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Seagate Technology PLC (NASDAQ:STX)

F4Q 2013 Earnings Conference Call

July 24, 2013 08:15 ET

Executives

Kate Scolnick - Vice President, Investor Relations

Steve Luczo - Chief Executive Officer

Pat O'Malley - Chief Financial Officer

Rocky Pimentel - Executive Vice President, Chief Sales and Marketing Officer

Dave Mosley - Executive Vice President, Operations

Ken Massaroni - Executive Vice President and General Counsel

Analysts

Rich Kugele - Needham & Company

Ananda Baruah - Brean Capital

Aaron Rakers - Stifel Nicolaus

Rob Cihra - Evercore

Sherri Scribner - Deutsche Bank

Scott Smith - Morgan Stanley

Dan Garofalo - Piper Jaffray

Monika Garg - Pacific Crest Securities

Joe Wittine - Longbow Research

Cindy Shaw - DISCERN

Operator

Good morning, and welcome to the Seagate Technology’s Fiscal Fourth Quarter and Year End 2013 Financial Results Conference Call. My name is Shaquana, 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. 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.

Kate Scolnick

Thank you. Good morning, and welcome to today’s call. Joining me today in Dublin, Ireland are Seagate’s executive team, our CEO, Steve Luczo, CFO, Pat O’Malley, EVP of Sales and Marketing, Rocky Pimentel, EVP of Operations, Dave Mosley, and EVP and General Counsel, Ken Massaroni.

We have posted our press release and detailed supplemental information about our fiscal fourth quarter and the year-end 2013 on our Investor Relations site at seagate.com. During today’s call, we will review the highlights from the June quarter and provide the company’s outlook for the fiscal first quarter 2014. After that, we will open up the call for questions.

As a reminder, this conference call contains forward-looking statements including, but not limited to statements relating to the company’s historical and currently anticipated future operating and financial performance in the September quarter and thereafter, and includes statements regarding customer demand in general market conditions. These forward-looking statements are based on information available to Seagate as of the date of this conference call and are subject to a number of known and unknown risks and uncertainties and other factors that could cause the actual results to differ materially from those anticipated by these forward-looking statements. Such risks and uncertainties such as global economic conditions and other factors may be beyond the company’s control and may pose a risk to the company’s operating and financial performance.

Information concerning additional factors that could cause results to differ materially from those projected in the forward-looking statements are contained in the company’s Annual Report on Form 10-K, as filed with the SEC on August 8, 2012 and in the company’s quarterly report on Form 10-Q filed with the SEC on May 2, 2013. These forward-looking statements should not be relied upon as representing the company’s view of any subsequent date and Seagate undertakes no obligation to update forward-looking statements to reflect events or circumstances after the date they were made.

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

Steve Luczo

Thanks Kate. Good afternoon everyone and thank you for joining us today. Seagate demonstrated strong operational performance in the June quarter achieving revenues of $3.4 billion and on a non-GAAP basis gross margin of 28%, net income of $447 million, and diluted earnings per share of $1.20. Bulk of our revenue and gross margin results for the quarter were higher, were at the higher end of our expectations, primarily driven by near line market demands, as a wide variety of customers deployed Cloud infrastructure and applications.

Full year fiscal 2013 revenues were $14.4 billion and on a non-GAAP basis we achieved gross margin of 28%, net income of $2 billion, and diluted earnings per share of $5.31. We met our shareholder capital return goals for the year returning 70% of operating cash flow, and 90% of free cash flow in the form of dividends and share redemptions. In addition we successfully restructured our debt profile this quarter to optimize Seagate’s capital structure and to support the long term growth of the company reducing our annual interest expense by over $40 million. We ended the fiscal year with approximately $2.3 billion in cash and investments and 359 million ordinary shares outstanding.

Going forward we remain committed to return cash to shareholders through dividends and share redemptions. We have nearly completed our share redemption plans for the September quarter purchasing approximately 4 million shares in the month of July. For fiscal 2014 we are targeting to return upto 70% of operating cash flow and upto 90% of free cash flow to shareholders.

Our senior management is pleased that Seagate executed well in a time of change, uncertainty and opportunity over the course of fiscal year 2013. In addition to meeting the vast majority of our financial goals we successfully enhanced and expanded our storage technology portfolio through organic growth, partnership and acquisition to position us for future success with an expanding base of customers. For the cloud market we introduced several new enterprise products and features designed to specifically address the manageability, performance, total cost of ownership and security requirements for these environments. We’re particularly excited about the opportunities of our new 4 terabyte near line product with a competitive combination of capacity and energy efficiency that customers are demanding.

We expanded our SSD solutions over the last several months to include our newest enterprise SSD that we developed with Samsung and we have strategic investments focused on the emerging enterprise PCIe market and key architecture advancements in next generation SSD technology.

In the mobile market we have introduced our 7 millimeter hybrid drives and 5 millimeter disk drives for thin and light and tablet computing. As the mobile market continues to evolve and expand we believe we’re well positioned with competitive products that are high capacity, high performance and cost effective storage solutions.

And then in the branding market our acquisition of LaCie and new products such as Seagate Wireless Plus and Seagate Central has significantly boasted our external drives and personal cloud offerings for easy to use home storage solutions that we believe will continue to be in strong demand.

Over Seagate’s history we have successfully invested in our technology portfolio to deliver the industry’s highest standard of security, reliability and performance coupled with these efforts we have worked to make cost effective and well-timed capital investments to support our global manufacturing operations. In fiscal year ’13 our capital expenditures were less than 6% of revenue and focused on maintenance investment for our existing infrastructure and improvements to our global manufacturing and R&D footprint including the Korea Design Center for our Samsung acquisition and planning for our improved media R&D center in Fremont, California.

In fiscal year ’14, we expect our capital investments to remain within our long term targeted gains of 6% to 8% of revenue. Mobile and cloud will continue to be the priority areas where we are investing in our R&D efforts and aligning our technology portfolio and we expect our operating expenses to remain relatively flat. At the same time maintaining our product gross margin is a key priority at Seagate which will enable us to make the investments required for advancement of our technology portfolio. For the past several quarters our model has proven to be effective for us to leverage both market opportunities and manage through uncertainty.

We will continue to work to balance near term financial performance with long term strategic development or maximizing shareholder value. We remain mindful on the uncertainties affecting our industry including macroeconomic factors, monetary policies, government spending and the technology transition that’s taking place particularly in mobile computing.

For the September quarter we believe the demand environment will be moderately, sequentially and we expect revenues of approximately 3.5 billion to 3.6 billion and non-GAAP gross margins to remain relatively flat.

In summary, we believe Seagate is well positioned for this era of data growth and technology transformation. We are optimistic about our leadership position in product portfolio and technology, and we look forward to updating you on our vision and strategic plan at our Investor Meeting on September 10.

On behalf of the entire management team, I want to thank our employees for meeting our operational goals for the fiscal year and positioning Seagate for ongoing success in fiscal year 2014. I also want to thank our customers, partners, suppliers, and shareholders for continued support and commitment. We are now ready to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Rich Kugele representing Needham & Company. Please proceed.

Rich Kugele - Needham & Company

Good morning. Just a couple of questions from me. I guess, first on the long-term trajectory for your business. It seems you have intentionally focused on the enterprise and some of the other higher capacity opportunities can you just talk about perhaps long-term, Steve, what you think two years out your mix might be between enterprise and all of the flavors, retail and client?

Steve Luczo

I think it’s probably more corporate we talked about that at the Investor Day, Rich, where we are talking about our longer term strategic vision.

Rich Kugele - Needham & Company

Okay, I will hop off of that. And then more near-term to the enterprise hybrid that you launched, can you just talk about how you think that, that will work into the product line of the customer interest, would you expect most of your OEMs to move to that or is that for a specific subset of the client of the customer side?

Dave Mosley

Yes, Rich, this is Dave. I can give you some flavor of that. So, obviously we know a lot about enterprise workloads, because we have been studying the drive from the markets for that are part of 15 years as people have integrated into the high-performance servers that we develop today. As we look at those workloads, what we see that is that sometimes the drives get used as I am going to call them almost memory devices that the data is spread all over the place in the drive, but oftentimes, the systems level operating systems, the applications layers so on, have been able to aggregate into more sequential workloads. So, what the hybrid drive does is it allows the drive to shift from one to the other really well, and we foresee that there is not really any massive changes coming in server architecture or the operating systems architectures, that’s going to address the drive. So, this is going to be a good value proposition for the high-performance drive for some time to come. And we think that most of the market will move over to these kinds of drives as people see that value performance of that (pay more).

Rich Kugele - Needham & Company

Okay. Just two last housekeeping, one on the TAM, can you just give us your sense of what you thought the TAM was in June? And then lastly, if you can make any comments on the appeals court process was announced yesterday?

Steve Luczo

Yeah, it seems like the TAM in June was 132, 133, Rich. And I will let Ken answer the question about the Court of Appeals.

Ken Massaroni

Yes, Rich. I mean, the company is pleased of the Court of Appeals reversed and remanded the judgment back to the District Court with an order to enter the findings on our behalf that we did as indicators that will appeal to the Supreme Court Minnesota which has a discretionary appeal that Supreme Court is not compelled to take it. Seagate will do everything that we have to defend the judgment that we have received at this point in time, and we’ll see what Supreme Court likes to do.

Rich Kugele - Needham & Company

Okay, thank you very much. Congrats on the quarter.

Steve Luczo

Thanks Rich.

Operator

Your next question comes from the line of Ananda Baruah representing Brean Capital. Please proceed.

Ananda Baruah - Brean Capital

Hi guys. Good morning, and thanks for taking my question. A couple if I could. Hey, Steve, big acceleration, nice acceleration in the enterprise drives this quarter you referenced it as well. I was interested in saying if you give us some of the dynamics behind the 9% sequential increase and then also you are commenting on I guess if you think this is sort of the signal that some of the stronger growth (inaudible) that you mentioned on last quarter calls as well and then I’ve a follow-up. Thanks.

Steve Luczo

I think I’ll let Rocky follow-up and what I mean generically it's continuous to be what we see as big build-out we call the infrastructure whether not that’s CSG related or ISG related or even private (inaudible) related I mean clearly architecturally there is a big change going on in terms of how people are storing and managing their data. So I think it is a continuation of that trend, those growth rates you know tended to be accelerating and it is an extension of what I think happen over the course of the next several years. I think what’s going to be interesting about the business is that it will be spiky I think from time to time I think more from upside perspective, I think that the general trend is positive and I think on top of that you’re probably going to have these spikes for either big ISPs or CSPs decide that they have to do some big build out competitively or geographically and that’s what we kind of manage our way through. You don’t see that in the normal quarterly or maybe multi-quarterly planning process but then in quarter all of a sudden you can get these opportunities and the ability to respond to them is important. So I think it is the continued trend of overall architectural change that is certainly driving higher capacity drives in the infrastructure.

Rocky Pimentel

I will add to Steve’s comments, there definitely was a strength of the quarter to quarter growth and what we call define as the cloud customer class, as Steve mentioned between each account the characteristic differ but the overall group continues to grow you know very robustly on a quarter-to-quarter basis and I think also this last quarter we filled in some of our product portfolio on the near line which gained a lot of momentum particularly in our 4 terabyte drive class category so couple of very positive drivers in the whole near line data center class products that’s what we benefited from.

Ananda Baruah - Brean Capital

Yeah that’s helpful and I then guess just part and parcel with that, growth margin guidance was flattish in the September quarter, can you just walkthrough I guess the puts and takes on the flash margin guidance kind of in the face of seeing improved mix as we begin the second half of the year. Thanks.

Steve Luczo

Well actually in the second half of the year usually don’t get improved mix, you get a strong notebook playing (ph) you get a smaller gaming play so actually the mix works against you the second half of the year and that’s been in this case offset against you know we think continued growth on the cloud side.

Operator

Your next question comes from the line of Aaron Rakers representing Stifel. Please proceed.

Aaron Rakers - Stifel Nicolaus

The first question looking at your 855 average capacity per drive as we look forward through this next fiscal year what do you think that exists this next fiscal year and then I think last quarter you had alluded the possibility of tightness on finished media if the industry were to get towards a 500 exabyte level or about 420 right now, what’s your view on that updated view on that dynamic?

Dave Mosley

So we’re not quite there yet I think it really does depend on the growth of the cloud specific Aaron to the extent that five disc drives are in the norm Rocky mentioned the 4 terabytes for example, as that continues to grow so I won't (inaudible) talk about box but just talk about Exabyte growth and then that really starts to strain the media. I don’t think we’re going to be there in FY ’14 but it will be more of a FY ’15 commentary.

Steve Luczo

Now on the first question now I think if you look at the product offerings, the 4 GB product that we mentioned in kind of the demand we’re seeing for that and then in the consumer marketplace which is really for the higher capacity drives are going obviously, there will a bunch of 2 GB products coming on so I think exiting the fiscal year will be certainly crusting our near 1 terabyte on average capacity per drive you know again you got to remember that the classic enterprise drives are lower capacity drives but they are doing much higher performance. So it's really what’s going on in cloud and what’s going on in consumer both those trends are quite neo-positive from a capacity perspective.

Aaron Rakers - Stifel Nicolaus

Great and then the final question for me, what assumption are you making as far as the TAM through the back half of this calendar year and how does that reflect the new game council cycle?

Steve Luczo

Well, we have only talked to September quarter, so I know we are not really talking close to the back half of the year. Again, we will give you a little better clarity about what we think some of the longer term trends are for the December quarter and to Rich’s question earlier a little bit, our incentive up, two or three years out, but I think the market estimates are implied in our moderately sequential number. We are kind of thinking that it grew to 132 last quarter you can see 135 to 140 in the September quarter, and we would expect December to be up from that.

Aaron Rakers - Stifel Nicolaus

Okay. And game council?

Steve Luczo

In terms of what accident numbers or?

Aaron Rakers - Stifel Nicolaus

Yes, in terms of just the new game council cycle with the Xbox One and then the PS4?

Steve Luczo

Yes, it should be positive.

Aaron Rakers - Stifel Nicolaus

Okay, thank you.

Operator

Your next question comes from the line (inaudible). Please proceed.

Unidentified Analyst

Hi, good morning. Can you hear me okay?

Kate Scolnick

Yes.

Unidentified Analyst

Just following up on some of the comments around solid say drives developments that you had with Samsung, I was just curious in terms of where you think you would be on commercialization of some of those products between now and year end? And then secondly, any comments around some of that, there was couple of acquisitions that were relatively high profile in that area? And I was curious where you guys stand on build five versus build given those acquisitions and given your own incremental elements? Thanks.

Rocky Pimentel

Yes. So, I think based on the activities that, this is Rocky by the way, that we have done over the last year were still very interested in making strategic investments in SSD and PCI category products. Organically, we have been utilizing our Samsung partnership as well as our internal development efforts. And right now, based on our forecast as we would exit this year, our organic efforts in SSD would be greater than any of those companies that were recently acquired by in the open marketplace. So, I think we feel pretty positive about the evolution of our SSD initiatives.

Steve Luczo

Yes, I mean, obviously there was nothing secret about the acquisitions that occurred and it was our decision not to participate. We are confident in what we are doing internally right now.

Unidentified Analyst

Great, that’s very helpful. And then just secondly just looking at the notebook market for the second half, can you may be talk about where you stand in terms of 5 millimeter drives design wins, how much momentum you think that can contribute to your business as the year progresses?

Steve Luczo

Sure. I don’t know that I view 5-millimeter necessarily as a notebook drive. I think we view 7-millimeter as probably the right platform for thin and light notebooks. 5-millimeter probably is the more compelling drive for something even more mobile like a tablet. And we are happy with the engagement that we have on the 7-millimeter side as most OEMs are incorporating 7-millimeter and 7-millimeter hybrid into their next generation thin and light offerings. And we are pleased to-date with the engagement we have had on the 5-millimeter side going into tablet. So, we do think that high capacity, high performance, and much lower cost on a per gigabyte basis is compelling to mobile users. So, we will see how it plays out the rest of this fiscal year, but so far I would say we are encouraged by what we are seeing from the OEMs. Rocky, you want to add?

Rocky Pimentel

Yes, I was going to say this quarter we will be shipping a meaningful amount of 5-millimeter drives as we launch into our initial program. So, we are pretty positive. We have several major OEM commitments on the 5-millimeter that we will be pursuing as we exit the September quarter and then continue to build that volume in the December quarter.

Unidentified Analyst

Great, that’s very helpful. Thanks again.

Operator

Your next question comes from the line of Rob Cihra representing Evercore. Please proceed.

Rob Cihra - Evercore

Hi, thanks very much. Two questions, I guess, because one on gross margin, it was actually solid in the quarter 28% even on a weak PC market. I am just wondering though if you look at your target range, what you think you need to see to get higher up that, I mean, is it simply better capacity utilization or there are more drivers to that? And I have a follow-up, if that’s alright.

Pat O'Malley

This is Pat, Rob. Clearly, volume would be beneficial to us, I mean, but given the world that we are seeing is with the modern growth rates now, we’re really managing on the price stability as much as we can because we need these margins continue to invest and also just mix. As Steve talked about with the cloud build out that’s certainly been helpful to maintain it, but to drive to the middle of the range, you need either a greater mix or some volume because I think we’re doing a pretty good job on maintaining the economics on the drives being sold.

Rob Cihra - Evercore

Okay and then just in CapEx you obviously have been running lean and you said running is a sort of whatever operational levels, I know you gave the guide for fiscal ’14 to stay in your target range. Do you feel like you're almost running too low, I mean you’re running nicely conservative but it was fiscal ’13 almost too low when you start looking at new technologies and that sort of thing? I mean is that a, is there a chance for higher up in that range as you again in fiscal ’14 or do you think you can still sort (ph) around maintenance levels. Thanks.

Steve Luczo

I think it depends on I think the answer to your question is no, I don’t think it was too low. I think it was appropriate for the visibility that we have around demand and which is both again a technical transition issue on the client side offset by a technical transition on the enterprise side offset by very squishy macroeconomic conditions and not a lot of that has changed so we’re going to run the capital pretty tight. If the trends continue where the client side shows little or no growth and cloud continues to grow. We do think we will hit capacity issues, which then you we will probably evidence themselves and shortages and a different margin structure at which point then we can consider what we do on the capital side but we’re not going to lean into it other than maintaining what we need for technical advancements. Dave do you want to add?

Dave Mosley

No I think that’s right.

Operator

Your next question comes from the line of Sherri Scribner representing Deutsche Bank. Please proceed.

Sherri Scribner - Deutsche Bank

I just wanted to get a little bit of detail on your thoughts on ASPs as we have head into the back half, I know Pat you said that you’re managing to have good economic, I mean there is a good growth margins in the quarter but I think some of the OEMs had said they had seen HD pricing starting to come down. So can you give us some sense of your expectation for ASPs as we move into September?

Pat O'Malley

Our position has been in the last several quarters remaining relatively flat. Obviously there is, our view is we still want to drive the cost of storage down by delivering compelling products through technology and cost management, but our view on the price is going to be relatively stable and that’s our plans for the rest of this calendar year.

Sherri Scribner - Deutsche Bank

And you also talked about having I think the commentary was meaningful and also a 5 millimeter drives in September quarter, are you’re going to start breaking out the hybrid and the SSD products in any time over the next couple of quarters because it seems like it's becoming a more important piece of your business.

Randy Olmstead

I think we will be able to give some level of guidance as that market develops for us, probably a little premature right now as Rocky said we’re going through a lot of OEM qualifications, we’re feeling fairly positive but once it starts taking traction that’s probably a fair breakout for a period of time.

Sherri Scribner - Deutsche Bank

Okay great and then just my final question. I know you guys, anniversary anniversaried the Samsung acquisition in the beginning of the year or last year December. Have you had any progress in terms of integrating that business, I know couple of quarters ago you said you weren’t really focused on that but just wanted to get an update. Thanks.

Pat O'Malley

We’re still under MASCOM agreement which we’re working very positively with the agency and so we don’t view it as a huge challenge but we’re operating these two entities on the interface of the customers vary independently still today.

Steve Luczo

Yeah I mean the R&D side and the ops side has been integrated for a while but it's just the customer facing activities that we’re managing separately and we will continue to do so until we’re released from those restrictions by MASCOM (ph).

Operator

Your next question comes from the line of Scott Smith representing Morgan Stanley. Please proceed.

Scott Smith - Morgan Stanley

Guys can you just run through some of the puts and takes in the free cash flow side and when do you expect to get back to levels that allow to meet your repurchase goals?

Pat O'Malley

So, maybe on the repurchase goals I don’t know what you are referring to, but from our standpoint, Steve in his prepared comments talked about returning 70% of operating cash flow, which was our goal last year and we met it, and we are continuing try to target up to that this year as well and also as much as 90% cash flow. So, for fiscal 2013, we have never had a stated goal other than to continue to return large amount of the use of the cash flow to the shareholders.

Scott Smith - Morgan Stanley

Yes, I guess, and just referring to the $250 million target exiting 2014?

Pat O'Malley

Yes, okay, that’s calendar 2014. So, that’s still a target with us. Obviously, the share price does have an effect on it. So, we will manage the business and we will continue. In the meantime, the return significant amounts of capital cash flow to the shareholders. So, that’s the fiscal ‘13 goal.

Scott Smith - Morgan Stanley

And then Pat, just on the free cash flow this quarter, I think there was a large other item, can you just run through what drove the lower free cash flow in the quarter?

Pat O'Malley

The redemption of the debt we issued $1 billion, but we also redeemed $700 million. So, we had $111 million of basically premium and charges to accelerate that redemption, but in the period, we are going to say of over $40 million a year, extend their debt maturities over two years and dropped overall portfolio by 130 basis points. So, that was a one-time charge of the whole restructuring of the debt profile.

Scott Smith - Morgan Stanley

Great, thank you. Thank you.

Operator

Your next question comes from the line of Andrew Nowinski representing Piper Jaffray. Please proceed.

Dan Garofalo - Piper Jaffray

Good morning. It’s Dan Garofalo on for Andy. Thanks for taking the questions. Just wanted to focus on the enterprise, I know there has been a few questions, obviously another strong quarter, especially in the near line category. I guess, as you look at that category, it looks like 21% year-over-year unit growth in fiscal ‘13 given the increasing capacity that is getting shipped in cloud applications, how should we think about unit growth in that category. Is it fair to think that it could accelerate?

Steve Luczo

It is tended to have accelerated over the last two years. And I think the conditions that are causing that acceleration are still in their early stages. So, I think as Cloud continues to build out, we still expect growth in that area.

Dan Garofalo - Piper Jaffray

Okay. And then I guess just one follow-up if I could focusing on the PC industry, in addition to talk about second half catalyst related to new product intros, there has also been talk of Microsoft gaining support for Windows XP next April, potentially being a catalyst for the PC industry. I just wonder how are you looking at that event, as well as any color you can provide on your view of the PC pipeline for the second half of the year. Thanks.

Steve Luczo

Well, I don’t think we have – I mean, we have our own perspective on, which is we are positive, we are more positive than the doomsday scenario of the PC is dead. As you know, we tend to – we still wise line about PC Plus, not post PC. And we believe that the PC has an important role to plating and computing environment for sure as do the mobile devices that connect to it and around it as does the cloud that everything on it is going to ultimately connect to. So, our view is positive on the client side in all of its forms. And I wouldn’t want to specifically identify an action by Microsoft, but we think the long-term trends are still positive for the PC industry, but there is no reason for us to kind of plan to that right today. We just – we have the capacity and ability to address that marketplace that’s in front of us. And as it stabilizes or recovers we will be in a position to I think have a good product offering to fit all the different segmentations that are occurring around how people use technology and make their lives better.

Dan Garofalo - Piper Jaffray

Great, thank you.

Operator

Your next question comes from the line of Monika Garg representing Pacific Crest Securities. Please proceed.

Monika Garg - Pacific Crest Securities

Hi, thanks for taking my question. My question is on enterprise SSD market, I mean, we are seeing strong adoption of enterprise SSD, and Seagate has also made investment in the field. So, could you may be talk about the impact of enterprise SSDs on the mission critical drive?

Rocky Pimentel

Clearly there is emerging evolution of what’s the high performance layer in the data centers which is the, it's a blend between mission critical and enterprise SSD and I think it's important that we have both sides of that equation covered, certainly there is again ebbs and flows of the transition between somebody wanting mission critical elements of HDDs and their typology versus SSD. So, I think with the growing success of our enterprise SSD initiative we’re less concerned about what does that mean for mission critical drives and what it means about our kind of high performance element of the enterprise overall.

So, certainly we see some customers migrating more to SSD enterprise class SSD solution but still the mission critical is an important element in the overall architecture so both elements are important and the fact that we’re succeeding it both kind of gives us confidence that whatever the customer wants we can fulfill their need.

Steve Luczo

We like to garner our characterization and these are complementary technologies, I have heard that somewhere before.

Monika Garg - Pacific Crest Securities

And then if I may just a follow-up on the same question. I mean we have seen the NAND companies moving in the enterprise SSD space and given more than 80% cost of the enterprise SSD is just raw flash so the question is how you think HDD industry and Seagate compete against with NAND vendors when given they are increasing the offering in this space too.

Steve Luczo

Obviously understanding the customers and integrating with the customers is a key point of how successful you’re going to be and so pointing back you will see a variance in the enterprise space understanding customer workloads, is really important. I will say that the market itself is very complex and so at some places the SSDs are being used as storage devices and some places they are actually storage class memory or memory like devices. And difference (inaudible) that it might be hanging up of, it's a really complex space maybe with one brush (ph) and say you know 10k or 15k HDDs belong here and SSDs belong here especially given the plethora of applications and the servers this will be really completed.

Pat O'Malley

So I think the reality is that the workload and application aspects that we either favor SSD or HDDs are different and those that favor SSDs weren’t really being served by HDDs it's actually opening up in an entirely new application set and the front end of that set has advantages to SSD if it's random and if it enables therefore the analysis of more and more data then we think that obviously supports the need for high availability data to run through that front end and so we actually think warrant store (ph) and things like that are becoming very important as well. So again the replacement aspect of IE, I use an SSD drive to replace a boot drive that’s a three year old story that was about 1% of the mission critical drives that we sold. I think the reality is just like phones that aren’t using disk drives or driving the creation and sharing content that’s impacting the need for more HDD and the infrastructure, SSDs on the enterprise side are doing the same thing with basically big data analytics and we’re one having products that will participate in that category directly, we do it with partners, we do it with our own products and it also benefits us on the HDD side or on the hybrid side to one of the earlier questions I think which Kugele asked about the nature of that customer which seems to be the big data customers that need an accelerator into the SSD.

So we think again this is just part of an overall architectural change that favors big data growth and big data needs to sit on that disk drive ultimately.

Operator

Your next question comes from the line of Joe Wittine representing Longbow Research. Please proceed.

Joe Wittine - Longbow Research

I think, hate to look at market shares on a short term basis but any comments you can make on whether the strength in enterprise reflects any share gains during the quarter and conversely the softness and client reflects any share losses or anything you walked away from? Thanks.

Steve Luczo

We have tended not to chase prices much on the client side, which may have resulted in some share loss. I would say, on the enterprise side again, it’s the ability to kind of execute in quarter. Those could either be architectural issues, where we have to be qualified at some OEM or with some particular CSP in someone else isn’t or it could product related. We do feel good about it’s probably more of a Q1 story than a Q4 story, but we do feel good about the positioning of our new 4 terabyte drive. But I think in general, I think any market share shifts in the 1% range is pretty much noise level at this point. And I wouldn’t read too much into it. I think the industry is kind of fairly stable in its market share right now, and I don’t see any big shifts occurring there one way or the other.

Joe Wittine - Longbow Research

Thanks, Steve. And then a quick follow-up on OpEx, we have crept over the percentage of sales for a few quarters now, maybe it’s not surprising given all the new products you have introduced, but you got it flat again kind of what changes – what changes going forward that enables if you kind of keep at this current level, any….

Steve Luczo

Yes, I know, it’s an important question. Yes, I know, it’s an important question. I think with the gross margin change that we have seen over the last couple of years anywhere from 800 to 1000 basis points of additional gross margin, and of course, the company has been good about returning a big percentage of that to our shareholders, I also think given all the opportunities in storage both on the mobile and the cloud side that it’s important for us to invest in some new technologies and products that are resulting from that change in marketplace and that’s where we have been making some investments. And it has pushed the OpEx up marginally. It’s obviously tied to our expectations of revenues and profits down the stream., Some of that is SSD related, some of that is core technology related to make sure that we can keep aerial density growing at the rates that we need to, some of it specifically to mobile and some of it is to cloud.

And again at the September meeting, we will continue to update you on whatever our views are about these investments and the particular markets and the technologies that we are deploying, but I do think it’s important for the company to make those investments and position itself to generate revenue growth and margin growth down the stream from those investments. We watch it closely as you know. OpEx is something that we fight hard for every day, and it’s one of the nice DNAs of Seagate. So, we are actively managing it, but I do think it’s important for us to take some of that gross margin expansion and position our company for growth, because there is so much growth related to the storage that we would be remised not to.

Joe Wittine - Longbow Research

Fair point, thanks.

Steve Luczo

Thank you.

Operator

You have time for one final question and that question comes from the line of Cindy Shaw representing DISCERN. Please proceed.

Cindy Shaw - DISCERN

Thank you. Several questions. First, you talked at your Investor Meeting last year about going out after the cloud storage by trying to really go up the stack and go more directly, and there is talk about potentially getting higher margins and prices to that value-add. As you look at what you are getting in terms of cloud business now, is that what’s happening or is it more of a classic near line drive?

Steve Luczo

No, it’s a classic near line drive.

Cindy Shaw - DISCERN

Is there still a thought that you can with some of these folks that are trying to use more commodity-like drives go up the stack and get those higher margins?

Steve Luczo

We think about it very differently. With OpenStack deployment, there is the opportunity for a desegregation of the software and services level that exist today and many companies are pursuing architectures that say how you take our devices and deploy it with OpenStack to achieve their storage goals. To do that, there are many changes that we may need to make at the device level that effectively move us up the stack, and yes, we have those discussions ongoing with a wide variety of technology providers.

Cindy Shaw - DISCERN

And then it’s thought as to when that might actually start to happen in the marketplace, so we are talking the quarters, years?

Steve Luczo

Quarters.

Cindy Shaw - DISCERN

Okay. And then following up on a couple of the earlier questions, there was some discussion about potential for capacity constraints as demand and start to improve and the constraint being media. Do you feel like you have got a lot of capacity in another area such as (inaudible) and things like that or would you start to bump into other things pretty quickly after the media?

Rocky Pimentel

It really depends on how it comes out Cindy, if it's the cloud drives there honestly heads media rich, if their client devices which were not as Steve said earlier we’re not really leaning into and those are more box cap related (ph) where we have to procure individual parts and test time and things like that, so there is a balancing act. I think right now we’ve got enough capacity for what we see in FY ’14 and we’re going to be cautious with our CapEx.

Cindy Shaw - DISCERN

Okay and then one final clarification, when you answered one of the error questions I wanted to see, it was talking about PC long term trends, you used the word stabilizing, recover. Is it your view that the year-over-year declines in PCs was been seen, in the last few quarters are somewhat temporary phenomenon and the PC units are going to actually start to grow or is that factored in potentially getting hard drives into tablets.

Steve Luczo

Yeah I think it's maybe closer to the second half, I think that we need to stop viewing the world as defining it as the technology that’s 10 year’s old. When someone says PC I don’t know what they think about that giant desktop thing or the notebook, our technology market has continued to evolve over the 35 years I have been in it and what’s happening with tablets is in my mind not any different than what happened when we went from mainframe to many decline servers to PC to now phones and it's a constant evolution of technology that’s basically becoming more and more available to more and more people which allows more people to share and create and at the end of the day that’s driving more stores. So yes we’re positive on the future of client devices if client devices are things that go in individuals hands and they will take the form of something that I can carry in my pocket or something that I can carry in my briefcase or something that’s in my home or something that’s in my workplace that is all connected and some of it may also be in a shared services that many people connect to. So I think we need to kind of change our thinking about what’s happening to the PC, the PC is evolving just like it has for the last 30 years and continue to evolve.

Okay. I think that’s last question. Again we want to thank everybody for your time this morning and for coming in for our early call and we look forward to seeing you in September and then talking to you on the next call. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a great day.

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