01—Abstract
Summary
Summary of the 10-K filed August 5, 2016. Cited figures are marked; the original filing is the authoritative source.
Seagate's fiscal 2016 (ended July 1, 2016) was a difficult year.
Revenue fell 19% to $11.16 billiona from $13.74 billion, driven by 43 million fewer unit shipments (169 million versus 212 million), with the decline concentrated in client compute and mission-critical enterprise HDDs, plus ongoing price erosion. Gross margin compressed roughly 500 basis points to 23%, reflecting price erosion and factory underutilization. Operating income fell 78% to $445 million, and net income dropped to $248 million, or $0.82 per diluted share, from $1.74 billion a year earlier.
Fiscal 2015 had been inflated by a $620 millionb arbitration gain and a $773 million partial payment from Western Digital, so the year-over-year comparison flatters nothing and the underlying deterioration is clear. Cash generation and shareholder returns remained substantial despite the earnings decline. Operating cash flow was $1.68 billion, capital expenditures were $587 million, and free cash flow was roughly $1.1 billion.
The company returned about $1.8 billionc to shareholders through $1.09 billion in buybacks and $727 million in dividends, and it spent $674 million acquiring Dot Hill Systems. Cash and short-term investments fell to $1.13 billion from $2.49 billion, and total debt was $4.13 billion. The $0.63 quarterly dividend was maintained and, notably, the company declared a $2.43 per-share annual dividend, which exceeded the $0.83 basic EPS.
Investors should note that dividend coverage on earnings was thin, although it was supported by cash flow. Management responded with multiple restructuring plans. The company cut roughly 4,600 employees during fiscal 2016 and announced a July 2016 plan to eliminate about 6,500 more roles, with total pretax charges of about $164 milliond expected in fiscal 2017.
Management also guided to capital expenditures below its 6% to 8% of revenue target. The share price fell sharply, from a high of $69.40 in the January 2015 quarter to a low of $18.42 in the June 2016 quarter, and the total shareholder return graph reflects that decline. The central investor question is whether the demand shift toward NAND flash and the cyclical weakness in client compute can be offset by cost reductions and enterprise and cloud growth.
02—Key points
Key Highlights
- Revenue fell 19% year over year to $11.16 billion, driven by 43 million fewer units shipped (169 million, down from 212 million) and continued price erosion, primarily in client compute and mission-critical enterprise HDDs.
- Gross margin dropped to 23% from 28% (about 500 basis points) due to price erosion and underutilization of legacy hard drive factories, partly offset by improved product mix in the second half.
- Net income fell to $248 million ($0.82 diluted EPS) from $1.74 billion ($5.26 diluted EPS), and operating income declined to $445 million from $2.06 billion. Fiscal 2015 included a $620 million arbitration gain, so the underlying decline was steeper than the headline figures suggest.
- Operating cash flow of $1.68 billion and capital expenditures of $587 million produced roughly $1.1 billion of free cash flow, which funded $1.09 billion of share repurchases and $727 million of dividends.
- Cash and short-term investments fell to $1.13 billion from $2.49 billion, while total debt remained about $4.13 billion, with the company citing compliance with its revolver covenants after an April 2016 amendment loosened the net leverage ratio.
- Restructuring charges rose to $175 million, with about 4,600 employees cut in fiscal 2016, and a further July 2016 plan targets roughly 6,500 additional headcount reductions and about $164 million of pretax charges in fiscal 2017.
- The company acquired Dot Hill Systems for $674 million to expand its OEM-focused cloud storage systems business, while enterprise SSD and flash competition continued to pressure HDD demand in notebook and mission-critical segments.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2016, Seagate Technology Holdings plc kept $0.02.
- Revenue$11.16B100.0%
- Cost of revenue−$8.54B76.6%
- Gross profit$2.62B23.4%
- Operating costs−$2.17B19.4%
- Operating income$445.0M4.0%
- Interest, other & tax−$197.0M1.8%
- Net income$248.0M2.2%
Where FY2016 revenue went
$11.16B- Cost of revenue: $8.54B, 77% of revenue
- Net income: $248.0M, 2.2% of revenue
- R&D: $1.24B, 11% of revenue
- SG&A: $635.0M, 5.7% of revenue
- Other operating costs: $298.0M, 2.7% of revenue
- Interest, other & tax: $197.0M, 1.8% of revenue
Kept 2.2% as net incomeNet income $248.0M · 2.2%Other operating costs $298.0M · 2.7%Interest, other & tax $197.0M · 1.8%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2016filed August 5, 2016Financial Statements
FY2016 against FY2015
| Line item | FY2016FY2015 | Change |
|---|---|---|
| Revenue | $11.16B$13.74B | −18.8% |
| Cost of Revenue | $8.54B$9.93B | −13.9% |
| Gross Profit | $2.62B$3.81B | −31.3% |
| R&D Expenses | $1.24B$1.35B | −8.6% |
| SG&A Expenses | $635.00M$857.00M | −25.9% |
| Operating Expenses | $10.71B$11.68B | −8.3% |
| Operating Income | $445.00M$2.06B | −78.4% |
| Interest Expense | $193.00M$207.00M | −6.8% |
| Net Income | $248.00M$1.74B | −85.8% |
| EPS (Basic) | $0.83$5.38 | −84.6% |
| EPS (Diluted) | $0.82$5.26 | −84.4% |
| Shares Outstanding (Basic) | 299.00M324.00M | −7.7% |
| Shares Outstanding (Diluted) | 302.00M331.00M | −8.8% |
05—Questions
Frequently Asked Questions
Why did Seagate's revenue and margins decline so sharply in fiscal 2016?
Shipments fell 20% to 169 million units, with the steepest drop in client compute (93 million units versus 132 million), as tablets, smartphones and SSDs displaced PCs and notebooks. Enterprise mission-critical HDD demand also weakened as flash replaced disk in some applications. Average selling prices were flat at $61 per unit, but price erosion and reduced factory utilization pushed gross margin down to 23% from 28%.
Is the $2.43 dividend per share sustainable given the drop in earnings?
Not on an earnings basis: the $2.43 declared dividend was well above basic EPS of $0.83. It was supported by cash flow, with $1.68 billion of operating cash flow covering $727 million of dividends, and by the company's cash balance. However, cash and short-term investments fell by more than half during the year, and management explicitly warns that dividends are at the discretion of the board and subject to financial position, covenants and market conditions. The current $0.63 quarterly rate is the figure investors should track.
What are the main risks to Seagate's outlook for fiscal 2017?
Key risks include continued price erosion if industry supply exceeds demand, further migration of notebook and enterprise workloads to SSDs, and the cyclical nature of cloud service provider purchases, which the company says create lumpy demand. Execution risk on the restructuring program and the ability to hit projected cost savings also matter. The company carries about $4.1 billion of debt, making cash flow sensitive to a revenue shortfall, and it faces tax audit exposure in China and other jurisdictions.
How much cash has Seagate returned to shareholders, and how much capacity remains for buybacks?
During fiscal 2016 Seagate repurchased about 24 million shares for roughly $1.1 billion and paid $727 million in dividends, for total shareholder returns of about $1.8 billion. As of July 1, 2016, $1.8 billion remained under existing repurchase authorizations, which have no expiration date. Buybacks were concentrated in the first three quarters, with minimal repurchases in the final quarter as the share price fell to historic lows, which suggests management was cautious about repurchasing at declining prices.
What is the company's exposure to large customers and to Dell and HP?
Revenue is concentrated among a few large OEMs. Dell accounted for about 12% of fiscal 2016 revenue, down from 14% the prior year, and HP's two successor companies each fell below the 10% disclosure threshold after the split. OEMs account for about 70% of revenue, distributors 16% and retail 14%. Because OEM orders can be deferred with limited notice, the loss of or reduced purchases from a key customer would have a material effect on results.
06—Continue