Kate Scolnick - Seagate Technology Plc Stephen James Luczo - Seagate Technology Plc David H. Morton, Jr. - Seagate Technology Plc William David Mosley, Ph.D. - Seagate Technology Plc Philip G. Brace - Seagate Technology Plc.

Joe H. Wittine - Longbow Research LLC Edward Parker - BTIG LLC Rich J. Kugele - Needham & Co. LLC Robert Cihra - Guggenheim Securities LLC.

Good morning. And welcome to the Seagate Technology Fiscal Third Quarter 2017 Financial Results Conference Call. My name is Liz and I will be your coordinator for today. At this time, all participate are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session.

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

Thank you. Good morning, everyone, and welcome to today's call. Joining me today from Seagate's executive team are Steve Luczo, Chairman and CEO; Dave Morton, Executive Vice President and CFO; Dave Mosley, President and COO; and Phil Brace, President of Cloud Systems and Silicon Group.

We've posted our press release and detailed supplemental information for our March quarter of fiscal 2017 on our Investor Relations site at Seagate.com.

For the last few years, we have communicated our belief that data growths trends will continue to drive storage exabyte demand and the related measurement of capacity per drive and that units are less relevant to mobile cloud environments and future client addressable markets.

In today's newly deployed architectures and applications, high-capacity mass storage is critical. Importantly for Seagate, it is the advanced technology and heads of media, as well as manufacturing absorption of these technologies and test capacity absorption that will most significantly impact our financial performance.

Going forward, we will continue orienting our conference call remarks and supplemental data to key market exabyte results and other business metrics and discontinue providing unit detail.

We recognize this represents a change for the investment community in the short term, but believe it better reflects how we are managing and measuring our business performance internally and will help our industry to be evaluated more effectively in a forward-looking manner.

During today's call, we will review the highlights for the March quarter and provide the company outlook for the June quarter and then open the call for questions. 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.

We will refer to GAAP and non-GAAP measures on this call. Non-GAAP figures 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 measure 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, a reconciliation of the non-GAAP financial measure guidance to the corresponding GAAP measures is not available without unreasonable effort.

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. I would now like to turn the call over to Steve Luczo. Please go ahead, Steve..

gross margins of 31.4%, up 870 basis points year-over-year; net income of $329 million; and diluted earnings per share of $1.10. Cash flow from operations for the quarter was $426 million, up 108% year-over-year. Our March quarter results reflect a relatively stable demand environment and improved profitability year-over-year.

HDD exabyte shipments for the March quarter were 65.5 exabytes, up approximately 18% year-over-year. Average capacity per drive across the HDD portfolio was approximately 1.8 terabytes per drive, up 27% year-over-year. ASPs of $67 were sequentially flat for the March quarter and up 10% year-over-year.

Our Cloud Systems and Silicon Group demonstrated 19% year-over-year growth in the March quarter, with particular strength in our flash-based solutions.

We are pleased with Seagate's execution in the March quarter, both in terms of our ability to maximize the profitability of our storage technology portfolio and our continued execution on operational efficiencies. I will turn the call over to Dave Morton now to go into more detail on our operational activities..

Thanks, Steve. For the March quarter, Seagate's addressable HDD market was relatively in line with our forecast. We continue to drive our HDD product sales towards our higher capacity products across our portfolio, benefiting both our revenue and margin results year-over-year.

HDD enterprise revenues were up 3% year-over-year, reflecting exabyte growth of 20% year-over-year and representing 36% of our total consolidated revenue. Within this, nearline revenues were up 9% year-over-year and represented 24% of our total consolidated revenue.

Hyperscale nearline revenues were up strong double digits, and our 8 terabyte nearline product continues to be our leading revenue SKU. Our HDD client high-capacity growth opportunities include consumer, surveillance, DDR and NAS markets.

Revenues from these markets were up 25% year-over-year, reflecting exabyte growth of 41% year-over-year and representing approximately 28% of the total consolidated revenue. Average capacity per drive across these markets was over 2 terabyte per drive, up 22% year-over-year.

In our mature mission critical and PC client markets, revenues declined year-over-year, as expected, and exabytes declined slightly. PC client revenues continue to represent approximately 25% of the total consolidated revenue. Operating expenses for the March quarter were $550 million on a GAAP basis and $443 million on a non-GAAP basis.

Total consolidated expenses were slightly higher than forecast, primarily due to non-executive variable compensation. Capital expenditures were $95 million for the March quarter for maintenance capital and manufacturing footprint redeployment supporting the continued ramp of new HDD products in our portfolio that utilize new tooling and equipment.

Our capital expenditures and maintenance capital requirement levels are expected to be less than 5% of our revenue for the remainder of the fiscal year. And through our manufacturing consolidation activities, Seagate is and will continue to operate at, or very near, full capacity.

Cash flow from operations in the March quarter was $426 million and free cash flow was $331 million. These results include approximately $150 million in cash payments related to restructuring charges and biannual non-executive variable compensation. Excluding these items, cash flow from operations would have been approximately $576 million.

Our balance sheet remains healthy, and we ended the March quarter in $3 billion in cash and cash equivalents and 297 million ordinary shares outstanding. Our board has approved our quarterly dividend payment of $0.63 for the March quarter, which will be payable on July 5.

In January, we successfully completed a debt offering of $1.25 billion of investment-grade financing with a weighted average interest rate of less than 5%. This funding will serve as a pre-financing of our 2018 and our 2021 notes and other corporate purposes. We have called our 2021 7% senior notes with a payment of $158 million scheduled for May 1.

Interest expense for the March quarter was $60 million and will be similar in the June quarter. Our debt structure and level of interest expense continues to be well within our financial capabilities and reflective of our investment-grade framework, given our staggered maturities and low interest rate.

Our March quarter results continue to reflect strong execution of our business model objectives and our ability to generate strong cash flow from our Storage portfolio. Combined with our Cloud Systems and Silicon Group, we view that approximately 80% of our Storage product revenue opportunities in calendar 2017 and beyond have growth potential.

While we are still in the process of executing a number of our cost actions in our manufacturing sites and at the corporate level, we believe the combination of these cost alignment activities and the competitiveness of our HDD product portfolio will continue to benefit our product gross margins and overall profitability of our business over the course of calendar year 2017 and beyond.

I would now like to turn the call back to Steve..

in the nearline market, our 10 terabyte Helium HDD is continuing to ramp with large hyperscale cloud service provider customers. Customer evaluation feedback on our 12 terabyte Helium HDDs has been positive, and we plan to start volume shipments in the June quarter.

We believe our opportunities in the nearline market will continue to span across multiple capacity points as our customers evolve their capacity infrastructure for a growing multiple of enterprise workload applications. We are successfully refreshing a number of products in our portfolio, utilizing our fourth generation SMR technology.

And to-date, we have sold over 35 million HDDs into the nearline client and consumer markets with this technology. We believe our technical leadership in areal density will continue through calendar 2017. Our planned 1 terabyte and 2 terabyte product refreshes for the PC compute markets are on schedule.

And this week at NAB, we announced new consumer products including our first offering for the drone marketplace, the Fly Drive, which includes enough space for 60 hours of 4K video footage and developed in partnership with top drone manufacturer, DJI.

From an R&D technology perspective, we continue to invest in our next-generation areal density HAMR technology. With products on the road map for the late 2018 calendar year, we believe we are leading the market in developing and bringing to market this important cost-benefit solution for mass storage capacity needs.

Turning to the market outlook, we remain cautiously optimistic about the current macroeconomic environment and IT spending trends. For the June quarter, we are expecting to achieve revenues of between $2.5 billion and $2.6 billion.

Our expectations reflect a seasonal decline in revenue, our desire to maintain lower inventories going into the summer months and some conservatism due to the potential impact of component shortages in DRAM and NAND on various aspects of our customers' businesses in the server, CSP and client space.

We are raising our gross margin expectations for the June quarter to 31%, and we are targeting a new range for calendar 2017 of 29% to 33%. As Dave indicated, operating expenses will trend sequentially down to expect approximately $430 million in the June quarter.

We anticipate operating expenses will continue to decline through the rest of the calendar year and exit the December quarter at or below $400 million. Cash flow from operations will be down slightly sequentially, reflecting lower seasonal revenue and cash payout related to our elimination of U.S. vacation accrual.

We continue to expect overall exabyte demand to grow double digits in calendar 2017 over 2016, representing modest revenue growth opportunities for Seagate.

Assuming market conditions remain intact, we continue to believe Seagate will achieve earnings per share of at least $4.50 in calendar 2017, and we will provide a fiscal 2018 outlook on our July call. Thank you for joining us on the call today. And we'll now open the call up for questions and answers..

Our first question comes from the line of Joe Wittine with Longbow Research..

Hi. Thanks. Maybe discuss your go-forward exabyte growth expectations by the segments as you lay them out. And specifically....

We're not going to provide exabyte growth by segments. That's highly competitive information..

Okay. Maybe I should ask....

We still believe in exabyte growth that's consistent with what we've said over the last couple of years. Exabyte growth in excess of areal density growth..

Can nearline still grow in the mid to high-30%s this year after the 20% start? I ask because the remaining quarters have some pretty difficult comps. So maybe talk a little bit more detail with that..

Yes, I do think they can. As you see the 10s and 12s start to ramp.

I think the first half of the year has been an issue both of what's really the right marketplace for the 10 terabyte, especially with the 12 kind of coming right behind it, as well as the CSPs have been – and we've kind of expected this the whole time, that the second half of the year was going to be stronger than the first half of the year.

So I think the combination of stronger demand signals for the second half plus the rotation of the portfolio that's going to have 8s, 10s and 12s and not just pretty much 8s, you're going to see exabyte growth there that's going to continue..

Okay. And then as a follow-up, price per exabyte declined at the lowest rate in a few years. It's now the second quarter you're kind of in a 13% to 14% range versus the low 20%s range that the industry has been in.

What is a good expectation to model going forward, given you said you're generally near peak capacity?.

Yes. I think that's a great question. I think we've got to continue to be very careful on the pricing, especially, again, as you go from 10s and 12s. On the one hand, the customer demand is certainly there for those higher capacity drives, but the industry's capability to deliver that technology is coming through solutions that effectively cost more.

Either you're adding more heads in disk or other technology to handle that kind of workload. And especially when you're adding more heads in disk, you have to obviously be very careful about the aggressive price takedowns that have occurred because somehow you have to absorb the extra parts.

So I think you're going to see some resolution where those price declines are going to continue to stabilize just because we have to afford the new technology. And, of course, we're not going to end at 10s or 12s. We're going to have to get to 16 and then 20 and 32, and that's all going to take a lot of technology.

So we definitely believe you're going to see stabilization in that pricing..

Okay. Thanks, Steve..

Yes. Thanks..

Our next question comes from Edward Parker with BTIG..

Thanks. Steve, I wanted to ask you about price elasticity and I'm just wondering if you could talk a little bit more about the impact of higher NAND pricing in the quarter on your HDD business.

Are you seeing higher unit sales because of higher prices for SSDs or higher unit sales because of the lack of availability for SSDs? And then secondly, how do you think about price elasticity across your portfolio? And how could that change as you look at your business over the next couple of years?.

Well, I think the NAND shortages are interesting because, at the end of the day, I think it's more challenging for the technology industry to deal with the shortages than it is maybe beneficial to HDDs because of some comparison on a 500 gig.

I mean, the reality is even a 500-gig NAND drive, at today's prices or even at six months ago prices, aren't remotely competitive to an HDD price. I do think that the lack of availability of NAND in certain market segments results in people then shifting their strategies around do they use HDDs or not.

So I think, for example, the NAND companies are constantly optimizing where do they shift their NAND.

Does to go into phones? Does it go into the data centers? Does it go into the servers or does it go into the PCs? And depending on the grade of flash you're building, the capacity plans you put in six months ago and then what customers are asking for, there's this constant re-optimization of where the NAND is flowing.

I think in the short term probably, and I think HP indicated this on their call two quarters ago, that they felt that the PC industry was being constrained a bit on NAND.

I think that probably has shifted some longer-term strategy around product portfolios that breathes some more life into the HDD space, in that people don't want to be caught short with storage technology of any type. And, of course, there again we're talking about 128 or 256.

For us, it's really an issue of getting the volumes ramped on the 1TB, where we have a substantial lead, and then offering that product to the PC companies that maybe today are taking a lot of 500- gig product because at volume, obviously, it's a single-disk and two-headed product, so we can be quite competitive.

So I think from a Seagate perspective, we feel that the shortage overall might marginally help us on the client space as we move through the calendar year and maybe even to the beginning of next year.

I think where it's more problematic for the industry in general, and I mean everyone, is if it's constraining build-outs at all at the CSP space, that with the DRAM shortages. And we have seen indications of certain deployments being delayed because they basically can't get all the component technology that they need across the board.

We experience that a little bit in our own CSSG business, where we obviously need to get flash to sell our flash drives. We have a big demand profile for our current-generation products, which are quite competitive. But we're constrained by as much as $40 million or $50 million in revenue in terms of can we get the flash or not.

So that's one of the issues that we're going to be working hard and one of the reasons that I think there is some opportunity on the revenue side if we can secure that NAND. So it's a pretty dynamic situation that you're on top of. I don't know that it's as easy to say that it's good or bad.

I think there's some good to it and there's some pressures from it. We've always said it's a better world if there's a lot of NAND because that means people have more devices in their hand and they're creating more data. And that's still our thesis.

Next question?.

Our next question comes from the line of Rich Kugele with Needham & Company..

Thank you. Good morning.

Steve, can you just elaborate a little more about your comment that less than 10% of your portfolio would be exposed to competing flash devices? Like over what timeframe are you referring and how do you get there? Is that walking away from categories, or is that just a mix change towards more cloud service providers?.

Well, I'll let Mosley go into more details, but we've already walked away from those markets. Basically, again, we don't participate in the 500 gigabyte market really today. Ad that's because we have a technology lead and we want to leverage that.

And, of course, the recent price increases from the NAND folks have made a 500 gigabyte drive unattainable, for sure. Even the 256s, I think we've heard price talks in the $60 or $70 range, which is pretty amazing. So I think it's a more longer-term trend, and I'll have Dave talk to it, but it doesn't really talk to the CSPs.

The CSPs are enabled by all tiers of storage..

Yeah, Rich. This is Dave. I would go back to Ed's question as well to dovetail on to that. So we have to model what the NAND pricing is going to be out in time. And then we model where Seagate wants to be selling product; is it 500 gigabytes, 1 terabyte, 2 terabyte and so on.

And we look at those price banding for our various market segments and we make those estimates. So we what we said is, over the next year, it'll develop such that less than 10% of our portfolio is exposed. I think by this time next year, it will be far less than 10%.

And we're working hard to make sure that happens, make sure we move up in capacity points. Of course, some of that's what the customers want and some of that is dictated by where exactly the NAND pricing is. But that's how we run the model..

Great. And then just lastly as a follow-up, the Systems business you said a good quarter on the flash side, but embedded in there is also the systems that are going to some enterprise players, like HP, for the mid-range MSA stuff.

So in light of the Nimble acquisition, just how should he with think about the Storage Systems business?.

Yeah, Rich. This is Phil. The Storage Systems business certainly in the current quarter had a good performance as well, year-over-year growth. And we expect to see year-over-year growth going forward. Customer activity in that space continues to be really high, particularly in the OEM space.

What we see is that as OEMs look to be figure out where they spend their R&D dollars, they certainly are making opportunities available for Seagate for us to come in and work with them on higher levels of integration.

And that's particularly true as we start to have higher levels of integration between, I'll say, our component-related products, like SSDs and HDs, and our system-level products. So, overall, that business continues to grow nicely..

Okay. Great. Thank you..

We have time for one more question I think..

Our last question comes from the line of Rob Cihra with Guggenheim Partners..

Hi. Thank you very much. I guess I wanted to follow up on Rich's question on the Systems business. If you go back, you guys have made a couple of acquisitions both in Systems and with LSI on the flash side. And yet it's still well under 10% of revenue.

I was just wondering from a strategic standpoint, as Systems are moving higher up the enterprise stack, is that strategically a big part of what you guys are looking to do do you think over the next few years, or is that kind of taking a back seat? Thank you..

Yeah, I don't think it's really changed much in terms of our original intention. We've always felt there's an opportunity in the Systems business in the higher value-add categories because our Systems business, at least a good hunk of it, has a fair amount of software competency to it as well. And so we serve OEMs in that space.

And more and more so, we're getting traction with the cloud service providers that are looking at solutions beyond the device level. So I think, from our perspective, we've always viewed this business as attractive in terms of its core business of selling into OEMs as well as servicing cloud service providers at one level.

But really the opportunity to, as architectures evolve and different customer needs evolve, to have the capability to optimize the devices, either at the device level, the sub-system level or the systems level.

And if you don't have the software capability to do that, you really can't take advantage of what we think will be a potentially significant long-term trend.

I think the issue is, one, is that how does that evolve, over what period of time and what does it cost you in the mean time? And so I think, for us, we continue to work the financial model so the Systems business is profitable to the overall business and then gives us the option to grow into some of these markets if we see either OEMs or CSPs decide that they want to see solutions at the systems level versus the device level.

And we still believe that's the opportunity in front of us. I would say, if anything, over the last six to 12 months we've seen and had dialogues with customers that have us more encouraged about that opportunity versus less encouraged.

So we are as committed as we have been to growing that business to what we with think will be a meaningful business in the overall portfolio..

Makes sense. Thank you..

Okay. Great. All right. Thanks, everyone. We appreciate the time you've taken this morning. And I want to again thank our employees, our customers, our suppliers and our shareholders. And we look forward to speaking with you again in July. Thank you..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day..