Kate Scolnick - VP, IR Steve Luczo - Chairman & CEO Dave Mosley - President, Operations & Technology Dave Morton - EVP & CFO Phil Brace - President, Cloud Systems & Silicon Group

Rich Kugele - Needham & Company Sherri Scribner - Deutsche Bank Aaron Rakers - Stifel

Good morning and welcome to the Seagate Technology Fiscal Third Quarter 2016 Financial Results Conference Call. My name is Christy and I will 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 at the end of the call. As a reminder, this conference is being recorded for replay purposes. At this time, I would like to turn the call over to Kate Scolnick, Vice President, Investor Relations. 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, Operations and Technology and Phil Brace, President, Cloud Systems and Silicon Group. We have posted our press release and detailed supplemental information about our third fiscal quarter 2016 on our Investor Relations site at seagate.com. During today's call, we will review the highlights for the quarter, provide the company outlook for the fourth fiscal quarter 2016 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 are planning for the call today to go approximately half an hour and we will do our best to accommodate your questions in that timeframe. As a reminder this conference call contains forward-looking statements about the company's anticipated future operating and financial performance, customer demand 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 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. In addition to my usual commentary I have extended the prepared remarks for today's call and I have asked the management team to cover a few aspects of our business as it relates to the March quarter and the position of the company moving forward. We will discuss some of the actions we are taking to align with near-term market realities and to improve the company's profitability and cash flow. First I will cover the high-year level trends I have seen from customers and provide information as the direction we will be taking with the company with respect structure and focus. Dave Morton will then walk through certain financial metrics. Kate Mosley will cover the HDD business particularly with respect to our revolving product portfolio and our close recalls our guidance for the June quarter and our general expectations for the second half of calendar 2016. For the March quarter Seagate achieved revenues of $2.6 billion and a non-GAAP basis gross margin of 23%, net income of $66 million, and diluted earnings per share of $0.22. Non-GAAP operating expenses in the March quarter were $39 million reflecting cost controls on lower variable compensation. Overall inventory levels were down 11% sequentially and ended at the lowest cost of finished goods excluding the flood since June 2010. Capital Expenditures of $95 million were in line with our expectations. We believe Seagate's March quarter results are reflective of a generally weak macroeconomic environment as well as accelerating usage shifts of technologies and architectures by end users. Our HDD shipments for the March quarter were $39.2 million units and 55.6 Exabyte's reflecting a seasonally lower than expected overall. In the March quarter we initiated targeted pricing increases across our product line. And we were successful in some areas and unsuccessful in other. We continue to believe the industry needs a stable pricing environment to deliver the higher level of requirements being placed on our products and to realize the value we are providing to the market. As a result we will continue to pursue a pricing strategy that reduces and properly reflects the investment in technology the market requires. We experienced particular weakness in the client desktop as well as the enterprise legacy markets, adding strength in the enterprise cloud markets. Overall average capacity per drive was 1.4 Terabytes up 30% year-over-year and within this near line cloud average capacity per cloud was 3.9 Terabytes up 25% year-over-year. On a year-over-year basis unit shipments were down 22% while the Exabyte's shipped were up 2%. The decrease in the unit temp in our markets percent challenges for Seagate that will requires alignment to operational preference and pressures the overall HDD supply chain. Especially for suppliers that are supplying one part per drive. However, we are encouraged by the trend towards significantly higher average capacity per rive applications which result in great absorption and heads this in favor HDD storage device now and in the foreseeable future in terms of costs as a function of required performance. The continued advancement and adaptation of mobile and cloud based computing architectures is reflected in the revenue shifts we are seeing in our portfolio. Our long term business thesis continues to be that there will be a significant transition in the HDD from a historical split. Revenue split of 60% client and 40% enterprise revenue to 40% client and 60% enterprise revenue over the next several years. We also expect that the average capacity per drive will increase in all markets. Most important to our product positioning and related investments is not just the mix between client enterprise and the mix shift within these markets. In the client's base, we expect to continue decline in PC shipments that we anticipate to moderate in the next year. PC HDDs now represent about 56% of Seagate client revenue and approximately 30% of total company revenue. While overall PC HDD client revenues is declining the remaining share is dominated by high capacity products which will continue to increase with the new product offerings that we have started to introduce in the June quarter. we are starting to see our client business shift to consumer, surveillance, gaming and DVR markets which are all high capacity user environments which I believe over the next several quarters this growth will result in these combined markets being greater than the traditional PC compute market today. As an example our consumer business revenues as a percentage of total client revenues have grown 6% in the last 12 months whereas PC revenue as a percentage of total client revenues has declined 6%. This is consistent with our belief that reducing the amount of storage on certain client devices propagated to another location. In the enterprise market, revenue mix continues to trend from the legacy mission critical to near line car market. In the March quarter we experienced unexpected weakness for a legacy mission critical HDDs which were approximately 700,000 units below our forecast. While it's difficult to attribute the enterprise mission critical between macroeconomic factors and architectural shifts we expect further declines in the mission critical markets in June quarter and then decline should moderate over the quarters thereafter. This mission critical weakness in the March quarter was offset by near line cloud upside demand of more than 500,000 units over which we could only deliver 350,000 additional units due to the long wait time as required to fulfill demand. Importantly in the March quarter the average capacity per drive for the mission critical HDDs that came out of our forecast versus the average capacity of ATB to 8 Terabytes of near line HDD outside the demand we saw reflected the shifts in Exabyte's of almost 6:1. Demand signals from our near line customers has improved over the last few weeks and we are planning for our fourth consecutive quarter of high demand for HR Byte portfolio and initial volume shipments our 10 Terabyte Helium HDD product. As a result of these trends as well as input from our major cloud customers we believe that these shifts from legacy to cloud for enterprise applications has accelerated in the last 6 months and is now complementing the cloud storage generated by consumer applications. As we managed the shifts in our product portfolio demand and changing the nature of our customer base we are aligning the operating model of our HDD business to optimize our manufacturing preference and we are reducing our capital expenditure to maintenance capital requirement levels. Through these actions Seagate will be operating at very near full capacity in our operating capacity to our shift in chasing demand upside versus managing excess capacity. In the March quarter we began the process of reducing our 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 6 to 9 months. At the same time we are continue to accelerate the utilization of our own drive factories internal head and media facilities. For fiscal 2016 total capital expenditures are expected to be approximately $535 million down approximately 28% over fiscal year 2015. For fiscal year 2017 assuming current outlook on demand we are targeting an additional reduction in spending reflecting a very low maintenance capital plan of approximately $400 million. In addition we will continue operating expense management across the company that aligns with the market trends. We believe that given the shifts in our product revenues above as well as recognizing the full impact in our management changes and our manufacturing footprint and operating expenses, the company will see revenue growth, product gross margin improvements and improved profitability assuming relatively stable macro environment. Dave Morton and Dave Mosley will go into more details on these activities and I will turn the call over to Dave Morton now.

Thanks, Steve. With the shifts taking place in Seagate's business there a few specific areas in our financial model that were impacted in Q3. I would like to provide details in these conditions to provide further context to Steve's earlier discussion around the actions we are taking manufacturing and operating expense levels. For the March quarter the addressable HDD and cloud storage systems markets were lower than forecast impacting our revenue results for the quarter. Within this there were specific HDD product areas where demand fell short of our expectations including traditional mission critical HDD enterprise products and desktop client's products in China. In addition we made strategic decisions to not aggressively participate in certain areas of the low capacity notebook market. In our systems in Silicon business we experienced weaker than expected demands across most of the product lines. The lowered and forecasted HDD demand impacted our production levels and increased our factory absorption costs. We also aggressively managed our finished goods in the quarter and improved our inventory levels by approximately a $180 million. This reduction in inventory negatively impacted our factory utilization. Combined these factors were the primary reasons that our product gross margins declining approximately 290 basis points sequentially to approximately 23% with 80 basis points impact from the HDD revenue shortfall, 70 basis points from the systems and silicon business revenue shortfall and 140 basis points from factory underutilization. While we are disappointed we did not anticipate the weaker demand in the March quarter. The company is evaluating and implementing a variety of actions to reduce the company's cost structure which will result in financial improvements over the next level months. Towards our infrastructure cost alignments and fiscal Q3 alone we implemented certain cost reduction activities and recognized approximately $90 million in onetime restructuring charges right off of certain fixed assets, certain terminated contracts and discontinued inventory. We are currently sizing future non-reoccurring restructuring cash charges that we are estimating will be approximately $150 million over the next several quarters. We anticipate having more detailed actions identified within 60 days and we will expect that the financial benefits of these actions will begin to have a positive impact in the September quarter with the full benefit occurring in calendar 2017. As we formalize the specific actions and timing of cost savings we will continue to provide updates to this framework. While we are formulating all of the actions we will take to address gross margins and operating profits, we believe the overall cost of alignment activities we will implement will benefit our product gross margins and overall profitability of our business with the goal of achieving a minimum of $2.50 in non-GAAP earnings per share in calendar 2017. For the March quarter non-GAAP operating expenses were approximately $439 million slightly lower than forecasted. Looking ahead our expenses in the June quarter will be relatively flat with additional cost reductions in plan for FY 2017. Cash flow from operations in the March quarter was $205 million and free cash flow was a $110 million. Fiscal year today we have generated $1.4 billion in cash flow from operations. Our balance sheet remains healthy and we ended the quarter with $1.2 billion in cash and cash equivalents and 298 million shares outstanding. Our debt structure and level of interest expense s manageable. As announced today the board has approved our quarterly dividend payment of $0.63. There has been no change in the dividend policy and our dividend payout of $188 million a quarter is recorded by our cash flow generation forecast albeit at a higher payout ratio than previously stated as our objective. I will turn over the call to Dave Mosley to cover our HDD business in more detail.

Thanks, Dave. Beginning with the near line product lines are 8 Terabyte business critical products continues aggressive volume ramp and we have been essentially sold out for the month of March and April. We have had over 200% volume growth of 8 Terabyte in the March quarter and we anticipate continued growth in the June quarter. In addition our 10 Terabyte product lines shipped a large volume of qualification units in the March quarter and our volume growth is accelerating in the June quarter as well. We believe our 10 Terabyte product to be leading in all performance and power metrics and we are very happy with the feedback from our customers and our qualifications. In the client space as Steve sad the PC market continued to decline in Q3 and we began end of life activity on some of the older 500 Gigabyte and below products that have very low margins. Most of the margin cost benefits of these products will be realized over the next few quarters. In the March quarter we began the ramp of our 1 Terabyte and 2 Terabyte 7 mm 2.5 inch product line for our consumer notebook and DVR customers. This new product line allows us to address the target markets with lower costs and improved value proposition for our customers. Qualifications have gone well with customer interest high and we anticipate shipping several million units in the June quarter. Initially the product will be a consumer offering moving to OEM offering in September and December and we believe we will competitive technology through the end of the calendar year. We are also accelerating the application of these same technologies into our lines for surveillance as DVR at the end of the calendar year. The mission critical market served by our 10,000 and 15,000 RPM products has been declining over the last few quarters and we have seen traditional trends of approximately 8 million to 8.5 million units per quarter decline to approximately 6.5 million to 7 million units in the March quarter. Within the mission critical market approximately 25% of the volumes are 15,000 RPM HDDs. This is the primary area where we are seeing a shift in low end servers to lower capacity flash SSDs and we expect it to continue. In 10,000 RPM HDD there has been some technology shift happening as well however we believe that market will have a much longer transition horizon. Our goal over the coming months is to manage our forecasting conservatively with mission critical TAM decline in the June quarter potentially leveling to modest decline in the back half of the years. Over the long term we believe the technology shifts in the market will report our complimentary investment thesis of flash ware performance and driving HDD for architecture. Shifting our HDD build volumes to our higher capacity offerings will allow us to simplify our wafer requirements and optimize our product portfolio which will not need further product refreshes for some time. Improved utilization of our own factories properly for the market demand will improve our costs considerably. We realize our non-depreciation related fixed costs are high competitively and also too high for current demands. These cost items will be addressed sooner than those related to the manufacturing footprint. There are also mini costs related to the product transitions that while temporarily driving a higher cost profile will also us to improve our cost footprint in FY 2017. With respect to the shift of the higher capacity products we do need to be mindful of longer lead times and supply chain management for these products. By engaging directly with the broader customer base and establishing deeper channel partnerships we believe we will improve our sales operation efficiency and forecast. Thanks now I will turn the call back over to Steve.

Thanks, Dave. Given the recent published earning results and the related conservative guidance from a broad base of large corporations that serve the global technology and industrial markets we are planning for season declines and revenue in June quarter for most of the markets we serve with the exception of near line markets. Based on these factors as well as our decision of not to participate in the GPC client market we expect to achieve revenues of approximately $2.3 billion in the June quarter with relatively flat gross margins and operating expenses. We continue to expect the demand in the second half of calendar year 2016 will be stronger than the first half with positive seasonal trends and continued growth in near line demand offset somewhat by macro-economic pressures. With this anticipated revenue growth as well as the actions we are taking to align our manufacturing footprint our operating expense, gross margins and profitability will improve in the second half of 2016. Should there be improvements in the macro economic conditions we should expect to see HDD unit across all markets with commensurate benefits to the company's performance. Thank you for joining us on the call today and we can now open it up for questions and answers.

Thank you [Operator Instructions] Our first question is from the line of Rich Kugele of Needham & Company. Your line is open.

Thank you, good morning, in terms of the restructuring Steve you talked about getting to something around $2.50 should we assume something revenue wise lower first before it can start to grow again as you realign those lines, $35 million to $40 million units of capacity, you would assume you are probably exiting quite a few categories?

I think the capacity issue also relates to the amount of outsourced drives we have Rich, so in the second half of the year we expect revenue growth for the guide for June and we would expect that to continue through 2017 so the adjustments manufacturing of where we taking our internal capacity which was under absorbed and taking production inside which was basically additional under absorption but that was the non-operating fix costs or the cost of the factories themselves so there is a double effect of what happens once we bring the drives in as well to reduce our overall footprint. But we would expect to counter your 2017 revenues other than seasonal decline from December to March should continue to grow assuming the macro condition is stable in part because the portfolio also gets a lot stronger with the 1 TB and 2.5 and the 2 TB which are then products which are highly competitive and we believe at least six months ahead of the competition and capacity better much more relevant to us than the clients base.

Okay. And then just to understand the difference from moving from mission critical to high capacity can you just expand the gross margin dollar impact and the technology, investments required to go and do that. Is it similar R&D investments, any thoughts about that?

Let me just give a general trend and then you can talk about the R&D side. In general the gross profit dollars is the same which is why losing 700,000 units but picking up 350,000 the gross margin percentages are about the same and once you reach the crossover point where we can either meet the upside demand or naturally exceed or whatever erosion continues in mission critical and like I said, its' really hard to understanding mission critical right now, is it being driven by macro or flashes or certain segments of that. And maybe the macros even accelerating the incursion of flash, it doesn't really matter; it's not going to reverse itself so we are preparing for the continued decline of the 15K segment. But as Dave indicated the 10K segment from our customer input will remain intact for a number of quarters if not for a number of years. I think it's more about managing the investment in the portfolio forward and then obviously again adjusting the manufacturing footprint so you are keeping pace and are a little bit ahead of the decline so all sold out versus having excess capacity. Dave will talk to you in more detail

From a R&D perspective Rich it's fairly applicable you can move the technologies where it's headed, media technology is over at the money market segment. Other as Steve commented and I won't elaborate too much. The speed of the shift last quarter was really high demand with the cloud product and the following demand for the mission critical price were more a factory reaction than time issue anything.

Okay. Thank you.

Our next question is from Sherri Scribner of Deutsche Bank. Your line is open.

Thank you. The cash flow number came in a little bit this quarter obviously with gross margins coming down. I wanted to get your sense about how your thinking your uses of cash going forward, how will the cash cost related to some of these restructuring actions impact you, are you still committed to the dividend, is there a plan to buy back shares considering shares have come back and do you have plans to buy back any of your debt which is trading at a discount to par?

Hi Sherri, this is Dave. As we think about heading back into the year. Obviously first and foremost we are going to invest in business ourselves. As we stated and looked around these onetime costs, restructuring cash charge specifically around the $150 million, we think that is very manageable over a generation and what we are able to yield here again over the next 6 month to 9 months and then as far as the dividend we think that is well manageable albeit at the higher end of those payout ratios and obviously up to the board of directors. With that said we feel that the very defendable against what we are able to generate moving forward.

I think in the near future Sherri meaning the next 6 months to 12 months the consideration clearly go invest in the business because we do feel we have technology and product leads as long as the macro environment stays like it is with the product execution. We feel pretty good about the company's position competitively. And then in terms of what we will do with the cash flow, I think defending the dividend is the first we would do and would certainly like to keep the dividend level where it is. Initially obviously where the payout ratios are involved 30% and 50% as we had indicated but if the company is growing into that and improving revenues and margins, certainly we will put the company in position where the board has easier decision to make or the other way around. I think in terms of buy backs whether it's debt or equity, for the near term we will probably not reduce the cash or probably if there is excess cash we would keep it on the balance sheet, just in case the macro situation turns on us as we had more confidence about 2017 outlook. And again the success of our products, we would evaluate that in terms of best use of it beyond dividend or going on balance sheet.

Thank you.

Our next question is from the line of Aaron Rakers of Stifel. Your line is open.

Thank you for taking the questions. Steve I was curious in past you have talked about returning to the 27% plus gross margin or the analyst they even talked about 27% or 32% on top of that you talked about 13% to 15% operating expense derivative. Understand there are a lot of things going on and realignments, when are you able to give back into that target model at this point?

Yes, we talked about was it worth guessing right now to provide you some guidance on that and I think I would prefer just for us to get through this next 60 days of really understanding to the changes we are going to be making to the operational footprint and investments because the reality is depending upon which decisions we make there is different timing. Some of the things we can get after right away is mostly mentioned but others are really a function of product transitions, customer call issue, regulatory issues etcetera so I think this is probably not worth guessing at this point and as we get more clarity on that specific actions we will get back to you. The question is do we still get back in that range in a reasonable period of time the answer is yes, we can get ourselves back into the range. But we want to just get little more work done before we give you an idea of when that's going to happen in this quarter. We rather do a little more work before we lay that out for you.

And Steve what gives you confidence that the mission critical business declined to the June quarter but then seems to stabilize into the back half of the year and going forward. It seems that there's not that much visibility there given the moving parts of macro and obviously the element of flash.

Yes our feeling based on customer input was that the economics mostly talking to the application shift Aaron so the macro stuff I am not going to speculate on, if it gets worse than obviously all these markets will be under pressure. If it gets better all get a little bit reprieve. But it feels like the trend of where mission critical 15K is being taken out the point of exposure in 10K is in for now, maybe not for a while based on customer effects. So, our point is that as the transition to some point stabilizes and this probably happens in the second half of the calendar year.

Okay.

Great. Everyone, thanks for taking the time today. And we look forward to talking next quarter and thanks for all your support as well to our customers and suppliers and most importantly our employees. Thanks very much.

Ladies and gentlemen, thank you for participating in todays' program. This concludes today's program and you can disconnect. Everyone have a great day.