Seagate Technology Holdings plc (STX) Earnings Call Transcript & Summary

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] As a reminder, this conference is being recorded for replay purposes. At this time, I would like to turn the call over to Shanye Hudson, SVP, Investor Relations and Treasury. Please proceed, Shanye.

Thank you. Good afternoon, everyone, and welcome to today's call. Joining me are Dave Mosley, Seagate's Chief Executive Officer; and Gianluca Romano, our Chief Financial Officer. We posted our earnings press release and detailed supplemental information for our June 2020 quarter and fiscal 2020 year-end on the Investors section of our website. During today's call, we will refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and Form 8-K that was filed with the SEC. We've not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control, and/or cannot be reasonably predicted. Therefore, 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'll open the call up for questions. I'll now turn the call over to you, Dave.

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 [Technical Difficulty] 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 return 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 6 decades, which has wide-reaching effects on how businesses are planning and investing near term. Additionally, the restrictive measures and vision disclosures have created emotional and financial hardships on people, communities and businesses. I'm proud of how 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 health care workers, provided funding and support for food banks, schools and elderly care facilities. We've also leveraged our data science expertise to volunteer resources through our data for good program and have granted free access to our patent portfolio in 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 in streaming video, online gaming and the rapid shift to public cloud drove ongoing data center 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 midsized 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 led to a deeper 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 the 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 3 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 continued to execute our technology road map. 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 within 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 capacities. 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 Lyve Drive, an integrated solution intended to help CIOs cost effectively move data from endpoints to edge to core. And we launched Lyve Labs, an innovation center to work collaboratively with customers on solutions to their data management challenges. These 3 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 reinforce the massive growth in data, which the study predicts will grow at a compound rate of 42% over the next 2 years, but also reveals how data is being widely distributed across multiple data centers 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 that 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 road map and broad product portfolio, including our system solutions and evolving Lyve 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.

Thank you, Dave. The business environment in the June quarter remain highly dynamic due to the effect of the pandemic. However, we are continuing to manage the business well while prioritizing the continued 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 a migration to cloud services, but we saw weaker-than-expected demand in our other key end markets, 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 enable 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 were shipped into the mass capacity storage market, less sequentially and up from 52 exabytes 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's 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 investments remain 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 SD edge, will drive strong revenue growth for nearline products. Revenue for video and image applications declined for the second consecutive quarter, primarily as a result of the evolving health situation. While we saw indication early in the quarter that demand conditions were improving, we began seeing municipalities enforcing tighter restrictive measures and diverting funds towards COVID-19 relief effort, impacting the base of new security and smart video installations. However, video and image application remain a strong, long-term secular growth driver. Nearly 1/3 of global datasphere growth is projected to come from these and other applications, including data generated from security devices and IoT sensors used in 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 exabytes. The consumer MPC market remain 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 slow over the next couple of quarters, 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 terms 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 sustained strong demand for our nearline product with a broadening of customers. However, sales into the video and image application and mission-critical markets 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 just described as well as higher COVID-19-related costs. These higher costs include underutilization, logistics, worker safety and other labor-related expenses but 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. Given the major impact that the global pandemic is having on our industry, we expect to incur elevated costs 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 certain onetime savings, primarily related 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 of our long-term financial model range of 13% to 16% of revenue. Based on a share count of approximately 260 million shares, 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 reflect lower revenue as well as higher costs, 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 needs 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 investments around this level, given the current market uncertainty over the next couple of quarters. We will continue to work closely with our customer and monitor business conditions as we progress through the calendar year. We remain focused 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 used $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 remains strong with cash and cash equivalents 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 strengthened our balance sheet by restructuring our debt profile in the June quarter to extend our average maturity level to about 7 years and lower our average interest expense. At 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 2 fiscal years. Inventory remained relatively flat quarter-over-quarter at $1.1 billion. To better respond to current market conditions, 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 of the elevated freight charges. Reduction would result in slightly higher inventory levels. As we enter FY '21, the level of uncertainty remains high, and we cannot predict the timing or shape of an economic recovery. We are now 4 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 are now planning for broader market demand to improve this quarter. With this in mind, our guidance reflects 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 of 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 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 final comments.

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 stressed 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% 1 year ago and 24% 5 years ago. This pivot has been intentional and has 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 6 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 5 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 road map 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 over this medium-term horizon, it's worth noting that we also expect the 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 have 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 customers. With that, Gianluca and I are happy to take your questions.

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

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?

Yes, 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 that 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's a fairly strong demand. We expect that, 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 have 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 enterprise that's 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's big data growth trends, even on the -- even in on-prem, where people aren't necessarily buying right now. There's anecdotal evidence that the utilization rates are going up of the capacity. So data is growing everywhere, but that on-prem part to watch right now, and we do expect some recovery over time. I don't think -- 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 and meet their service level agreements. Sorry, Gianluca.

Yes. I would say, no, first of all, we had a record quarter in F Q4, so -- which is a very high starting point in terms of 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 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 it's not the level of F Q4, but it doesn't mean that is a very low level for the quarter.

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

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 of 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 made after those server buys are completed?

It's a very interesting question. I think -- back to my point about digestion periods to expand on that whole topic, Patrick. In the past, digestion 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, as 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 to -- 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's 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 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.

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?

Yes. Thanks. I mean, we think about serving the customers and what they need. So for those customers that are still maybe 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 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 12 and 14s and all the other things. That'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 dialogues with the customers and when they want to pivot, we'll pivot.

Yes. I would add to that. No, 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 it's now that is our top focus for the short term. We always focus on free cash flow, as Dave was saying before and profitability.

One other thing we said in the prepared remarks, to take you back about 4 quarters or so is, in at a time like this, you make sure that you watch your cash really carefully, and that means we -- what I've learned over time is watch production. So don't build in anticipation of 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'll continue to do.

Your next question comes from the line of Ananda Baruah.

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 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 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.

Yes. Yes, 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 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. So 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 that's going on. And to take advantage of that, the cloud service provider is going to have to put a lot of stuff online. I think there's also a lot of on-prem opportunities. So long term, we feel more certain, but it's 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, but we've got to just get through that period.

And Dave, do you use to hit that -- sorry, Gianluca. Go ahead.

You were asking about the -- a little bit longer-term outlook. And in the prepared remarks, we are seeing that for FY '21 we are looking right now at a revenue that is fairly flat with fiscal year '20. Of course, there is an impact from the COVID situation. So our assumption is based on an 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.

And do you think nearline -- or 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?

Yes. I think the other mass capacity markets like surveillance and NAS, they come back on and they start moving to 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, private data center applications. We need those to grow in exabytes and come back, but we think that will happen, and then you'll see exabyte growth again. Yes.

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

I was curious on cash flow. You talked about some insight into flat revenue for next year. How should we think about cash flow opportunity to drive maybe some working capital improvement?

Thanks, Shannon. I'll let Gianluca answer this. But loosely speaking, we have 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 factories 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 bringing in quite a bit of capital as we did last quarter, but I'll let Gianluca talk about more color.

Yes, completely agree. We have generated a very strong free cash flow in fiscal year '20, and we said we are expecting a revenue that is comparable. And probably the free cash flow will also be comparable. 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 terms of shareholder return we have a commitment to return at least 50% of our free cash flow to shareholders. And this is done in the form of dividend and in the form of share buyback. So we will continue with this policy, and we expect another fairly strong year in terms of free cash flow.

Yes. And we don't look at it as a tactical discussion either. It's more -- we'll manage the cash tactically, but the shareholder return is more long term. That's who we want to be.

Our next question comes from the line of Kevin Cassidy from Rosenblatt Securities.

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 deployments that as soon as the COVID is released or there's a virus immunity, are you expecting a surge in that business or is it going to be more gradual?

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's 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 points. So one of the earlier questions, there's 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's some early indications this quarter that it's coming back to life. And it's geographically very dispersed. Of course, there's lots of different regions of the world where people are going to be doing this spending. But that's what we see. It should start to improve quarter-over-quarter this quarter. Don't know how fast it will improve into Q2, but it's certainly a market that long-term we're watching.

Okay. And just for a little more detail, what's the drive capacity for those systems?

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

Our next question comes from the line of Steven Fox from Fox Advisors.

I had 2 questions if I could. The first one is, you touched on some of this, but I was wondering, Dave, when you talk about getting to flat revenues for the full fiscal year, you start off in about a $300 million hole, and you've talked about some pressures that in the back half of the year could still be there. So how would you map out sort of a recovery so that the full year is 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 did the underutilization have anything to do with just the missed top line? Or is that related to specific manufacturing issues?