01—Abstract
Summary
Summary of the 10-K filed August 27, 2007. Cited figures are marked; the original filing is the authoritative source.
Seagate Technology's fiscal 2007 10-K (fiscal year ended June 29, 2007) shows a company that grew revenue sharply but saw profitability compress, largely because of the Maxtor acquisition.
Revenue rose 23% to $11.36 billiona from $9.21 billion, driven by a 34% increase in disc drive unit shipments to 159.2 million, partly offset by a 9% decline in average selling price to $71 per unit. Gross margin fell to 19% from 23%, reflecting lower-margin legacy Maxtor products, acquisition-related charges, and an aggressive pricing environment. Operating income dropped to $614 million from $874 million, and interest expense rose sharply to $141 million after the $1.5 billion debt issuance in September 2006.
Net income of $913 millionb (diluted EPS $1.56) was flattered by a $359 million tax benefit from a release of deferred tax asset valuation allowances, so underlying operating profitability was weaker than the headline figure suggests. Operating cash flow fell to $943 million from $1.46 billion, and capital expenditures were $906 million. Management guides to roughly $900 million in fiscal 2008 capital spending and expects continued amortization of acquired intangibles and quarterly interest expense above $30 million.
Capital returns were significant: the company repurchased about 62 million shares for roughly $1.5 billionc under a $2.5 billion program, leaving about $974 million authorized, and paid $0.38 per share in dividends (the quarterly rate was raised to $0.10). Key risks for investors include ongoing price erosion, customer concentration (HP at 16% and Dell at 9% of revenue), supply dependence on Komag (being acquired by Western Digital), ruthenium cost and availability for perpendicular recording, and leverage that totals about $2.06 billion in debt.
02—Key points
Key Highlights
- Revenue grew 23% to $11.36 billion, with disc drive units up 34% to 159.2 million following the Maxtor integration
- Gross margin contracted to 19% from 23%, driven by lower-margin Maxtor-designed products, acquisition charges, and pricing pressure
- Operating income fell 30% to $614 million, while net income of $913 million was boosted by a $359 million tax benefit from a valuation allowance release
- Interest expense more than tripled to $141 million after issuing $1.5 billion of senior notes in September 2006
- Operating cash flow declined to $943 million from $1.46 billion, with $906 million of capex and $178 million for the EVault acquisition
- Returned capital through about $1.5 billion in share repurchases (62 million shares at an average $24.62) and $212 million in dividends, with $974 million remaining on the buyback authorization
- Concentrated customer base and supplier dependence remain key risks: HP (16%) and Dell (9%) of revenue, and substantially all recording media purchases had come from Komag, which is being acquired by Western Digital
03—Questions
Frequently Asked Questions
Why did net income rise while operating income fell?
Net income of $913 million included a $359 million income tax benefit, mainly from releasing part of the valuation allowance on U.S. deferred tax assets after restructuring intercompany arrangements. Operating income fell to $614 million from $874 million due to Maxtor-related amortization, lower gross margins, and higher marketing and administrative costs. Investors should view the tax benefit as non-recurring when judging core earnings power.
How did the Maxtor acquisition affect Seagate's fiscal 2007 results?
Maxtor was consolidated for the full fiscal 2007 year, versus about six weeks in fiscal 2006. It boosted unit volume and revenue, but Maxtor-designed products carried lower margins during the transition, and the company recorded integration costs, $150 million in amortization of existing technology, and a $40 million bad debt charge tied to distributor eSys. Management expects acquired-intangible amortization to continue to weigh on fiscal 2008 results.
What is the company's debt and liquidity position?
Total debt was $2.06 billion at June 29, 2007, up from $970 million a year earlier, after the $1.5 billion senior notes issuance used to redeem the 8% notes and repurchase shares. Cash, cash equivalents, and short-term investments totaled about $1.1 billion, and the company had a $500 million revolving facility with $453 million available. Management says cash sources are sufficient for at least the next 12 months, and interest expense will exceed $30 million per quarter in fiscal 2008.
What are the main risks to future profitability?
Key risks include persistent price erosion across desktop, mobile, and high-capacity 3.5-inch products; competition from captive manufacturers and flash-based SSDs; reliance on a few OEM customers, notably HP and Dell; supply constraints for recording media after Komag's pending acquisition by Western Digital; and rising costs for ruthenium and other precious metals used in perpendicular recording. Leverage also limits financial flexibility, and the company faces ongoing intellectual property litigation, including Convolve/MIT, Siemens, and StorMedia.
How is Seagate returning capital to shareholders?
The board authorized up to $2.5 billion in share repurchases over two years in August 2006. Through June 29, 2007, about 62.0 million shares were repurchased at an average price of $24.62, leaving roughly $974 million available. Quarterly dividends totaled $0.38 per share in fiscal 2007, and the quarterly rate was increased to $0.10 per share, though dividend payments are subject to covenants in the revolving credit facility and board discretion.
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