Business Context and Reporting Period
Seagate Technology plc, a provider of hard-disk drives and other data-storage products and solutions, filed this unaudited Form 10-Q for the fiscal quarter ended April 1, 2016 (13 weeks) and the first nine months of fiscal 2016 (39 weeks). Fiscal 2016 is scheduled to end July 1, 2016.
Financial Results and Liquidity
- Quarter revenue: $2.595 billion, down 13% from the December 2015 quarter and 22% from the year-earlier quarter. The company shipped 39 million drives, totaling 56 exabytes; reported average selling price was $60 per drive.
- Quarter profitability: Gross margin was 20% ($524 million), versus 25% in the prior quarter and 29% a year earlier. Operating income was $27 million; net loss was $21 million, or $0.07 per diluted share, compared with net income of $165 million in the prior quarter and $291 million a year earlier.
- Nine-month results: Revenue was $8.506 billion versus $10.811 billion; gross margin was 23% versus 28%; operating income was $343 million versus $1.851 billion; net income was $178 million versus $1.605 billion.
- Cash flow: For the nine months, operating cash flow was $1.411 billion, investing cash outflow was $1.065 billion, and financing cash outflow was $1.632 billion. Cash and cash equivalents fell $1.286 billion to $1.193 billion; short-term investments were $6 million.
- Capital allocation: Nine-month share repurchases were $1.090 billion and dividends paid were $539 million. The quarterly dividend was $0.63 per share. The company reported $1.8 billion remaining under its share-repurchase authorization.
- Debt and liquidity: Long-term debt was $4.130 billion. The $700 million revolving credit facility was undrawn. Current assets were $3.600 billion and current liabilities $2.259 billion. The company said it complied with amended credit covenants and expected compliance for the next 12 months.
Material Changes Versus Comparable Periods
- Management attributed lower revenue primarily to fewer drive shipments and price erosion, including weaker client-compute demand and reduced demand for mission-critical enterprise drives. Quarter shipments fell to 39 million from 50 million a year earlier; nine-month shipments were 132 million versus 167 million.
- Quarter gross margin fell 460 basis points sequentially and 850 basis points year over year. Management cited factory underutilization, costs from terminated contracts and inventory write-downs, and a $32 million charge for manufacturing asset write-offs and accelerated depreciation; price erosion was partly offset by product mix and cost savings.
- Nine-month 2016 results included $95 million of restructuring charges, versus $24 million a year earlier. Two workforce plans targeted approximately 1,000 and 2,000 job reductions; the latter was largely completed in the quarter.
- Year-over-year nine-month comparisons are affected by the prior-year $620 million net arbitration-award gain and approximately $181 million of tax expense related to a China tax assessment. In the current quarter, Seagate recorded $33 million of additional interest received on the Western Digital arbitration award.
- Cash declined mainly because of the Dot Hill acquisition, share repurchases, dividends, and capital spending. Dot Hill was acquired for $674 million in cash in October 2015; its revenue and earnings included since acquisition were not significant.
Outlook, Commentary, Risks, and Contingencies
- Management described accelerated industry declines in drive shipments, particularly in mission-critical and client-compute HDDs. It expected fiscal 2016 capital expenditures at or below its long-term target of 6%–8% of revenue. No specific revenue or earnings guidance was provided in the filing text.
- On April 28, 2016, the revolving-credit agreement was amended to raise the permitted net-leverage covenant temporarily: 2.25-to-1 through June 2017, stepping down thereafter to 1.50-to-1. The amendment reflects the company’s current liquidity position.
- Risks highlighted include uncertain global demand and adverse drive pricing, competition and new technologies, product qualification and manufacturing execution, supply-chain or production disruption, foreign-exchange movements, cyber incidents, restructuring savings, and credit-covenant compliance.
- Several intellectual-property cases remained unresolved, including Convolve/MIT, Shukh, and Enova; the company said it could not reasonably estimate possible loss ranges for these matters. The LEAP litigation was settled with no loss to the company. Seagate stated environmental-site costs were not expected to be material.
- Other notable items include $12 million of nine-month impairment charges on strategic investments and a $3 million gain on repurchase of debt. Management reported disclosure controls were effective as of April 1, 2016.
Important Facts for Investors to Verify
- Whether the steep shipment and gross-margin declines persist, and how industry demand and pricing develop.
- Cash generation, cash balance, debt service, and compliance with the amended leverage covenant as its limits tighten.
- Whether restructuring actions deliver savings sufficient to offset factory underutilization, price erosion, and other cost pressures.
- The sustainability of dividends and repurchases relative to liquidity and operating cash flow.
- Developments and potential financial exposure in the outstanding litigation and tax matters.