Seagate Earnings Preview: Favorable Product Mix, Job Cuts To Help Drive Profits

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Seagate Technology

Seagate Technology (NASDAQ:STX) is scheduled to announce it Q2 FY 2017 results on Tuesday, January 24. [1] The storage hardware manufacturer has witnessed a slowdown over the last few years due to falling prices and particularly low demand in the consumer market for laptops and desktop computers. As a result, Seagate’s revenues have fallen on a year-over-year basis in each of the last eight quarters. Falling hard drive prices have led to revenue declines as well as low profit margins over the last two years for Seagate. This trend is likely to be highlighted in the December quarter earnings as well.

We have a $33 price estimate for Seagate Technology, which is around 10% lower than the current market price.

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Outlook For Q2 FY’17

Seagate has given an overall positive outlook for the December quarter, despite the fact that revenues are expected to be down 3% year over year to $2.9 billion. A favorable mix of high-margin enterprise hard drives and other high-end products could help post high margins. Seagate expects its non-GAAP gross margin to stay at around 29% in the December quarter — almost 4 percentage points higher than second fiscal quarter last year.

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Shipment Trends Through 2016

Seagate’s net revenues through the first three quarters of 2016 have fallen by 12% year-over-year to around $8 billion. Much of the decline was attributable to low unit shipments this year across product lines. Combined hard drive units shipped for the Compute segment (which includes hard drives for laptops and desktop computers) was down by 20% y-o-y to 48.7 million units, as shown in the table below. [2] The sales in the compute segment have largely mirrored trends in the global laptop and desktop computer sales over the years given that Seagate and Western Digital (NASDAQ:WDC) enjoy a near duopoly in the hard drive market. According to an estimate by IDC, the decline in PC sales could halt by 2018 and stabilize in subsequent years. [3]

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In terms of hard drives for consumer electronics and branded external storage drives, Seagate reported a 12% annual decline in unit shipments through the first three quarters of the year to 37.7 million units. Despite a fall in shipments, the company has sustained average selling prices in this segment through a tough period. Revenues generated from consumer electronics and branded products as a percentage of net revenues increased by 6 percentage points in the first half of the year. [4]

Seagate’s enterprise storage shipments through the three quarters of 2016 were roughly flat over the comparable prior year period at just under 25 million units. Within enterprise storage, nearline storage products have demonstrated strong growth this year, with unit shipments increasing by 20% to 15.5 million units. Comparatively, mission critical hard drive unit shipments fell by 21% to 9.4 million units.

Profitability Remains Low In 2016

Seagate’s gross margin (Non-GAAP) through the first three quarters of the year has been around 30 basis points lower on a year-over-year basis to 26.1%. Seagate’s long-term targeted gross margin range lies from 27-32%. To compensate for low revenues and lower gross margins, Seagate announced its intention to reduce the global workforce by 6,500 employees by the end of fiscal 2017, which would reduce its global workforce by 14%. [5] Through the year, Seagate managed to reduce its non-GAAP operating expenses by 14% to $1.4 billion. More recently, Seagate announced that it has shut its factory in Suzhou, China in order to cut down over 2,000 jobs. [6] This should help the company reduce its SG&A expenses in future quarters. Despite lower operating expenses, Seagate’s non-GAAP EPS fell by over 20% y-o-y to $1.90 for the three quarters of 2016 combined.

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Notes:
  1. Seagate Technology To Report Fiscal Second Quarter 2017 Financial Results On January 24, 2017, Seagate Press Release, January 2017 []
  2. Seagate Q1’17 Supplemental Info, Seagate Press Release, October 2016 []
  3. PC sales outlook improves: Now terrifying instead of catastrophic, The Register, December 2016 []
  4. Seagate Q3 FY 2016 Earnings Call Transcript, Seeking Alpha, April 2016 []
  5. Seagate to cut 6,500 jobs worldwide as PC market continues to slide, Silicon Republic, July 2016 []
  6. Seagate closes Chinese factory, cuts 2,000 jobs, ZD Net, January 2017 []