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Seagate Technology (NASDAQ:STX)

F4Q10 (Qtr End 07/02/10) Earnings Call

July 20, 2010 06:00 pm ET

Executives

Steve Luczo - Chairman, President & CEO

Pat O’Malley - EVP & CFO

Bob Whitmore - EVO & CTO

Dave Mosley - EVP, Sales, Marketing and Product Line Management

Analysts

Rich Kugele - Needham & Company

Mark Miller - Nobel Financial

Keith Bachman - The Bank of Montreal

Sherri Scribner - Deutsche Bank

Aaron Rakers - Stifel Nicolaus

Jayson Noland - Robert W. Baird & Co., Inc.

Kathy Huberty - Morgan Stanley

Operator

Good afternoon ladies and gentlemen and welcome to Seagate Technology’s fiscal fourth quarter and year-end 2010 financial results conference call. My name is Amesia and I’ll be your coordinator for today.

At this time all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. (Operator Instructions).

As a reminder, this conference is being recorded for replay purposes. This conference call contains forward-looking statements including, but not limited to statements related to the company’s future operating and financial performance in the September 2010 quarter and thereafter and includes statements regarding expected revenue, gross margins, customer demand for disk drive and general market conditions.

These forward-looking statements are based on estimation available to Seagate as of the date of this conference call, but are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from those anticipated by these forward-looking statements.

Information concerning additional factors that could cause results to differ materially from those projected in the forward-looking statements is contained in the company’s annual report on Form 10-K as filed with the US Securities and Exchange Commission on August 19, 2009 and in the company’s quarterly report of Form 10-Q as filed with the US Securities and Exchange Commission on May 5, 2010.

These forward-looking statements should not be relied upon as representing the company’s views as 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 will now like to turn the conference over to your host Mr. Steve Luczo, CEO. Please go ahead.

Steve Luczo

Thank you, Amesia. Good afternoon everyone and thank you for joining us today. On the call with me are Pat O’Malley, our Chief Financial Officer; Bob Whitmore, our Chief Technology Officer and Head of R&D and Manufacturing Operations and Dave Mosley, Executive Vice President of Sales, Marketing and Product Line Management.

Beginning with today’s call, we are implementing a new format for our quarterly results announcements. As you have hopefully already seen, we have posted supplemental information about the quarter on our Investor Relations website.

The majority of the information that Dave, Bob and Pat have previously conveyed verbally on our earnings conference calls is in that document which we posted about two hours ago in order to give investors and analysts time to review it.

Our goal with this format is to give all of you more time with the basic factual information about the quarter in a form you can download yourselves. And then focus the call on topics and issues that are most important to you. At the end of my prepared remarks, we will address a few questions of particular interest to our investors and then open the call up for questions.

I want to start with a few observations about the fiscal year that we just completed and then turn to fiscal Q4. For the year, we saw record shipments of 193.2 million units, record profitability of $1.61 billion, record operating margin of 15.3% and record diluted earnings per share of $3.14. We also generated nearly $2 billion of cash from operations enabling us to continue to strengthen the capital structure by improving our net debt position by $775 million and repurchasing $584 million worth of Seagate common stock.

We also had a series of important product announcements this year including our successful entry into the Enterprise SSD market with our Pulsar product, our ground breaking Momentus XT solid-state hybrid laptop drive and the high versatile GoFlex family of external storage products.

These products are expected to broaden our product leadership and provide opportunities for incremental revenue growth in fiscal year 2011 and beyond. We introduced these and many more products while successfully managing through a volatile supply and demand environment and continuing to improve the fundamentals of our business.

Global demand for storage remained strong throughout the year, reflecting the pace at which digital content and information is being created.

However, in the June quarter, demand throughout the industry began to slow and exhibited linearity more typical of the June quarter. The biggest issue that we faced in the quarter was that the broader macroeconomic conditions deteriorated during the quarter, particularly in Europe. The economic slowdown and debt crisis in Europe and to a lesser extent the global freight interruption due to the Iceland volcanic eruption caused inventory disruption and contributed to an industry TAM near the low end of the expected range. These effects were more pronounced in the consumer market versus the commercial market which in turn negatively impacted mix and pricing.

In addition, we believe the economic slowdown resulted in a supply demand imbalance in the quarter of approximately 5 million units. While most industry participants including Seagate reduced production from the prior quarter against the decreasing TAM, there was at least one competitor which significantly increased production during the quarter. As a result, pricing and channel inventory and certain capacities were negatively impacted in the quarter versus our expectations.

Despite these challenges, we generated revenue of $2.66 billion and gross margin of 27.4% and produced the highest operating profit for Seagate in the June quarter. This was also our fourth most profitable quarter in Seagate history. In addition, Seagate ended the quarter with four weeks of inventory on hand in the distribution channel with the inventory balance across all of our product lines. While we continue to expect that demand will strengthen as we progress the relative remainder of the calendar year, there are many conflicting data points concerning the strength of second half growth.

On the negative side, there was a deceleration in hard drive demand in the June quarter. Negative macro economic events impacting exchange rates, availability of credit, and other forms of liquidity, the US Commerce Department reported lower than expected retail sales for the month of June and the recent Federal Reserve forecast of slower second half growth in the United States.

On the positive side, there was increased indication that the corporate technology refresh is accelerating and certain bellwether technology companies that have longer lead time visibility than Seagate have recently forecasted strong growth for the second half of 2010. Overall, we still believe that the industry TAM for the full calendar year will be approximately 650 million to 670 million units. However, given the mounting negative influences I just discussed, we have shifted our view from one where we might be accelerating through the second half of 2010 to one of more modest momentum.

For the September quarter, we are planning for the industry TAM to be between 165 million and 175 million units. Our key underlying assumptions for our September quarter financial outlook include: no additional slowdown in consumer spending on technology; no meaningful shifts in market share with Seagate expecting to hold about 30% share. No attempts to shift market share through over-production or aggressive pricing, weeks of inventory on hand to remain apt or around current levels, and that the cooperate technology refresh cycle will continue.

Given the uncertainties around second half growth and the historical linearity of September quarters, we believe it is prudent to plan our business with what we hope is a conservative forecast with the ability to respond to upsides, if demand proves to be at the high end of our forecast. As such, we expect revenue of $2.7 billion to $2.9 billion and gross margin as a percent of revenue at or near the low end of our target range of 22% to 26%.

Given that Seagate’s business is over 70% OEM, we are pricing contracts and negotiated well in advance of the quarter. A large part of our business was insulated from price declines in the June quarter. Therefore, we were able to effectively manage our gross margins in the June quarter. In the September quarter however, the aggressive pricing environment now carries through to our entire product portfolio and will have a more pronounced impact on our gross margin.

We believe that being closely aligned with our OEMs is a strategic benefit to Seagate over the long term. Finally, we expect R&D and SG&A for the September quarter to be flat sequentially.

Before we open up the call for questions, we will address the questions I referenced earlier. I am going to take the first question which is we’ve had a lot of calls from investors inquiring about the success of iPad and other types of tablet or slate devices and what the possible impact might be on the demand for hard disk drives.

I think and I haven’t had the opportunity to listen to the Apple call yet other than to look at the top line results which obviously were impressive and obviously the iPad sales were impressive as well. It’s still our belief that devices like this which, are for the most part I would contend not really compute devices but maybe more content viewing devices. They obviously have some capabilities for compute, but on the most part it’s a content viewing device. We still believe that those devices [Audio Gap] at the end of the day increased requirements for storage throughout the eco system, and in particular if they are going to be used for content rich video as wannabe applications that’s being pursued with those devices, maybe a better example is the Cisco slate which is certainly being targeted more in the business environment to enable TelePresence, which again we think is going to drive a lot of back end storage throughout, not just the server but the storage subsystem architectures.

To the extent of those devices cannibalized notebook market, which again the notebook systems vendors would have a better view on it than us, then clearly it has a potential for impacting hard disk drives. But to date, we just don’t believe that a lot of people are buying those devices to sub-plant what they were doing with the normal computers. So, our view on it still is that we think this is a net positive for the storage industry and we also believe by the way that those devices, not speaking to the specific products, but at the end of the day will obviously have access to external storage in one or more forms that will follow a benefit to Seagate and any other drive company that’s in the retail business.

Second question is why will September gross margins be well below the run rate of the last three quarters, and one made a recovery to the mid to upper end of the target range occur? And I’m going to turn that over to Pat and perhaps to Dave, to weigh in on that.

Pat O’Malley

Thanks Steve So, I’ll address that two aspects; one, just the gross margin bridge from where we performed over the last fiscal year to where we expect to perform in the September quarter, and you know, a simple break down on that is that what we are seeing in the September quarter vis-à-vis, coming out the fourth quarter is that the historical trends for pricing across the whole portfolio or above the norm, not offset traditionally by a mix up in product. So, that itself is probably having the more significant portion of the detriment on our gross margin percentage.

The other aspect is lower production volumes in the month of June in particular and the early part of the quarter because given the cautious outlook we are going to manage inventory just throughout the quarter very tight, is leading the higher production cost unit for those products going out in this quarter that long term we think we can certainly manage by giving the cautious outlook in this quarter. We certainly want to be prudent with inventory and which could lead to higher per unit cost.

Now as part of recovery, when the margins could accrete back to the higher end of the range, obviously you have to make some assumptions that the macro economics of the US consumer and the Euro-zone, whether that’s in the countries or just the currency of the Euro. If they stabilize or strengthen, we certainly think that would be an adder to the margin and also with production being brought in line with demand. So having that a balanced equation and with no attempt for share gains by any competitor without really product advantage, so having a balanced price environment with supply and demand.

I don’t know, Dave do you want to add to that?

Dave Mosley

No, I think I am okay.

Pat O’Malley

So you want to me to segway into the third question which is somewhat related. How much did supply exceed demand in the June quarter and what is the expectation for the September quarter of upstate mostly going in on that.

Bob Whitmore

Yes. This is addressed in the supplemental that Steve referenced earlier. If you haven’t had a chance to read it yet, we quantify it and said its five million drives where supply exceeded demand and we’re actually moved in the quarter. Putting an exact number on this is always difficult but I’d say this, I’d break it into really two dynamics. One, very early in the quarter, where the consumer demand particularly in Europe sell-off very quickly. A particularly high caps, so mix was effected as well and there are a lot of dynamics for that. There’s various components, pricing that effect these things and obviously consumer sentiments and other big driver for these shifts that we see going on.

At that time, I believe that people were still putting out units above what the two demand signals were and putting them into that region and then therefore, starting to move, tried to move those units with price. And so, obviously, when that’s happenings, we’ve got to keep an eye on it to pass comments before we’ve got to make sure that we ratchet back production as quickly as possible to make sure supply and demand stay in balance. The industry always needs to a better job at that. At the back end of June, it’s a little bit different as typically this quarter, as Steve referenced, the linearity of 50% of the quarter is done in the month of June.

I think we’re even a little bit higher than that this time and in my opinion right now, some of the deals that were taken, that I saw taken probably really could have been fulfilled at July, supply it anyway. So I think, I think not controlling production there at the back end is probably causing some of those other behaviors also. So that’s why, that’s how I’d rationalize five million. It’s a fairly easy number, maybe a tad higher than that even. We probably have to get through the first few weeks of July into August to probably see exactly what the, how the dynamics should have played but, that’s our opinion on it for now.

Steve Luczo

Okay [Amesia], we are ready to open up the call for questions.

Question-and-Answer Session

Operator

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

Rich Kugele - Needham & Company

Thank you good afternoon, a few questions first the relative to history when one of the stereotypes people use were really formed. How quickly do you think that Seagate and the industry responded to those changes in demand may clearly if you exceeding it four weeks inventory, you responded to the difference in demand relative to the guidance you have provided so and any comments there will be helpful?

Steve Luczo

I think that’s a good point Rich, just as look at the 3.5 inch inventory in the channel for example going out. We talk about this in our supplement a bit. The industries still not bad shape historically, its just over four week. So the industry has responded just didn’t respond quickly enough at the start of the quarter in particular in some capacity points, the high capacity points that I made reference to earlier but I do think that over the course of the quarter there was definitely control in place.

Pat O’Malley

Rich this is Pat, I would say historically the historical perspective, it may have taken up to two quarters before so as much as we may have liked to have seen a quicker response, it is getting tighter and so as they’ve said we saw signs of the inventory coming in back in line by the end of the quarter.

Rich Kugele - Needham & Company

Okay and in terms of the question we always get us on trough earnings potential, if you look at your current and projected platforms, the cost basis on those are more normal gross margin range. What do you think both for Seagate and the industry the trough earnings really are? I mean do you think the industry has moved beyond where the trough is negative?

Steve Luczo

Yes. I mean I think what we are talking about where we are going obviously the key is you know Rich in this industry it is product transitions and you know product positioning with true technology is held one competitor outweighs the other and as the supply demand stays and balances the second. And I think as to your first question as the industry saw, was getting ahead it pulled back, so I think to Steve’s point a quick yes is sufficient because I think the industry is trying to manage to a tighter range in the profit pool.

Pat O’Malley

I think Rich the difficult thing the rest of this year and really in the fiscal year 11 is against what macro economic environment and I think fiscal year 11 for the drive industry on the whole is, it’s a challenging year because most of us are in-product transitions which means the products we are shipping are going probably stay in production for the mass amount through the fiscal year and what we are doing is developing next generation technology under that.

You don’t see that in terms of the benefit of a ramp really till the end of fiscal year 11 and then probably really in to fiscal year 12. That’s a tough enough environment to manage yourself in, from a cost perspective in a growing environment and with the industry participants matching supply and demand. When the macro scenario is more volatile then you have to have the ability to either change your mix or change your bills pretty quickly, and I would say that this quarter showed that some of the industry participants have those controls in place and able to respond quickly change mix, reduce build and maybe not the entire industry is there but this is a lot better than it has been historically yes and we believe that it gets a lot better, you know over the next year or two as well as, as companies continue obviously to streamline their operations, it doesn’t help anyone to over billed on a sustained basis because as we all know you can’t sustain market share gains by over-building and pricing, its all about new products.

Rich Kugele - Needham & Company

Okay. Then just a last one on the buyback, is there anything left on the buyback that you have out there for the Anti-Dilution and any thoughts on, you should still be generating a significant amount of cash flow in fiscal 11 and any comments there?

Pat O’Malley

Yes, rich in January [due] formally with the board approves for the management to execute an Anti-Dilution plan given what the shares outstanding and the outstanding options. We still have ability to continue buyback shares if we deem that appropriate and we probably would have at a run rate what we just accomplished in the last quarter we probably had a couple more quarters of that if all things were in line, i.e. the stock prices and a few other variables, but we do have more ability to buy back shares under that board authority.

Operator

And the next question comes from the line of Mark Miller with Nobel Financial. Please proceed.

Mark Miller - Nobel Financial

Just wondering as you noted the OEM pricings is going to cast and stone I assume there is no ability that putting in much will exist throughout the whole quarter. My question is more about, do you anticipate the channel pricing to be more aggressive this quarter or than it was last quarter was it the channel pricing non-linear was more of the pricing erosion seen at the very end of the quarter?

Steve Luczo

I definitely think things stabilized, it wasn’t just the back end of the quarter, it was also the very front of the quarter because of the dynamics I mentioned earlier but, I definitely think things will stabilize into this, calendar Q3 and beyond. Just simply because they’ve already come down to levels, if you look at the various capacity points and as Steve said, you know what products are playing there, there’s not any major industry transitions coming for the next couple of quarters foreseeably, so I just don’t see the cost coming out, so I think those pricing points will stabilize.

Mark Miller - Nobel Financial

And the OEM pricing will probably be as you just said it in the auctions a few weeks ago was that correct or there is very little latitude that’s going to change, is that correct?

Steve Luczo

Yes, that’s correct.

Bob Whitmore

Yes and then of course they will reflect above the aggressive pricing that occurred in the June quarter mark.

Operator

And the next question comes from the line of Keith Bachman, The Bank of Montreal. Please proceed.

Keith Bachman - The Bank of Montreal

I was hoping if you could talk about your expectations on the enterprise side of your business for not only September quarter but December quarter. What’s the feedback from the demand side and then more specifically, what are you thinking about potential share shifts in this part of your business and I have a follow-up please.

Steve Luczo

Yes, I think in terms of share shifts again, last quarter I think it was or the quarter before you know we hit a very high market share which was as we indicated pretty reflective of lack of execution and one of the big enterprise players and we expect to hold that. However, we do believe that the 62% of share that we’re operating in is probably the right share for Seagate and we probably expect to hold that share and potentially do a little better if there’s execution issues which tends to be in the enterprise because it’s a difficult portfolio.

I think in terms of demand, maybe just a little bit cautious still in terms of the cross currents that I indicated before against I would say it’s the one area where there seems to be recurring theme of strength whether or not it’s out of Intel or whether or not it’s out of IBM, or we’ll see what we hear from some of the other systems level companies. But maybe we’re a little more cautiously optimistic about enterprise in the September quarter. And then, clearly through the end of the year and through calendar 2011, we would expect that to be impacted by the refresh, the corporate technology refresh, and that’s going to be probably more a function of just what’s the macro scenario if you’ll like.

Pat O’Malley

Most of the comments that we said about consumers don’t really hold in the enterprise it’s been fairly, I’ll call it seasonal off the levels that we’re at right now, but seasonally up to just slightly, and that goes for the mission critical and business critical products that we’re talking about so.

Keith Bachman - The Bank of Montreal

And I would assume given your share and what not that prices have been fairly stable in the enterprise?

Pat O’Malley

Yes, I think there’s been some aggressiveness there as well. A big picture I think Seagate has a really strong broad portfolio and our OEM customers understand that so, we can manage it.

Operator

And the next question comes from the line of Sherri Scribner with Deutsche Bank. Please proceed.

Sherri Scribner - Deutsche Bank

Hi, thank you. I wanted to ask a couple of clarifications and then a question. Did you guys provide EPS guidance? I’m not sure if I missed it.

Pat O’Malley

No, we gave enough of the assumptions I think you can come up with a good range Sherri.

Sherri Scribner - Deutsche Bank

And then on the growth margin, I just want to clarify; you said you’d be at the low end of your 22% to 26% range?

Pat O’Malley

That’s how we are planning our business for this quarter to be conservative. We certainly as Steve said, we hopefully we had a conservative forecast based on everything that we see, but we just want to manage a business on that level of optics right now given the level of uncertainty that as Steve called cross currents that we are getting.

Sherri Scribner - Deutsche Bank

Okay, I mean I think it’s definitely prudent to be conservative right now, but I guess if I think about the gross margins when you go from the June to the September quarter, we’ve never seen a 500 basis points decline in gross margin. Typically the margins are up, pricing was a bit worse, there’s a lot of movement in pricing in June, so I’m trying to get a better understanding of why that might be down so much.

Pat O’Malley

Generally, the pricing in the September quarter over the last couple of years has been fairly benign, and I would say that given the June dynamics, we are certainly the channel where we’d be somewhat insulated because we have over 70% of business OEM, that sort of crossed the whole portfolio, so I would say that September is not, I would not call it a traditional pricing quarter for a September quarter.

Steve Luczo

I would say that a typical September quarter, not to overly beat a dead horse, but a typical September quarter doesn’t have as many of the cross currents that we are currently facing right now. I mean we’ve definitely transitioned I think from an environment that three to five months ago most CEOs of technology companies were planning for the upside and reacting to the downside and I would say that most of them are probably shifted more to a plan for the downside and be able to react to the upside.

Seagate certainly has the operational flexibility to address that TAM that is at the high end of the range or frankly even higher than the high end of our range pretty quickly, and if that’s how it turns out, great. On the other hand, there was certainly enough going on in the June quarter and pricing that occurred at OEMs and in the channel that make us believe that, that’s a more prudent way to address the quarter from an investor perspective is to say that we are going to be at the low end of the range, and if things turn out better than that, then that’s great.

Sherri Scribner - Deutsche Bank

Then in terms of the CapEx, you mentioned in the supplemental information that there is some stuff that was deferred, you will pay the cash in the September quarter I wanted to get a sense of how much cash will there be that you are spending on CapEx in the September quarter? So, roughly how much will CapEx be in September and then also because of the lower demand environment we saw in June, did you adjust your CapEx plans down for the calendar year?

Pat O’Malley

One, on the latter we have continually adjusted our CapEx, what we see, what production line, so, Bob would comment but we, currently we have a fairly dynamic capital planning process, even with long lead times we try to manage at. We have a cash based receipt method. So, I’d say what rolls over, we might have some that we buy, and September rolls over and we will manage the CapEx about 6% to 8% of our revenue. We think that’s a long-term model to stay in technology production at a healthy level to support the business.

So, as opposed to the number, we will just manage it within that range.

Steve Luczo

Yes, but to answer your question our capital budgets have come down significantly, whether or not they are significantly relative to the models the street has, I don’t know, because ours are obviously very dynamic and again when we were entering the quarter, there was a possibility as you may remember that we actually felt we would be at or above a 165 million units for the June quarter and then accelerating through back half of the year that was driving an expectation of a lot of capital. I think the dynamics have changed and up to the point now where we have definitely addressed our capital and reduced our budget significantly.

Operator

Next question comes from the line of Aaron Rakers with Stifel Nicolaus.

Aaron Rakers - Stifel Nicolaus

Obviously I think everybody as you know touched on the pricing dynamics and on the context of gross margin but what I would like to understand is the second point on their gross margin impact going into the quarter and obviously it sounds like more fixed cost coverage from a production standpoint eclipsing what was slower production in June. So can you help us bridge the gap between let’s say 27.4% down to let’s call it 23%, how much of that is associated with that fixed cost coverage dynamic?

Pat O’Malley

Roughly 50-50 with the pricing mix and the fixed cost dynamic would be other 50-50. As Steve said is, if we have upside we certainly have to go manage that but given that we see a long-term growth in the industry. We could certainly shed fixed cost but that wouldn’t be the wise thing to do in the short term. So, we will manage the business conservatively until we see line of sight where maybe upsides or if there are, we will manage that through the quarter and try keep inventory tight which will drive to a higher production cost through the beginning part of the quarter. That’s our assumption in the model.

Aaron Rakers - Stifel Nicolaus

Okay. And additionally, I thought one comment that you had made was that, one competitor and I think we all know who that might be, continues to add production capacity, you actually said through the quarter. Are you guys saying that hasn’t necessarily changed despite the challenges that the industry had seen or did that start to show some improvement, let’s say late May into June? And then I have one final question.

Dave Mosley

I think we talked about adding and continue to build not adding capacity.

Steve Luczo

Yes, whether or not they added capacity or not, I don’t know. But I mean, from our perspective in the down term of 8%, it doesn’t really make sense to be up and build by 10% plus depending on how you account for the last 500 million drives that got shift. And I think that that behavior, it seemed like it took a long time for that competitor to adjust to production and whether or not that was a control issue or a goal to take market share for revenue growth or some other dynamic, we don’t understand. And how they are going adjust next quarter, obviously we don’t know, that’s why we are competitors. But, its just hard to say right now, Dave I mean…

Dave Mosley

Its all right, I think you said it.

Aaron Rakers - Stifel Nicolaus

Okay, fair enough. Final question for me is more of a longer term side. Aerial density and I think you guys talk about lack of kind of meaningful platform transitions through the next couple of quarters. Can you remind us Seagate’s thoughts as it pertains to aerial density growth slowing and how that relates to underlying fundamental dynamics in the hard drive industry?

Steve Luczo

I’ll let Bob handle that.

Bob Whitmore

Aaron, I don’t know if you remember a couple of quarters ago I gave an update of where we thought we were aerial density-wise and at that time I said that we continue to invest to stay on what I’ll call industry trajectories of aerial density, what we expect the compounded annual growth rate to be. And I said that we are happy with the way things were going that the results were in line with those trajectories and I’d say six months later we feel the same way. We continue to see our internal components demonstrated at a rate that will keep us on track with what I’ll call again traditional trajectory, so we don’t see that obvious fundamental shift in the way we have to do business as it relates to aerial density.

Operator

Your next question comes from the line of Jayson Noland with Robert Baird. Please proceed.

Jayson Noland - Robert W. Baird & Co., Inc.

Yes, thank you. There has been some talk in the distributor channel of HDD prices coming up in the September quarter and that’s obviously not in your guidance, is it even possible that we would see more price stability in September? I guess it’s somewhat surprising that 5 million drives would cause that sort of a decline in June.

Dave Mosley

I know what I think you are referring to about channel pricing behaviors that are stabilizing. What I’d say at this point right now is just stability, which is good. The clients were so dramatic at the start of last quarter that I think the exit points that we have being stabilized and in some cases raised like you are seeing, is evident for the fact that our model is probably stable from here. That’s exactly what the biggest driver last quarter, and I think some to watch this quarter if you can.

Pat O’Malley

And Jason, we are not saying that 5 million caused this impact. As Dave said, it started early in the quarter and continued through. So the pricing environment just didn’t end on those 5 million drives.

Dave Mosley

I think Jason you have to look at it from a little bit different perspective. Early when in the quarter, April, May timeframe, when consumer is so soft and people are just trying to get the early part of the quarter moving. They know that June is going to be big too so its really hard to see what the ending trajectory is, right. That’s setting those knobs properly as I think some of the, and versus the inventory that people had in the chains, that’s the thing we are questioning right. Now we ended as an industry with okay inventory levels but obviously the price is set where it is. Now as we see, as we enter the next quarter, seeing people stabilizing those pricing and in some cases saying, this isn’t good economics for me, I am going to raise the prices, I mean that makes sense to me. But I don’t see that trend going on a lot. I guess that’s it.

Pat O’Malley

Yes, but I’d also caution you not to just count the impact of 5 million units too much. I mean when the industry was 5 million units short consecutive for three or four quarters you saw price stability that we haven’t seen in a decade. So, 5 million units of over production especially since most of its going into very limited customer base, it’s a lot of units to be all of a sudden trying to move and you have to remember that those prices are very transparent not withstanding, this is just a special deal for you, and it impacts pricing across the board very quickly.

Jayson Noland - Robert W. Baird & Co., Inc.

Okay, I appreciate the color there and last question from me is Dave you mentioned new products and we heard Momentus XT was on allocation. It sounds like an interesting product. I assume a nice margin profile. What’s demand like and are you seeing OEM qualifications?

Dave Mosley

Yes, I mean we are really excited about the product. We have indicated I think for about the last year that we believe that the hybrid drives whether or not, ultimately that’s what we should be calling them, but drive where you basically utilize silicon technology in combination with HDD as probably by far in a way a better solution for the vast majority of client computing. I think in enterprise clearly there is a play for SSDs which Seagate feels very good about its roadmap right now. But in the mid-range of enterprise and clearly in the client, the hybrid drive has basically all the benefits of an SSD. In fact you might argue some that you can’t do with an SSD because you can actually cash between the rotating media and the silicon, then of course with the costing capacity advantages of HDD. So, we do feel good about it.

It’s a very interesting question about OEM’s, there are classes of OEM customers who basically you can’t even finish the presentation and they understand it, and they run hard. There are others who I think are stuck more on some of the cost benefits if you will. But we feel really good about the product and I think as I have said on occasion looking out five years I wouldn’t be shocked if 80% of our portfolio is hybrid.

Operator

And the final question comes from the line of Kathy Huberty with Morgan Stanley.

Kathy Huberty - Morgan Stanley

What does linearity looks like in Europe? Did you actually see some stabilization in June and early July or is it still continuing to decelerate?

Dave Mosley

It stabilized to the lower numbers what we kind of amended through the quarter Kathy and I would remind not holding the fence its still not great going into the following quarter now. We know a lot about vacations and consumers and affecting consumer behaviors in Europe through the month of July but I am still very, very cautious on what the true demand is.

You know there is indications and we are watching, Steve made comments about this in his script there that calendar Q4 may actually tick up in Europe but I think we’re going to have to get solidly into August probably before we know what the consumer spending patterns are in Europe and whether they have started to recover.

Kathy Huberty - Morgan Stanley

And to that point, we’re coming off low base just given consumer weakness in calendar 2Q and 3Q and then for drives in particular as it relates to the inventory adjustments and as we look into the calendar fourth quarter you have Europe coming back seasonally.

We talked about commercial enterprise being a recurring theme of strength. Is there a potential set-up where fourth quarter unit seasonality could be even better than we have seen in past years? I know there is a lot about stuff going on and you don’t want to make a heroic call but is there a potential set-up for calendar fourth quarter strength here?

Steve Luczo

I think maybe Kathy and I think that the only one piece of (inaudible) control out there and so is supposed to wishful thinking is the strength of Intel numbers. And obviously Intel has a 13 week lead cycle or more and they’re certainly seeing a different scenario than we feel because we’re at the closer end of the integration chain and they just do that, that’s indicative of a possibility of strong demand and people obviously aren’t going to walk away from Intel because if they close down a fab, that’s something that shuts off supply for six months like what happened a year ago. And so, yes there’s a possibility of that and again, its just back to how did the industry manage itself in terms of inventory in the channel and supply and demand and overall production capability.

But we certainly wish that we could get better visibility earlier in the September quarter but the nature of the September quarter is you don’t get great visibility probably till mid to late August but I think that at least there is a shot of that for sure.

Kathy Huberty - Morgan Stanley

And then, as it relates, just last question on gross margin, same sort of play on the fourth quarter, the industry is going to hopefully take care of the extra five million units. If you end up seeing a mix shift back to enterprise and prices stabilize at these new lower levels, could we actually see gross margins kick up nicely sequentially in December?

Steve Luczo

Yes, I think so.

Kathy Huberty - Morgan Stanley

Okay thank you.

Steve Luczo

Right, I’d like to thank to everyone for joining us on the call today. Please give us your feedback on the format. I’d also like to thank our customers, our suppliers and our employees for their continued effort over the year and during the quarter and a great year to all the Seagate employees and again, thanks to our customers and suppliers. We look forward speaking with you next quarter. Thank you.

Operator

Thanks for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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Source: Seagate Technology F4Q10 (Qtr End 07/02/10) Earnings Call Transcript
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