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More SEG recap: (for personal use only)
$0.14A vs. $0.08E - Maintaining Outperform
SEAGATE'S CQ4 EPS CAME IN AT $0.14A VS. OUR $0.08E.
The primary driver of the upside was gross margin. Revenue was lower than
expected at $1.64B vs. our $1.74BE.
-DYNAMICS SEEMED BETTER ON THE DESKTOP THAN IN ENTERPRISE
SEG lost share at the high end due to not having a new low end of the high end offering. Still estimates are rising due to margins.
-SEAGATE INDICATED IT PLANS TO MANAGE TO THE BOTTOM LINE
Seagate is hunkering down to withstand a tough HDD environment. Cost cutting and new products are moving ahead.
-MAINTAINING OUTPERFORM AND $57 TARGET.
We are conservative in our valution of the HDD business and still see the Investment summary and conclusion:
We continue to rate Seagate shares Outperform with a $57 price target. Financially, CQ4 was good not great on the top line ($1.6BA vs. $1.7BE) but demonstrated solid improvements in profitability. The disk drive market (particularly at the high end) is challenging, but we continue to believe Seagate presents a very compelling investment opportunity. Operating EPS of came in at $0.14, above our estimate of $0.08 on better than expected margins.
We continue to like Seagate because we believe that management has a realistic view of the market, will manage earnings to the bottom line estimates on the street, is investing aggressively in the future to set itself ahead as a long-term market leader, and is very focused on helping shareholders? benefit in as tax-efficient a manner as possible from the company?s large investment portfolio.
Our price target is still based on conservative assumptions on the disk drive business and a tax-effected view of Seagate?s equity investments including 85MM shares of Veritas (worth $11B pre-tax post yesterday?s close), 5MM shares of SanDisk ($420MM pre-tax), and 5MM shares of Gadzoox ($210MM pre-tax).
Revenue Down 9% Y/Y and 2% Q/Q
Overall, Seagate?s revenue of $1.6B was slightly lower than our estimate of $1.7B, and was down 9% Y/Y and down 2% Q/Q. This was a little disappointing. Despite this shortfall in revenue, Seagate reported higher than expected EPS of $0.14 (versus our estimate of $0.08) owing to solid gross margins of 18.9% (versus our estimate of 16.5%).
Disk drive sales were $1.5B or 93% of sales and were down 5% Y/Y and 2% Q/Q. Record total unit sales of 10MM, up 24% Y/Y and 6% Q/Q, were slightly lower than our 10.7MM estimate but showed a solid Y/Y share gain.
Desktop demand trends were positive in the quarter and we think that Seagate held its share well. Pricing in this segment was less aggressive which was a positive driver. We continue to suspect there is room for upside for other desktop disk drive companies in CQ4 as a result.
The major revenue issue for Seagate appeared to be at the high end. Here, revenue was a tad short of our expectations owing to a mix shift towards the low end of the high end disk drives in the enterprise business. Seagate didn?t have a product in this fast growth segment and lost some share even though demand trends were healthy overall. We also think that enterprise revenue was impacted by some aggressive pricing as new entrants drive for share gains at the enterprise (Fujitsu and Quantum).
In order to address its product line at the low-end of the high end, Seagate plans to announce three products that will directly target the low-end server market, including the Baracuda 18XL and the Cheetah 18XL which are currently in qualifications at major OEMs. These products will begin to ship in CQ1 and CQ2 will be the first full quarter ramp of these products. In addition, Seagate plans to release the Cheetah 36LP which will target more on the higher end.
In order to address pricing, Seagate continues to drive cost savings aggressively in order to keep its products at leading market positions.
The other category represented 7% of revenue (including software, tape, components and other). Software revenue of $29MM, or 1% of sales, was flat Q/Q. Seagate is focused on execution in this business and is targeting double-digit sequential revenue growth after CQ1 (March). Tape sales of $71MM, or 4% of sales, was down 5% Y/Y and down 4% Q/Q. Components revenue of $11MM, or 1% of sales, was down 8% Y/Y and down 15% Q/Q.
The OEM/Channel split of revenue was 65/35. The OEM percentage was flat. OEM sales were down 7% Y/Y and 7% Q/Q and distribution revenue was down 11% Y/Y and up 7% Q/Q. The mix shift toward desktops and low end servers, which are somewhat more channel oriented, made the OEM percentage number look larger. The company indicated that its new channel program in the U.S. is proceeding along its plan and that it is comfortable with channel inventory levels.
Gross Margin Was Primary Upside Driver and Rose 240 Basis Points Q/Q
Gross margin increased 240 basis points Q/Q To 18.9% owing to a better mix of products from the previous quarter, more tame pricing trends in the desktop market, and improvements in operational efficiencies. A return to gross margins level from a year ago of 23.8% is not likely to happen any time soon, given the steady erosion in average unit prices at the high end but current levels should be somewhat attainable.
Average unit prices for disk drives declined 24% Y/Y and 7% Q/Q to $149 owing to mix and some pricing pressure at the high end (prices were down 6% in CQ1, 14% in CQ2 and 18% in CQ3).
At the same time, Seagate is working very hard to drive costs down. The company indicated that it believes the disk drive industry will stay competitive and volatile. This is keeping the company cautious on this front.
One thing the company is very focused on is driving efficiency. Seagate has greatly improved its output per employee on both its desktop and enterprise disk drive lines. In fact, output per employee improved more than 40% compared to a little more than a year ago.
Opex Decreased Y/Y
CQ4 opex was $275MM (down 9% Y/Y and up 4% Q/Q) or 16.7% of revenue. R&D of $146MM was down 6% Y/Y and up 4% Q/Q. SG&A of $125MM fell $10MM Y/Y and increased $7MM Q/Q. In addition, Seagate posted a one-time restructuring charge of $23MM.
Headcount continued to decline in the quarter ending at 71,510 (down 15% Y/Y and 8% Q/Q).
$32MM in Operating Net Income
Excluding a restructuring charge of $23MM, charges related to Seagate?s investment in Veritas of $374MM, gains on sales of its investment in Veritas and SanDisk of $344MM and $62MM, respectively, net income was $32MM or $0.14 per share.
The Balance Sheet Continued To Be Strong
The balance sheet was solid with $1.5B in cash and well controlled inventory and receivables. This is a highlight of the Seagate story.
Cash rose $128MM Q/Q and Seagate ended CQ4 with healthy cash and short-term investments of $1.5B or $6.92 per share. The company repurchased 4MM shares for $137MM during the quarter. We think that Seagate may have been unable to repurchase shares as aggressively as it would like due to the recapitalization of its software business and its acquisition of XIOtech which may have thrown the company into a blackout period for buybacks.
AR DSO were flattish Q/Q at 42 (based on our L6M calculation) on a $31MM Q/Q decrease in accounts receivable to $779MM.
Total inventory of $369MM fell $35MM Q/Q and included $96MM in purchased materials (down $18MM Q/Q), $68MM in work-in-progress (up $9MM Q/Q), and finished goods of $206MM (down $25MM Q/Q). Inventory turns increased from CQ3 levels at 13.4 times, based on annualized L6M inventory.
Channel inventory looks tame.
Capital additions totaled $162MM for the quarter, up $45MM Q/Q, and depreciation & amortization totaled $178MM vs. $173MM in the prior quarter.
Raising Estimates on Strong Gross Margin
We are raising our CQ1:00 estimate to $0.14 (from $0.10) and we are slightly raising our CQ2:00 estimate to $0.15 (from $0.14). For the fiscal years, we are raising our F2000 (June) estimate to $0.50 (from $0.45) and we are maintaining our F2001 (June) estimate at $1.00.
We think that the state of affairs at Seagate is positive. While market dynamics continue to be tough, the company is moving itself smartly into a very cost competitive position. Moreover, the company is actively protecting its strong balance sheet position as this is a critical advantage during tough times.
Investments are Compelling
With 85MM shares of Veritas with a paper value of roughly $13B before tax, Seagate said it plans to continue to monetize the shares as tax-effectively as
possible. Seagate also has 5MM shares of SanDisk, 5MM shares of Gadzoox and 2MM shares of CVC. Seagate also said the company continues to explore different actions it may take that will be the least taxing. |
