Kate Scolnick - Vice President-Investor Relations Stephen James Luczo - Chairman & Chief Executive Officer David H. Morton - Chief Financial Officer & Executive Vice President.

Sherri A. Scribner - Deutsche Bank Securities, Inc. Rich J. Kugele - Needham & Co. LLC Ananda P. Baruah - Brean Capital LLC.

Good morning, and welcome to the Seagate Technology's Fiscal Fourth Quarter and Year End 2016 Financial Results Conference Call. My name is Kevin and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question and answer session.

As a reminder, this conference is being recorded for replay purposes. At this time, I'd like to turn the call over to Kate Scolnick, Senior Vice President, Investor Relations. Please proceed, Kate..

Thank you. Good morning everyone and welcome to today's call. Joining me today in the room from Seagate's executive team are Steve Luczo, Chairman and CEO and Dave Morton, Executive Vice President and CFO.

Dave Mosley, President and COO is connected into the call remotely and Phil Brace, President of Cloud Systems and Silicon Group is not on today's call as he is traveling. We've posted our press release and detailed supplemental information about our fourth quarter and fiscal year end 2016 on our Investor Relations site at seagate.com.

During today's call we'll review the highlights for the June quarter and fiscal 2016, provide the company outlook for the first fiscal quarter 2017, and then open the call for questions.

We will refer to non-GAAP measures on this call, which are reconciled to GAAP figures on our supplemental information available on the investor section of our website.

We have not reconciled our non-GAAP financial measures guidance to the most directly comparable GAAP measures because material items that impact these measures are out of our control and/or cannot be reasonably predicted.

Accordingly, reconciliation of the non-GAAP financial measure guidance to the corresponding GAAP measures is not available without unreasonable effort. We are planning for the call today to go approximately half an hour and we will do our best to accommodate your questions following our prepared remarks as time permits.

As a reminder, this conference call contains forward-looking statements about the company's anticipated future operating and financial performance, customer demand, technology and product development advancements, and general market conditions.

These forward-looking statements are based on management's current views and assumptions and should not be relied upon as of any subsequent date. Actual results may vary materially from today's statements.

Information concerning our risks, uncertainties and other factors that could cause results to differ from these forward-looking statements are contained in the company's SEC filings and supplemental information posted on the investor section of the company's website at seagate.com. I would now like to turn the call over to Steve Luczo.

Please go ahead, Steve..

Thanks, Kate. Good morning everyone and thanks for joining us today.

For today's call, I will cover the high-level trends we are seeing in the business and the direction we will be taking with the company with respect to structure and focus, and Dave Morton will then walk through certain financial highlights and I'll close the call with our guidance for the September quarter and our general expectations for the second half of calendar 2016.

For the June quarter, Seagate achieved revenues of $2.65 billion, and on a non-GAAP basis, gross margins of 25.8%, net income of $207 million and diluted earnings per share of $0.69. Non-GAAP operating expenses in the June quarter were $443 million.

Capital expenditures of $146 million for the June quarter were higher than our previous forecast due to our decision to accelerate the ramp of new products in our portfolio that utilize new tooling and equipment.

In addition, we are accelerating the expansion of our Korat facility to expedite the plan manufacturing footprint reductions across many sites. For the full fiscal year, our capital expenditures were $587 million, approximately 5% of revenue and below our targeted long-term model range of 6% to 8%.

We believe Seagate's June quarter results are reflective of a generally stable but relatively benign macroeconomic environment as well as an acceleration in the deployment of cloud-based storage associated with usage shifts of technologies and architectures by end users.

Demand from cloud service providers was stronger than expected after several quarters of relatively modest demand from these customers. Our HDD shipments for the June quarter were 36.8 million units, representing a record 61.7 exabytes of storage.

Average capacity per drive increased to a record 1.7 terabytes per drive and ASPs of $67 were a record since the Thai floods. Overall inventory levels were down 6% sequentially and within this, finished goods were down 21%.

These inventory levels represent sequentially improved inventory turns and lean production schedules as we ramp our new HDD products throughout the portfolio.

With respect to our cloud systems business, we are making good progress in ramping new platforms and gaining new customers offset by some demand softness from top-tier OEM and government customers.

The integration of Dot Hill is complete and we will be launching converged storage platforms, including hybrid and all-flash array offerings later this fiscal year, which we believe are equal to or better than our competition.

On the silicon side, we have recently introduced a number of new products including our industry-leading 2 terabyte NVMe enterprise SSD product which is getting positive customer feedback.

This business is extremely competitive and we're working in construction with our key NAND partners who are enabling us to develop workload-specific and optimized products. For the fiscal year 2016, Seagate achieved revenues of $11.2 billion, and on a non-GAAP basis, net income of $684 million and diluted earnings per share of $2.26.

In fiscal 2016, we shipped 233 exabytes with average capacity per drive up 29% year over year. Within these results, we shipped 70 exabytes for the business-critical product portfolio, up 28% year over year.

Consistent with our expectations of the impact of the shift from client server to mobile cloud architectures, Seagate's HDD unit shipments over the last five fiscal years have decreased 15% while at the same time exabyte shipments have grown 112% and average capacity per drive has increased 133%.

Applications which require higher capacity HDDs are responsible for the record demand for HDD storage. Additionally, these application trends align with the Seagate actions that are in progress to optimize utilization in our heads, media and drive-test factories.

Since the majority of exabyte growth is related to high-definition streaming content where massive data ingest and sequential write operations are the key characteristics for the specific workloads, HDDs continue to be the optimal cost performance solution over any other storage device.

In the nearline enterprise market, our 8 terabyte products were the fastest growing products in units and revenue within our overall HDD portfolio this quarter. We expect the market to continue to shift towards this capacity point over the next two years.

Our 10 terabyte helium enterprise product is best in class for power performance and we will be shipping our 12 terabyte helium nearline enterprise test units for customer evaluation this quarter.

To meet the high capacity storage requirements of the client marketplace, we have recently introduced 10 terabyte capacity points across our Guardian Series client portfolio with particular focus on the surveillance, gaming, DVR and NAS markets.

Over the next several quarters, we will refresh most of our high volume capacity points in our portfolio with lower cost designs using our leadership in areal density and our improved operational footprint.

Our customers will benefit from the portfolio advancements and we believe that Seagate will be in the leading competitive position as our market shifts from a low capacity, units-based demand profile to the future applications which are component rich and require aggressive technology advancement.

This is particularly important as the storage market shifts from client server to mobile cloud applications and storage environments.

While we expect this shift to continue to pressure PC unit volumes with HDDs, we are encouraged by the capacity needs of the remaining PC client as well as the significant growth in non-PC-client devices and applications.

Assuming a relatively stable macro environment, we believe that given the continued shifts in our product revenues as well as recognizing the full impact of the significant changes in our manufacturing footprint and operating expenses, the company will achieve revenue growth, product gross margin improvements and improved profitability.

I'll turn the call over to Dave Morton now to go into more details on these activities..

Thanks, Steve. With the shifts taking place in Seagate's business, there are a few specific areas of our financial model that were impacted in FQ4. I would like to provide further context to Steve's earlier discussion around the actions we are taking to manufacturing and operating expense levels.

For the June quarter, Seagate's addressable HDD market was higher than forecast, driving benefit in our revenue and margin results for the quarter. Within this, there were specific HDD product areas where demand was stronger than our expectations, specifically for our nearline enterprise HDD products.

Our 8 TB nearline enterprise products were our leading revenue SKUs as overall ACD enterprise revenue increased to 45% of our total HDD's revenue.

By comparison, our PC client shipments were 25% of HDD revenue in the June quarter, reflecting the shift of client server storage environments and our strategic participation in the higher-capacity segments.

We continue to make strategic decisions to not aggressively participate in certain areas of the low-capacity notebook and gaming market where the gross margin contribution does not warrant the long-term manufacturing investment.

As a result, our future forecast for Seagate's HDD unit addressable market may have a variance to our competition, as we may not participate in all HDD unit sales demand in any given quarter.

As we manage the shifts in our product portfolio, customer demand and changing nature of our customer base, we are continuing to align the operating model of our HDD business to optimize our manufacturing footprint and we are reducing our capital expenditures to maintenance capital requirement levels, which is expected to be less than 5% of our revenue over the next fiscal year.

Through these actions, Seagate will be operating at or very near full capacity and our operating philosophy will shift to chasing demand upside versus managing excess capacity.

Earlier this year, we began the process of reducing the HDD manufacturing capacity from approximately 55 million to 60 million drives per quarter to approximately 35 million to 40 million drives per quarter. The actions required will be completed within the next six to nine months.

At the same time, we are continuing to accelerate the utilization of our own drive factories, internal head and media facilities.

Towards our infrastructure cost alignment, in the June quarter, we implemented certain cost reduction activities and recognized approximately $80 million in pre-tax charges and additionally in July, we announced further cost reduction activities reflecting $164 million in pre-tax charges.

Overall restructuring actions are proceeding as planned and we expect the financial benefit of these actions will begin to have a positive impact in the September quarter. For the June quarter we recorded a tax benefit of $16 million.

This is primarily related to the release of tax reserves and changes in our deferred taxes in foreign jurisdictions, impacted by our global footprint changes. Our overall fiscal year 2016 tax expense was $26 million.

While we are still formulating all of the actions we will take to address gross margins and operating profit, we believe the new high capacity and cost-advantaged products in our full HDD portfolio refresh and overall cost alignment activities we are implementing will benefit our product gross margins and overall profitability of our business over the course of the fiscal and calendar year 2017.

Given current demand outlook and assuming a stable macroeconomic environment, we are confident in exceeding the minimum of $2.50 in non-GAAP earnings per share in calendar 2017 that we indicated last quarter. We recognize that we are on track to exceed this goal and will provide additional insights for calendar 2017 on our October earnings call.

Cash flow from operations in the June quarter was $269 million, and for fiscal 2016, we generated $1.7 billion in cash flow from operations. Our balance sheet remains healthy and we ended the June quarter with $1.1 billion in cash and cash equivalents and 299 million shares outstanding.

Our debt structure and level of interest expense is well within our financial capabilities and reflective of our investment-grade framework given our staggered maturities and low interest expense. Due to the confidence in our cash flow generation, our board has approved our quarterly dividend payment of $0.63.

There has been no change to our dividend policy, and our dividend payout of $188 million a quarter is supported by our cash flow generation forecast. I would now like to turn the call back to Steve..

Thanks, Dave. As we manage the business in the near term, we are cognizant of the recent published earning results and related conservative guidance from a broad base of large corporations that serve the global technology industrial markets, as well as many consumer products companies.

As indicated, demand for our nearline drives has accelerated from earlier in the year as cloud service providers are deploying new systems and/or replacing HDDs that are in service. We expect this demand to be relatively flat in the September quarter.

We see growth in some areas of high capacity non-PC clients, specifically DVR, surveillance, NAS, and seasonal gaming demand, offset with declines in the PC-related markets as we narrow our participation in this segment. Overall, I expect demand should improve in the September quarter with our focus on high capacity opportunities for our portfolio.

Based on these factors, we expect revenue growth and gross margin improvement in the September quarter. Given the dynamic nature of the technology business as well as a still tepid macroeconomic environment, we have approached our outlook cautiously.

We expect to achieve revenues of at least $2.7 billion in the September quarter, with gross margins of at least 27%, and relatively flat operating expenses.

We believe it's important that investors recognize the continued shift from client server to mobile cloud, and the related infrastructure and application level changes taking place in our industry.

These shifts are impacting our traditional customer base, while also creating significant opportunities for core technology providers such as Seagate with an expanding customer base.

The new customer base includes our traditional OEMs and distribution customers as well as significant and growing demand from cloud service providers, surveillance companies, and will likely include corporate demand in the not-too-distant future.

As a result of these changes in product demand and customer base, we have experienced shifts in our traditional seasonal demand patterns. Cyclicality associated with cloud infrastructure buildout can now override seasonality, and this has implications for investors' expectations and management of our company resources.

While the overall shift in technology deployment and related growth in data science applications is quite favorable for the HDD industry on a moving annual average, the rate of growth for storage demand in the near term will likely fluctuate quarter to quarter as major systems installations either aggressively deploy or absorb capacity.

As we analyze these trends, we are considering that these changes in customer buying patterns and capacity utilization may be better reflected in annual guidance planning for investors. We will discuss this possibility with our investors over the next few months.

In addition, we continue to implement actions to align our manufacturing footprint and operating expense investment with market demand. These actions, as well as the product portfolio introductions previously discussed, should result in continued gross margin and operating margin improvement over the near term.

Should there be improvement in the overall macroeconomic conditions, we would expect to see improved HDD unit demand across all markets with commensurate benefits to the company's financial performance. Thank you for joining us on the call today, and we can now open it up for questions and answers..

Our first question comes from Sherri Scribner with Deutsche Bank..

Hi. Thank you. Just thinking about the restructuring actions you've taken, you've taken a number of actions over the past quarter.

Are you done with the restructuring actions? And how should we think about OpEx as we move beyond the September quarter? Should we start to see that trend down because of the actions, or is it still going to stay about flat?.

We're not done. And in terms of OpEx, I think for the next one or two quarters, it'll be relatively in this range, Sherri, and then it should reduce afterwards..

Okay. And I know you said you'd comment on the $2.50 in October, but it seems like at least at these levels, you're well ahead of that $2.50.

Do you have any thoughts for what the earnings power could be as we move into fiscal 2017 and calendar 2017?.

We're starting to get a sense of it, and to your point, obviously we're confident that the $2.50 will be exceeded. I think until we start kind of getting a better sense on some of these demand patterns on the CSPs, we just want to get a little more data under our belt before we give you a more specific number.

But to your point, we're confident that it'll be materially different than $2.50 a share..

Thank you..

Thanks..

Our next question comes from Rich Kugele with Needham..

Thank you. Good morning. First, congratulations on the balance sheet. It's good to see those turns. Just in terms of your comment about cyclicality overcoming seasonality, that's interesting.

When you look at the cloud service provider market, do you find that they tend to be more accurate if you look at it over six months versus a quarter? And also, about the qual cycle there, do you see the 10 terabyte and other high capacity products like that getting qualified quicker in the future? And would that help improve the visibility as well as you move out to 12 and other terabytes? Thanks..

Yeah, I'd say that the visibility over a year by quarter isn't great, Rich.

I mean I think they have a decent sense of what they think they need in terms of capacity deployment on an annual basis, but when it breaks down to quarter to quarter, I think given the nature of the customers, many of them aren't actually witnessing centralized perspective of demand.

So there's a bunch of BUs that are deploying, and a lot of those BUs actually buy on their own. Some of them go to a centralized deployment; some of them don't.

So you can't think of these big CSPs necessarily as holistically planning capacity for every one of their application sets, because a lot of those business units within those companies are on their own cycles and maybe it gets aggregated, maybe it doesn't, depending on the customer. So I think they're all learning.

I think what's going to drive the better visibility is just the lead time associated with these products, and we've already seen it with the ATB. As you know, the wafer cycle times on the heads are longer than the quarter and then the test times are three weeks on top of that. So you're well outside of a quarter in terms of lead time.

So if you don't do a great job of your capacity planning in advance of a quarter as a CSP, and you don't have excess capacity, you're going to be somewhat constrained, especially as they move into these spaces where they could see big step function changes in demand, i.e., they pick up a big corporate customer that's going to a huge cloud-based installation of applications, let's say.

If they don't have the capacity in place, they can't take that business. My guess is if they miss one piece of business like that once, all of a sudden the planning's going to get a lot better. And we've seen that. Those trends are starting where you have these Fortune 50 or even Fortune 20 companies that are now making big moves to the cloud.

And that puts on basically sometimes pressure of, we need a whole new data center. And this is the beginning of the trend, not even the middle or the end game. So we expect a lot more of that.

So the lead time, and the lead times of course with the 10 terabyte are longer and the 12 terabyte are long just because against the complexity of the technology. So your process content is way higher and of course, the test time is way higher. So I think in general, their views aren't bad on a looking out over 12 month basis.

It's just their quarter to quarter visibility is still developing. In terms of 8s, 10s, 12s, we think the 8s are going to be around for a long time. It's super high performance and very lost cost product for us. 10 TB, we certainly have customers that are taking the drive.

We don't know that we see a huge uptick in 10 TB just because you're only picking up 2 terabytes and it costs a lot more right now. Maybe as the two companies get up the yield curve and bring cost down, we'll see an acceleration of the deployment.

That's what we noticed on ATB, that once you got up the yield curve and in our case, because we have a disk and two heads less, we were able to hit cost points that really accelerated the replacement of 4s and 6s with 8s.

So whether or not it's 10 or maybe 12 where you pick up 50% more capacity or frankly, maybe even 16 where it's I'm doubling capacity in that same real estate, it'll be interesting to see where that transition happens.

I think the important thing is to make sure from a Seagate perspective that we're leading in areal density and we continue to deliver that in our products. And whenever the customers decide they want that product, we'll be there with it..

Thanks.

And, Dave, just on the free cash flow, if you fast forward nine, 12 months, are you confident in the company's ability to generate $1.5 billion type of cash flow?.

Yes. I think what we've laid out with a lot of our restructuring activity as well as where we're just relying and defaulting on maintenance capital and how that has come down compared to previous years, the trajectory that we're on would suggest that number..

Great. Thank you so much. Take care..

Yeah, thanks..

Our next question comes from Ananda Baruah with Brean Capital..

Hey, guys. Thanks you for taking the questions. And hey, congrats getting the confluence of these actions to come together pretty quickly in a nice way. Steve, just a couple for me real quick. I just love your context around second half, specifically second half CSP cycles. Sounds like you saw a little bit of a greater than expected pickup in June.

How long do you expect that to last? And then we'd just love your current thoughts around kind of the longer term normalized exabyte growth. And I'll actually squeeze my last one in. Just any thoughts you have on September Q TAM. That's it for me. Thanks..

Yeah again, the CSP influence on the overall business is a little tricky just because like we witnessed in this quarter, can be so kind of significant. And when they do start buying, they tend to start buying for longer periods of times, two, three, four quarters. That really hasn't been modeled into our expectations.

We'd rather kind of see the whites of their eyes before we make that call. We can say that July started off quite strong and the demand seems to be fairly solid. But as I think most of the analysts know, typically the September quarter is a back-end weighted quarter.

And if we overlay the back-end weighted quarter on what we've seen so far, it kind of doesn't make sense to us. So we've been a bit cautious and then we'll see what happens with that demand.

And again, I think until that customer base diversifies a bit more and we get I think more data around what happens month to month in addition to quarter to quarter, it's probably better for us just to be cautious about what we see and then be smarter as we move forward.

What was the second question?.

The annual..

I still think the annual demand for storage is still probably more defined by available capacity than it is real demand. I mean again, if you take population growth times connected devices times richness of content, it gets you easily to three or four zettabytes by 2020, which would imply kind of 30% to 35% annual growth in storage.

And I still think that's really kind of what the demands is, and the question is can the HDD industry or the NAND industry for that matter invest to those levels of capital or not. And we'll see. It's pretty tight though, given the budgets that people have deployed or the fabs that are lined up.

But I still think you're seeing exabyte demand that's well in excess of areal density demand, so in that sense we view it as demand's outstripping supply. And then of course the packaging requirements are moving to more high capacity, so more heads and disks per units, but units probably flattening out.

But from an absorption perspective for Seagate, making heads and disk or because the process content is so much higher or the test content is so much higher, that's a really good trend for us..

Thank you. And just real quickly, September Q TAM thoughts..

In terms of unit TAM?.

Unit TAM, yeah..

Yeah, we're not actually that focused on unit TAM. Again, we're more focused on exabyte. We've heard the 110 million number from our competitor, and on the face of it, that probably seems reasonable.

That's not probably a TAM we see visibility to, because we're not participating in the low end of that segment and there's obviously a lot of units there, especially in the gaming market. But it doesn't seem unreasonable to us..

Thanks for all the context. Appreciate it..

Okay, market's opening so we should probably wrap it up, everyone. We appreciate your support and thanks to our employees, our customers, our suppliers, and we'll talk to you in three months. Thanks..

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day..