returned to our shareholders through dividends and share repurchases. Demonstrating our commitment to our capital return program. I’ll address in a few moments, why we see the impacts that developed in the June quarter continuing in the September quarter.

I’ll also discuss why we remain confident that the company will emerge stronger from this current crisis. It’s only been a few months since COVID-19 was declared a pandemic. However, its impact on the macro economy and global society has been profound. Economists predict global GDP will sharply contract this year to levels we’ve not seen in six decades, which has wide-reaching effects on how businesses are planning and investing near term. Additionally, the restrictive measures and business closures have created emotional and financial hardships on people, communities and businesses.

I’m proud of our team has adapted quickly to this tough environment to continue serving our customers and partners, while also supporting our local communities and one another. As a team, we have donated equipment and supplies to hospitals and healthcare workers, provided funding and support for food banks, schools and elderly care facilities. We’ve also leveraged our data science expertise, the volunteer resources through our data for good program and have granted free access to our patent portfolio and support of the open COVID pledge to aid research efforts to diagnose, treat and ultimately prevent the virus.

For Seagate, ensuring the protection and safety of our employees, customers, partners and suppliers remains our highest priority and is vital to the continuity of our business. At this point, all of our manufacturing facilities are fully operational and we’ve worked through a majority of the supply chain and logistics challenges that we had faced early on, although there are cost implications that I will touch on later. The impact on our customer base has been more varied across our end markets. The increase in remote work and education, as well as acceleration of streaming video, online gaming and the rapid shift to public cloud, drove ongoing datacenter investments by cloud service and content providers.

These investments spurred strong demand for our nearline products in the June quarter and we expect these trends to ultimately accelerate the transition to mass capacity storage. Conversely, economic uncertainty and the extension of restrictive measures began playing out in other markets, as the quarter progressed, causing smaller and mid-sized enterprise customers to scale back their IT budgets, municipalities to delay certain projects and consumers to spend more selectively. These macroeconomic factors ultimately impacted sales of our video and image applications and lead to a steeper than seasonal decline for our legacy products.

Amidst this overall environment, we’re anticipating a continuation of these demand trends to impact our legacy markets in the September quarter. We will also continue absorbing meaningful cost to navigate the disruptions to normal business operations. These are factored into our guidance for the September quarter. While there remains limited visibility near-term, the underlying data demand trends have not changed. The rapid growth in data and race for businesses to extract value from that data is fueling need for more compute and mass storage. Accordingly, we believe current demand patterns will shift favorably, as enterprises adjust to the new normal.

In the meantime, we are being cautious and carefully managing our cash and expenses to maintain our strong financial foundation. Seagate has a track record of being good stewards of cash and taking a disciplined approach to managing capital, while maintaining the health of our supply chains. We are focused on continuing that track record while staying true to our legacy of returning excess cash flow to our shareholders. While we’ve been focused on navigating the tough near-term business conditions, we also made important strides in fiscal year 2020 to place the company in excellent position to capitalize on the world’s burgeoning growth of data that is driving secular demand for mass capacity storage and data management solutions.

I’ll highlight three key examples. First, despite tough business conditions, we grew both revenue and exabyte shipments in fiscal year 2020, supported by strong demand for mass capacity storage. Revenue from the mass capacity markets increased 25% year-over-year with exabyte shipments up 57%. Second, we continue to execute our technology roadmap. Our fiscal year performance underscores the success of our 16 terabyte nearline drives and launch of our common scalable platform. These drives are now used by the world’s leading cloud and hyperscale names. We target achieving the same success with our 18 terabyte drives. This common platform approach helps to simplify the qualification process for our customers, while allowing Seagate to improve operational efficiency.

We began shipping 18 terabyte drives as part of our system solution in the March quarter, with shipments to select cloud customers and channel partners starting in the June quarter. We expect to begin ramping 18 terabyte drives later in the calendar year, which aligns well with market readiness. We remain on track to begin shipping our first commercially available HAMR drives in late 2020, on 20 terabyte capacity. HAMR technology will be the industry’s path to achieving drive capacities of 30, 40, 50 terabytes and even higher. We plan to offer 20 terabyte HAMR drives to customers on a limited basis and as part of our system solution to collect production and field data.

Third, we announced Seagate Live Drive an integrated solution, intended to help CIOs cost effectively move data from endpoints to edge to core. And we launched Live Labs, an innovation center to work collaboratively with customers on solutions to their data management challenges. These three accomplishments demonstrate that Seagate is firmly pointed towards capturing market opportunities that are emerging in an ever-growing data world. Earlier this month, we launched the rethink data report, which is based on a survey commissioned with IDC of 1,500 global enterprise business and IT leaders.

The findings not only reinforced the massive growth of data, which the study predicts will grow at a compound rate of 42% over the next two years. But also reveals how data is being widely distributed across multiple datacenters and cloud environments. We refer to this in the report as data sprawl. With massive data growth and data sprawl, it comes as no surprise, the data management is a top concern among respondents. The emerging role of data-ops organizations are intended to address the challenges of collecting, moving, storing and curating data securely, across complex and disparate networks. Through Seagate’s innovative technology roadmap and broad product portfolio, including our system solutions and evolving live platform, we believe Seagate is the ideal mass storage partner for data-ops organizations.

With that, I’ll turn the call over to Gianluca to go into more depth on our June quarter results and share our outlook for the September quarter.

Gianluca Romano — Executive Vice President and Chief Financial Officer

Thank you, Dave. The business environment in the June quarter remained highly dynamic, due to the effect of the pandemic. However, we are continuing to manage the business well, while prioritizing the continuous safety of our employees and meeting customer demand. We continue to see strength in demand from cloud data center customers, as they address the transition to a remote economy and the migration to cloud services. But we saw a weaker-than-expected demand in our other key end market driven by economic uncertainties and business disruption brought on by COVID-19.

Despite these near-term challenges, revenue and EPS were still within our guided ranges and our June quarter performance compared favorably on a year-over-year basis, with revenue of $2.52 billion, up 6% year-over-year and down 7% sequentially. Non-GAAP operating margin of 14.8%, up 160 basis points year-over-year and down 70 basis points, sequentially. And non-GAAP earnings per share of $1.20 compared with $0.95 in the year ago period, a 26% increase year-over-year and down 13% quarter-over-quarter. Additionally, the resilience of our financial model and focus on operational efficiency, enables us to generate healthy free cash flow and strengthen our balance sheet.

In the June quarter, we shipped a total of 117 exabyte of hard disk drive capacity, 91 exabyte of the total where shipped into the mass capacity storage market. So that’s sequentially and up from 52 exabyte in the year-ago period, representing very strong annual growth. On a revenue basis, mass capacity storage represented 58% of June quarter revenue and about 63% of HDD revenue, up from 49% of HDD revenue in the year-ago period.

Additionally, we achieved our second highest revenue quarter in mass capacity storage in June, driven by robust demand of our high-capacity nearline drives, from a broadening base of cloud and hyperscale customers. Nearline shipments increased to a record 80 exabyte with average capacity increasing to 10.8 terabyte per drive. Our performance was supported by strong demand for our 16 terabyte drives, which remains the company highest revenue product in the quarter.

Looking ahead to the September quarter, we expect soft demand from the OEM and enterprise market, as Dave outlined earlier. While cloud data center investment remained relatively healthy. Accordingly, we expect to see some moderation in overall demand for our nearline products near term. Over the long term, we believe demand for mass capacity storage in the cloud, and at the edge, will drive strong revenue growth for nearline products.

Revenue for video and image application declined for a second consecutive quarter, primarily as a result of the evolving health situation. While we saw indication early in the quarter, a demand condition were improving, we began seeing municipalities enforcing tighter restrictive measures and they raising fund to our COVID-19 relief efforts, impacting the base of new security and smart video installations. However, video and image application will remain a strong long-term secular growth driver. Near the tort [Phonetic] of global datasphere growth is projected to come from this and other applications, including data generated from security devices and IoT sensor using smart city and smart factories worldwide.

The legacy market represented 34% of total June quarter revenue, down from 36% in the March quarter. Exabyte shipments into this market declined 9% sequentially to 26 exabyte. The consumer and PC markets remained relatively soft during the quarter as anticipated, but a sharper slowdown in enterprise IT spending, particularly among small to medium enterprise customers, resulted in weaker-than-expected demand for our mission critical drives. We currently expect enterprise IT spending to remain low over the next couple of quarter, which is also impacting demand recovery for our system solution. Systems are included in our non-HDD business, which represented 8% of total June quarter revenue, up from 7% in the March quarter. In term of absolute dollars, non-HDD revenue was flat quarter-over-quarter, as higher demand for our enterprise class SSDs offset the decline in systems.

To summarize, we sustain strong demand for our nearline product with a broadening of customers. However, sales into the video and image application and mission critical market are being temporarily impacted by the pandemic and led to the sequential revenue decline in the June quarter. Non-GAAP gross margin was 27.3% in the June quarter, down about 70 basis points sequentially, due to lower contribution from the margin-rich product, that I’ve described as well as higher COVID-19 related cost. This higher cost include under utilization, logistic, worker safety and other labor-related expenses that negatively impacted June quarter gross margin by approximately 130 basis points.

As of today, our factories are fully operational. However, we will continue to monitor the current situation, which remain fluid. Even the major impact with the global pandemic is having on our industry, we expect to incur elevated cost for at least the next couple of quarters. Non-GAAP operating expenses were down 8% sequentially to $313 million and below our previous plan. In addition to lower expenses, reflecting a full quarter impact of working from home, we also incurred a certain one-time saving, primarily ready to lower variable compensation and benefits.

Separately, we announced a restructuring plan in early June to drive additional operational efficiencies. We plan to reinvest most of the savings from this plan, back into the business, while also lowering operating expenses by about $10 million per quarter relative to our pre-COVID level of approximately $350 million. Non-GAAP operating income was $373 million and non-GAAP operating margin of approximately 14.8% of revenue was in line with our guidance expectation, to remain in the upper half f our long-term financial model range of 13% to 16% of revenues.

Based on a share count of approximately 260 million share, non-GAAP EPS for the June quarter was $1.20. We estimate the total impact to EPS from COVID-19 was between $0.25 and $0.30, which reflects lower revenue as well as higher cost, I previously outlined. We reduced capital expenditure by 12% sequentially to $114 million in the June quarter, consistent with our plan to align our capital need with the current market environment. For the fiscal year, capex represented approximately 6% of total revenue.

Looking ahead, we believe it prudent to keep our investment around this level, given the current market uncertainty over the next couple of quarters. We’ll continue to work closely with our customer and monitor business condition, as we progress through the calendar year. We remain focus on cash management and generated $274 million of free cash flow in the June quarter. We utilized $55 million to retire approximately 1.1 million ordinary share, exiting the quarter with 257 million shares outstanding. We use $168 million to fund our dividend and our Board also approved a quarterly dividend payment of $0.65 per share payable on October 7, 2020.

Our liquidity position remained strong with cash and cash equivalent totaling $1.7 billion at the end of the quarter and access of up to an additional $1.5 billion through our undrawn revolver. Additionally, we further strengthen our balance sheet by restructuring our debt profile in the June quarter, to extend our average maturity level to about seven year and lower our average interest expense. As of the end of the quarter, gross debt was $4.2 billion with net debt of $2.5 billion. We now have only around 6% of principal debt coming due over the next two fiscal year.

Inventory remain relatively flat quarter-over-quarter at $1.1 billion to better respond to current market condition, we will continue to proactively build supply for some critical components to mitigate potential supply chain risk in the future and also plan to increase use of ocean freight to offset some relative freight charges. Reduction would result in slightly higher inventory level. As we enter the fiscal year ’21, the level of uncertainty remains high and we cannot predict the timing or shape of an economic recovery. We are now four weeks into the September quarter and the pace of demand has been slow, a similar pattern to what we saw in both the March and June quarter.

We continue to foresee healthy cloud data center demand over the long term, but remain cautious and they’re not planning for a broader market demand to improve this quarter. With this in mind, our guidance reflect an appropriate level of conservatives in our cash management and our production plan. We expect the following for the September quarter. Revenue to be $2.3 billion, plus or minus $200 million. Non-GAAP operating margin at or slightly below our long-term range of 13% to 16% of revenue, and non-GAAP EPS is expected to be $0.85, plus or minus $0.15.

In closing, Seagate is executing well during this period of unprecedented and uncertainty. With our robust balance sheet and solid free cash flow generation, we believe Seagate is in a healthy position to navigate the current market, while continuing to capitalize on the attractive secular growth opportunities that will play out longer term.

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

Dave Mosley — Chief Executive Officer

Thanks, Gianluca. Looking ahead, the near-term outlook is unclear. However, we will continue to execute on what is in our control. We have an agile business model, strong balance sheet and ample liquidity that we believe allows us to operate efficiently and intelligently through stress business environments. We will manage our cash carefully, while maintaining our commitment to return at least 50% of our free cash flow to our shareholders.

As I covered at the top of the call, a bright spot through the course of this year has been the strong performance of our mass capacity portfolio. Mass capacity now represents 58% of the Seagate’s revenues, up from 46% one year ago and 24%, five years ago. This pivot has been intentional and is powered Seagate’s resilient performance through the first leg of this crisis. Going forward, we remain confident that our strategic focus on mass capacity storage and data management solutions is the right one, and that long-term trends tied to data growth will continue to drive secular demand for these products both in the cloud environment and at the edge. We anticipate demand across our end markets to improve within the next six months and currently model revenue to be fairly flat in fiscal year 2021, supported by the strength of our mass capacity product portfolio.

Reiterating the outlook we provided at our analyst event last year. We believe the mass capacity storage TAM will nearly double over the next five years. Growing from approximately $12.5 billion in the last 12-month period to around $24 billion by calendar year 2025. The innovation of our technology roadmap and product pipeline makes Seagate well positioned to capture these opportunities, grow revenue and drive strong free cash flow over time. While the mass capacity opportunity alone is sufficient to drive solid growth of this medium term horizon, it’s worth noting that we also expect to edge data opportunities and legacy markets to meaningfully contribute to revenue and cash flows as well.

Prior to opening the call for questions, I want to briefly address the important movement underway to finally drive much needed racial injustice reforms. As a company guided by the core values of innovation, integrity and inclusion, this is a vital moment for us to set a leading example with all of our stakeholders. We acknowledge that we do not have all the answers. But we are committed to taking this opportunity to look inward and create positive change across our global organization. We’ve already taken actions to raise awareness, open lines of communication, expand our training and further our inclusion efforts.

Inclusion is foundational to our success and extends beyond our employee base and I’m looking forward to this opportunity to make Seagate even stronger. My confidence in Seagate’s potential is reinforced by the determination of our people, the support of our diverse supplier base and the strength of our relationships with partners and the customers.

With that, Gianluca and I are happy to take your questions.

Questions and Answers:

 

Operator

[Operator Instructions] Your first question comes from the line of Katy Huberty from Morgan Stanley. Your line is open.

Katy Huberty — Morgan Stanley — Analyst

Thank you. Good afternoon. I think, I heard Gianluca say that you expect moderating growth in nearline in the September quarter. If that’s right, how should we think about the sequential drop in nearline exabyte shipments? And as a follow on to that, is there any visibility at this point into whether there would be a recovery in exabyte shipments going into the December quarter?

Dave Mosley — Chief Executive Officer

Yeah. Hi, Katy. I think we’ve been on a tear, of course, year-over-year, we talked about 57% growth in exabytes. As far as I can see the period that’s going on, we continue to see large growth and Gianluca can quantify it from here. But from my perspective, this digestion period so the people have been talking about is really quite different, it’s more of a race to get things online and that’s what we see. So there is a fairly strong demand, we expect that strength is going to continue up throughout the rest of the fiscal year. We don’t really have visibility into the customers’ inventory levels, but believe any disruptions are just very temporary, at least the cloud service providers.

More of the thing that affected nearline all in, was a smaller portion of the nearline, which is the — I’ll call it, on-prem enterprise. So that’s the small medium business enterprises that’s — the impact is. And we’re expecting that to slightly recover or start its recovery, but some of that was just because in Q4 and going into Q1, small-medium businesses are not really registering very much. So, over the long-term, there is a big data growth trends even in on-prem, where people aren’t necessarily buying right now. There is anecdotal evidence that the utilization rates are going up of the capacity. So data is growing everywhere, but that on-prem parts to watch right now and we do expect some recovery over time.

I don’t think you should take away from our comments that cloud is softening or anything else, if anything cloud is racing to get everything online to meet their service level agreements. Sorry, Gianluca?

Gianluca Romano — Executive Vice President and Chief Financial Officer

Yeah. I would say, first of all, we had a record quarter in F Q4, so which is a very high starting point in term of no exabyte volume. What we said in the script is, we will not see the same level in F Q1. We don’t expect to see the same level in F Q1. But for — over the long term, for sure, we expect this need for data to be there and to continue to drive this secular growth. And so we are very confident with the long-term situation and even Q1 maybe is not to the level of F Q4, but it doesn’t mean that is in very low level for the quarter.

Katy Huberty — Morgan Stanley — Analyst

Okay. Thank you.

Operator

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

Patrick Ho — Stifel — Analyst

Thank you very much. Maybe Dave, as a follow-up to Katy’s question regarding nearline drive and the demand trends. Just given that overall data center and cloud spending, does remain healthy right now. What’s the timing between purchases that drives versus say servers and memory products that are seeing strong demand. Is there a little bit of a lag time when storage purchases are may — after those server buys are completed.

Dave Mosley — Chief Executive Officer

It’s a very interesting question. I think, and back to my point about digestion periods to expand on that whole topic, Patrick. In the past, just in periods might have been more around storage optimization of software in the data center and things like that. I think right now, to your point, in order to meet the service level agreements, there is everything has been pushed into the cloud. The cloud service providers generally have really tough challenges responding on all fronts with, whether it’s network gear or servers to meet compute requirements for people that are using the compute aspects.

And then I think storage does lag that a little bit, but the data is growing as well very quickly in those service level agreements. And so generally speaking, I think there is a race to get everything online, it’s not really a typical digestion period characterized by software. And I think that this push that you’ve seen from the client server models, quickly into quickly into the cloud models is ultimately good for mass capacity. It’s just we have to — back to the answer to Katy’s question. We have to make sure that we’re satisfying this demand, as it’s growing very quickly. And then make sure that we are patient with the on-prem demand, because the on-prem right now is kind of stagnating.

Patrick Ho — Stifel — Analyst

Great. Maybe as a quick follow-up. You talked about the release and the introduction of the 18 terabyte drive and the common platform, which is very beneficial for a lot of your customers that are already on the 16 terabyte platform. How do you drive new customer wins and continue the share gains that you’ve achieved over the past year with the 16 terabyte, as you move to 18 terabyte?

Dave Mosley — Chief Executive Officer

Yeah. Thanks. I mean, we think about serving the customers and what they need. So for those customers that are still may be ramping 16s and not buying 18s yet we’ll continue ramping them on 16. Some people want to make the transition and I think we’re ready to go. So we have a lot of confidence on our — that platform now, because we’re deep into the platform, but we can also change — make the necessary changes that we want, which are fairly minor to get to 18 terabytes. And remember that this same platform allows us to go back down to 12s and 14s and all the other things. So it’s one of the reasons we drove it so hard. I think the pipelines around all those products relative to customer qualification and availability are quite good. We have great dialogs with the customers and when they want to pivot, we will pivot.

Gianluca Romano — Executive Vice President and Chief Financial Officer

Yeah, I would add to that. Now we manage the business for the long term, not really focusing on the short-term market share. The market share is an outcome of our good product and how we manage the business. But its not that is in our top focus for the short term, we always focus on free cash flow as they were saying before and profitability.

Dave Mosley — Chief Executive Officer

One other thing we said in the prepared remarks to take you back about four quarters or so. As you know, a time like this, you make sure that you watch your cash really carefully and that means, we watch — what I’ve learned over time is, watch production. So don’t build in anticipation to some of those things stay really tight with your customers and build exactly what they need. I think that’s the best way for us to watch our cash and that’s what we will continue to do.

Patrick Ho — Stifel — Analyst

Thank you.

Operator

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

Ananda Baruah — Loop Capital Markets — Analyst

Hi. Good afternoon, guys. Thanks for taking the question. Hi, Dave, Gianluca. Just to start a clarification or I guess maybe just a little bit more on what you’re expecting sort of demand-wise as we go through fiscal ’21? On nearline hyperscale, do you think that we’ve reached the peak exabyte ships in the June quarter or as you sort of digestion period end, do you think we could sort of revert back and go above 80 over the next few quarters. And Dave, it feels like maybe that has to happen to be able to hit flat growth given the September quarter guidance. And then also along with that any detail or any context on — in that flat outlook, how you’re expecting or sort of accounting for on-prem to bounce back as well? And then I have a quick follow-up. Thanks.

Dave Mosley — Chief Executive Officer

Yeah. That’s good. I think it is a question between on-prem, if you break down nearline between cloud service providers, which I said was a little bit more than 50% and then that changes quarter-over-quarter and then you have the rest of nearline, which is on-prem. I think on-prem is the thing to really watch. The near term is fairly uncertain like we talked about and we do need the on-prem to come back. It will and that’s my point about utilization levels.

I think as far as the data everywhere is growing very healthy and the demand for data is exploding with all the IoT and smart cities and autonomous vehicles and all that stuff is going on. And to take advantage of that, the cloud service provider is going to have to put a lot of stuff on line. I think there is also a lot of up on-prem opportunities. So long-term we feel more certain, but if this near-term period of small-medium businesses people can’t get in, or even if they can, they’ve got other priorities right now that we’ve got to just get through that period.

Ananda Baruah — Loop Capital Markets — Analyst

And Dave, do you — to hit that — sorry, Gianluca. Please go ahead.

Gianluca Romano — Executive Vice President and Chief Financial Officer

Now you were asking about the little bit longer term outlook and in the prepared remarks, we are saying that for fiscal year ’21, we are looking right now at a revenue which is now fairly flat with fiscal year ’20. Of course, there is an impact from the COVID situation, so our assumption is based on any impact from COVID that will start to decline in the next few months. But now, we are still very, very confident in Seagate outlook over fiscal year ’21 and on the long term.

Ananda Baruah — Loop Capital Markets — Analyst

And do you think nearline or just I’ll just say nearline overall, do you think it reaches it gets above 80, does it need to get above 80 as we go through the fiscal year to hit that flat revenue outlook?

Dave Mosley — Chief Executive Officer

Yeah. I think the other mass capacity markets like surveillance and NAS. They come back on and they start moving higher and higher capacity points, I think you’ll see the exabyte growth. So we need those more on-prem type of mass capacity applications on-prem. I’ll say, a private data center applications we need those to grow in exabytes and come back, we think that will happen then you’ll see exabyte growth again.

Ananda Baruah — Loop Capital Markets — Analyst

Got it. Great. Thanks guys.

Operator

Your next question comes from the line of Shannon Cross from Cross Research. Your line is open.

Shannon Cross — Cross Research — Analyst

Thank you very much for taking the question. I was curious on cash flow, you talked about some insight in the flat revenue for next year. How should we think about cash flow opportunity to drive, maybe some working capital improvement? Thank you.

Dave Mosley — Chief Executive Officer

Thanks, Shannon. And I’ll let Gianluca answer this. Loosely speaking, we have a quite a few levers to pull, should we need to. And from my perspective, cash flow is exactly what we’re driving right now as the metric we’re watching our cash very carefully. Like I said before, not bringing on too much inventory, although, we do have to make sure that we cover potential factors being down that’s the reality of where we were last quarter and that may still happen again. So we have a little bit more inventory, but we’re going to watch our cash very carefully not overbuild, make sure that we’re running things the right way. We’re still making investments in ourselves and we’re still being quite a bit of capital as we did last quarter, but I’ll let Gianluca talk about more color.

Gianluca Romano — Executive Vice President and Chief Financial Officer

Yeah, completely agree. Now we have generated a very strong free cash flow in fiscal year ’20. And we said, we are expecting revenue that is comparable and probably the free cash flow will also be comparable. At capex, we are investing for the growth that we are expecting in the long term. But in general, no, I would say, free cash flow should be fairly similar year-over-year. We have in term of shareholder return, now we have a commitment to return at least 50% of our free cash flow to shareholder. And this is done in the form of dividend and in the form of share buyback. So we will continue with this policy and now we expect another fairly strong year in term of free cash flow.

Dave Mosley — Chief Executive Officer

And we don’t look at it as a tactical discussion, either it’s more, we will manage the cash tactically, but the shareholder return is more long term, that’s who we want to be.

Shannon Cross — Cross Research — Analyst

Thank you.

Operator

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

Kevin Cassidy — Rosenblatt Securities — Analyst

Yeah. Thanks for taking my question. On the video and image business and applications, can you say, is it all COVID-related that they’re not being deployed or and is there a buildup of maybe some anticipated deployment as soon as COVID is release or there is a virus immunity. Are you expecting a surge in that business or is it going to be more gradual.

Dave Mosley — Chief Executive Officer

It is a really interesting space to watch, I think Kevin. So loosely speaking, these are on-prem applications and people just couldn’t get on-prem. And even if you could, sometimes there were — was nobody else there to be on-prem to surveil or whatever you would say, right. So it’s not surprising to see that these markets were down, they are starting back up again, sputtering to start, but starting back up again. We believe long term that these products are actually quite strong, because of smart cities and smart factories and smart hospitals. And so, we believe these on-prem applications will come back fairly, strongly.

Timing is everything and we believe we have the best product portfolio to go satisfy that. It will probably grow in capacity point to that — one of the earlier questions, there is more exabytes coming this way. So the trend that we saw in the last couple of quarters with surveillance in particular, being so far down, is not going to continue. We think, it will start ticking back up. There is some early indications this quarter that it’s back — coming back to life. And it’s geographically very dispersed. Of course, there is lots of different regions of the world where people are going to be doing the spending. But that’s what we see, if it should start to improve quarter-over-quarter, this quarter don’t know how fast will improve into Q2, but it’s certainly a market that long-term we’re watching.

Kevin Cassidy — Rosenblatt Securities — Analyst

Okay. Thanks. And just for a little more detail. What’s the drive capacity for those systems?

Dave Mosley — Chief Executive Officer

Typically in the past, it’s been 4 terabytes. Now it’s going up to 6 terabytes and 8 terabytes. And so that happens as a function of these technology transitions that — so all the while that the markets are going through with the markets are, there is a march towards higher and higher capacity points, because there is more value in those drives up in the edge.

Kevin Cassidy — Rosenblatt Securities — Analyst

Okay. Great. Thank you.

Operator

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

Steven Fox — Fox Advisors — Analyst

Thanks. Good afternoon. I have two questions, if I could. The first one is, you touched on some of this, but I was wondering, Dave, when you talk about getting the flat revenues for the full fiscal year. You started off in about $300 million a whole and you’ve talked about some pressures that in the back half of the year could still be there. So how do you map out sort of a recovery, so that the full year’s roughly flattish.

And then as a second question. Going back to the COVID-related costs that hurt the gross margins by 70 bps. What surprised you most in the quarter that what you weren’t prepared for and to be underutilization have anything to do with just the miss top line or is that related to specific manufacturing issues? Thanks.

Dave Mosley — Chief Executive Officer

I’ll let — Steven. I’ll let Gianluca take the latter part first.

Gianluca Romano — Executive Vice President and Chief Financial Officer

Yeah. So in general for the impact of COVID in the quarter, we’ve had 130 basis point which is only related to the direct cost. It is not related to the lower revenue that was actually not generated and impacted by COVID. So in this script, we’ve had the direct cost about $35 million for the 130 basis points. And then we also said, when you look at EPS, you have a second impact. And the second impact is related to the lower revenue and of course the margin of those revenue. And we quantified for a total EPS impact of between $0.25 and $0.30. So, as a level of EPS, you have — now a fairly huge impact in the quarter from COVID.

In the prior quarter, we had that additional cost that were little bit lower, but not still as we need to continue about $25 million. We didn’t have a lot of revenue impact. We probably had now some impact on the legacy part of the business. But cloud was probably offsetting that reduction. In fiscal Q4 compared to what we were expecting of nearline came out at the level we were expecting, but we had some impact in — on the legacy business, and also on surveillance, so overall we lost some EPS, because of the lower revenue.

Dave Mosley — Chief Executive Officer

And I’d say, to your question Steven, about the longer-term going out through that — throughout the fiscal year. Some of the legacy markets have been very slow of late, we don’t anticipate — there is some natural decline year-over-year, because they are by nature legacy, we’re not investing in them and we’re watching them develop. But I think some of them are temporarily down and they will come back to some level as previous, it’s a good business for us with good free cash flow and minimal incremental investments so we have to go make. So we’ll watch that and some of them have already shifted the flash like notebook and gaming and things like that. But there is things like mission critical, which we expect to come back to some level.

The other part of — I’ll call it on-prem that we talked about before. On-prem nearline has actually been fairly slow as well, it satisfied via some of the same channels that we have — but that will come back, because data is growing at the edge and in private data centers and things like that. So there is this enormous shift in locality going on between client server, business and cloud business, it doesn’t mean all client servers gone, it’s just some of it’s on temporary high and that’s what we’re expecting to recover somewhat, if you will, to make up the fiscal year guide.

Steven Fox — Fox Advisors — Analyst

Great. That’s really helpful. Thank you.

Operator

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

Michael Turrin — Wells Fargo — Analyst

Yeah. Hi, guys. Thank you for taking the question. This is Michael on for Aaron. I just had a quick one on pricing. Could you guys comment a little bit on what you saw in the pricing environment, particularly on the mass capacity side. And then, I’m just curious how you’re thinking about that going into the back half of the year as one of your big competitors start begins to ramp 18 terabyte. Thank you.

Dave Mosley — Chief Executive Officer

Yeah. As far as what we saw in the rear view mirror. I think that getting the right supply to the right places. We have a long plan, we’ve talked about this with our 16 terabyte, big volumes for most of the mass capacity people. I don’t think prices were unpredictable by any means for us. I mean they’re fairly predictable. I do think that out in some of the distribution channels, where the supply-demand picture isn’t so clear. And early on, there were some supply gaps, later on, there were some demand — there were demand promise to those on-prem enterprise, especially in that smaller distribution markets. I think that’s where you can see a lot of dynamics. From our perspective, that should stabilize pretty quickly, because supply is there so. Do you want…

Gianluca Romano — Executive Vice President and Chief Financial Officer

Yeah. If you compare to a couple of quarter ago for sure, the pricing environment is more stable, so its a better situation right now.

Michael Turrin — Wells Fargo — Analyst

Perfect. Thank you. And one more if I could, just on the opex, given that you guys outperformed during the current quarter. How should we think about opex in the September quarter relative to June. And then also kind of the 340 level that you had communicated previously? Thanks.

Gianluca Romano — Executive Vice President and Chief Financial Officer

Yeah. So what we were saying in the script is longer term, probably, you want to model around a $340 million. This is probably no after the COVID impact and when people will not be obliged [Phonetic] to work-from-home. For the September quarter, will be probably no — in the mid-between what we reported for F Q4 and this long-term view.

Dave Mosley — Chief Executive Officer

I think there’s two elements we’re obviously, there is some things that you save money on in the current work environment. And then the other thing is that there is a very tight cash management like investments are really being scaled back for us right now. And so I think it should re-equilibrate like Gianluca said to about that 340 level. That’s the way should think about the longer-term.

Michael Turrin — Wells Fargo — Analyst

All right. Thank you.

Operator

Your next question comes from the line of CJ Muse from Evercore ISI. Your line is open.

CJ Muse — Evercore ISI — Analyst

Yeah. Good afternoon. Thank you for taking the question. I guess, my first question is on gross margins, both short term and long term. So I guess short-term, can you walk through what you’re seeing in terms of under-absorption COVID-related costs and perhaps competitive pressure, as you look at September quarter. And then longer term, this is not easy stuff to make and there’s three players, it should be a 40% plus gross margin business. So as you think about that, I’m assuming, I agree with that assessment. What gets you there? Is it volumes? Is it higher price points on next generation technologies? What gives the earnings power for the industry to the level that is consistent with the technology being profit?

Dave Mosley — Chief Executive Officer

Yeah. I’ll let Gianluca walk you through the details of the gross margin impact last quarter. But to your point, actually, where the quarter ended up. Last quarter, we feel pretty good about our gross margin, our operating profit was above the midpoint of our range of 14.8%. Gross margins have — we not had some of the COVID impacts, which Gianluca can walk through what they were than we probably would have been in the gross margin range as well.

To your point, a supply demand balance is usually the way I answer that question. Demand for exabytes will continue to grow and we have to put capacity online to go get that. In times like this, we were actually putting capacity online for growth in exabytes and we’ve got a temporary low in some of the legacy markets right now. So we have excess capacity. So that’s not a long-term trend, that’s a short-term trend. But to your point, managing supply demand properly is the way that you add that value. Go ahead, Gianluca.

Gianluca Romano — Executive Vice President and Chief Financial Officer

Yeah. For the June quarter, we said that COVID-related impact in term of gross margin percentage was 130 basis point. So if you look at where we closed the quarter at 27.3%, you add the 130 basis points, we are at 28.6%. As you know they are this part of the business, as the gross margin that is little bit higher than the full corporation. So I would say, as Dave said before, we are close to the normal or there are still in the range of now 29% to 33%. For the September quarter, we have spent a COVID cost to be fairly flat sequentially, so I would — probably more or the same level of cost.

CJ Muse — Evercore ISI — Analyst

Thank you. If I could add one quick follow-up. Can you help modeling with stock-based comp interest expense and tax rate? Thank you.

Gianluca Romano — Executive Vice President and Chief Financial Officer

Sorry. Can you repeat the question.

CJ Muse — Evercore ISI — Analyst

As you look at September, can you help us model the interest expense, stock-based comp and the tax rate?

Gianluca Romano — Executive Vice President and Chief Financial Officer

Yeah. I would say, stock based comp is a little bit lower than $30 million and the tax rate is mid-single digit and the interest are very similar to the F Q4, so you can’t just take that as a reference.

CJ Muse — Evercore ISI — Analyst

Thanks so much.

Dave Mosley — Chief Executive Officer

Yeah. Sorry, CJ. One other point is just to make sure that, that we register this from a gross margin percentage perspective, we’re not really running the business like that right now. So if we see deals or cash flow we’ll take it. I mean and we were able to increase free cash flow by 5% last quarter, which is ultimately our focus. Just, as some of the legacy businesses might recover faster, even if it’s not great gross margin percentage, will take the cash.

Operator

Your next question comes from the line of Karl Ackerman from Cowen. Your line is open.

Karl Ackerman — Cowen — Analyst

Thank you. Good afternoon, everyone. First of all, I wanted to get your longer-term view on not just the mix of your hard drive units between enterprise and non-enterprise. But also the absolute level of units for the industry. I know you and peers have issued units over exabytes for some time, but your capital expansion plans factor a resumption of unit growth over the next several quarters. I ask, because the last restructuring action taken by the industry was contemplated in late 2018, when the hard drive TAM was annualizing your 400 million units. And see Q2 that number of peers closer to 240. Now clearly COVID has materially disrupted the supply chain and demand as you described. But I guess, how do you think about the capital allocation in opex longer term, as it relates to stable or most likely improving hard drive volumes in the mix toward nearline?

Dave Mosley — Chief Executive Officer

Yeah. I think from a space perspective if I think there first, I think, we have plenty of space. What’s settled [Phonetic] underneath this is obviously the nearline drives have a lot more heads and disks. And so the heads and disks space is full, the number of drives we make is actually not so relevant in the space that we have. I mean, we are manufacturing line footprints are pretty small. So we could pivot up in number of drives, if we had to exactly to your point. I don’t know, we cut a lot of space if we had fewer — necessarily fewer drives, depends on how many fewer of course but.

And from our perspective, almost all of our capex is really been pointed out that exabyte growth that we’re expecting in the cloud. We believe $24 billion of TAM up in 2025, we’ve got to get the right capacity online that looks like heads and disks and that’s what the way we’re filling things up and using our capital for that as well. And I think one other point is, even the big drives in the old days, you had a test floor and a clean room. Today you have 10 test floors and a clean room. If the test is actually the thing that’s consuming most of the space, the most of the capital and that’s all associated with nearline as well, mass capacity as well.

Karl Ackerman — Cowen — Analyst

Very helpful. Thank you.

Operator

Your next question comes from the line of Toshiya Hari from Goldman Sachs. Your line is open.

Toshiya Hari — Goldman Sachs — Analyst

Good afternoon and thank you very much for taking the question. Gianluca, I just wanted to go back to gross margin. You talked about there being a 130 basis point impact from COVID in the quarter. I was curious, on what level of impact was initially embedded in your thought process when you give guidance three months ago? And I guess importantly, I guess in response to CJ’s question, you mentioned that you expect relatively flattish COVID impact in the September quarter. But at what point do you think, at least some of the under-utilization rate headwinds start to abate in your business and I’ve got a quick follow-up. Thank you.

Gianluca Romano — Executive Vice President and Chief Financial Officer

Yeah. In the guidance we included the COVID impact slightly above what we had in the prior quarter. So let’s say between $25 million and $30 million. So not very far from where we ended up. And yes, for September, we expect the cost to be very similar, either full quarter impact. And so we expect more or less the same amount. We don’t know exactly when this will end. And what we have model internally is, if COVID to continue to have an heavy impact in F Q1 and F Q2 and not much in the second part of the fiscal year. But of course with this, it is a model and we don’t know exactly what will happen.

So but this impact also in the demand, so not only on the cost. Maybe the other part, which is maybe even more important at this point is, demand and the impact on our mix. So overall, you need to look at the cost and the demand and the final EPS impact for F Q4, we have estimated that overall impact to be between $0.25 and $0.30 that is a huge impact now, when you consider our EPS results for the quarter?

Dave Mosley — Chief Executive Officer

And it kind of points to the products, especially the on-prem enterprise products, nearline, mission critical and some of the surveillance that mix is fairly rich, has the media rich and actually these are tough drives to make as well. So that would have been accretive to gross margin, I think it’s the point.

Gianluca Romano — Executive Vice President and Chief Financial Officer

It’s very hard to add — it’s very hard. But, not so we — we tell you what we have in our model, we don’t pretend to be correct.

Toshiya Hari — Goldman Sachs — Analyst

Got it. No. That’s super helpful. Thanks for the color. And then as a quick follow-up and this one’s probably for Dave. I think historically you guys have talked about 35% CAGAR in terms of exabytes for your mass capacity business. Obviously you grew significantly in north of that in fiscal 2020. Within the context of the flattish revenue outlook you provided for fiscal ’21, are you expecting exabytes in mass capacity to be sort of consistent with about 35% or given the outperformance in fiscal ’20 should we be prepared for a slightly slower growth rate? What are your thoughts today based on your customer conversations? Thank you.

Dave Mosley — Chief Executive Officer

Yeah. Thanks, Toshiya. I think, it will probably be above the 35% to 40% range. I mean, it certainly in calendar year ’20 we’re — we’ve said that we expected to be greater than that and if we call that the slow part even with the mass capacity, then it will still be — that’s the front end of the year. I think, as we come out of the back of this, I think it will — the exabyte will accelerate as well. So this is why we’ve made this pivot, I think it kind of proves that it’s the right pivot of our portfolio. It’s why we want to get this — our product lines really tight and very manufacturable, be flexible and get the right margins and there saw I — to your point, I think we’ll outstrip the 35% to 40% certainly in calendar year ’20 and probably up throughout the fiscal year.

Toshiya Hari — Goldman Sachs — Analyst

Thank you.

Operator

Your last question comes from the line of Dustin Scaringe from Robert Baird. Your line is open.

Dustin Scaringe — Robert Baird — Analyst

Hi. Thanks for taking the question, right at the end. This is Dustin speaking for Tristan. Just a quick one on 18 terabyte. I know you guys talked about ramping it in the later part of this year. But I’m wondering at what point is 18 crossover 16 in the future? And then do you expect to gain market share until then? Thank you.

Dave Mosley — Chief Executive Officer

Yes, it’s an interesting question, Dustin. I’m not being cavalier with it, but I’ll say we’ll crossover when we’re ready and when the customers are ready. And I think, when we have such high volume on the 16s and people are demanding the 16s, I think, we have to be careful to make sure that we don’t again build the wrong product at wrong time for people. We can transition to the 18s fairly quickly, I think we do need some lead time, because that’s heads the media starts and whatnot.

But I think, we have great relationships with the big customers that would be demanding that. There — we’re lockstep with them on, what those transitions would look like and I have a lot of confidence of the drive. I don’t think it’s going to be the significant revenue contributor, certainly in the next two quarters, like we said before. But we can transition whenever the customers are ready and will take their Q on it.

Dustin Scaringe — Robert Baird — Analyst

Okay. Thanks for that, Dave.

Dave Mosley — Chief Executive Officer

Okay.

Operator

I will now turn the call back to management for closing remarks.

Dave Mosley — Chief Executive Officer

Yeah. I would like to — thanks, Jason. I’d like to take an opportunity to just thank our customers and suppliers, employees and investors for their support to Seagate, and we look forward to updating you on future calls. Thanks, everyone.

Operator

[Operator Closing Remarks]