Seagate Technology Holdings - Earnings Call - Q1 2012

Transcript

Speaker 2

Good afternoon, ladies and gentlemen, and welcome to the Seagate Technology fiscal quarter 2012 financial results conference call. My name is Francine, and I'll be your coordinator for today. At this time, all participants are in listener-only mode. Following the prepared remarks, there will be a question and answer session. If you'd like to participate in this portion of the call, please press star followed by one at any time during the conference. If assistance is needed at any time during the call, please press star followed by zero, and a coordinator will be happy to assist you. 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 December 2011 quarter and thereafter, and includes statements regarding customer demand for data storage solutions and general market conditions. These forward-looking statements are based on information 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. Such risks, uncertainties, and other factors may be beyond the company's control. In particular, global economic conditions and significant disruption to the industry supply chain from the severe flooding throughout parts of Thailand may pose a risk to the company's operating and financial performance.

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 and Form 10-K/A as filed with the U.S. Securities and Exchange Commission on August 17, 2011, and August 24, 2011, respectively. 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. We'd now like to turn the conference over to your host, Mr. Steve Luczo, CEO. Please go ahead, sir.

Speaker 8

Thank you, Francine. Good afternoon, everyone, and thank you for joining us today. On the call with me from Seagate are Pat O'Malley, our Chief Financial Officer, Bob Whitmore, our Chief Technology Officer, Dave Mosley, Executive Vice President of Operations, and Rocky Pimentel, Chief Sales and Marketing Officer. I first want to convey my heartfelt condolences and the condolences of the entire Seagate family to those affected by the tragedy in Thailand. This disaster has taken hundreds of lives and displaced thousands. The human impact is profoundly troubling. Our first thoughts and actions were for the safety and security of our employees, their families, and all personally affected. I will provide further context on the situation in Thailand and its effects on Seagate at the end of my prepared remarks. We have posted detailed supplemental information about our fiscal first quarter on our investor relations site at seagate.com.

In today's call, I will review the results for the September quarter, share progress on the Samsung transaction, and provide our view of the fiscal second quarter, including an update of our Thailand operations. After that, we'll open up the call to Q&A. On our last earnings call in July, we cautioned that our outlook for the first quarter was influenced by the following: the significant uncertainty surrounding global macroeconomic conditions, increasing costs of many upstream materials, especially rare earth elements, and higher costs associated with newer, less mature products. We expected the industry TAM to be 165 to 170 million units, Seagate's revenue to be up sequentially to approximately $2.9 billion, and non-GAAP diluted earnings per share of $0.29 to $0.33 per share. For the September quarter, the industry TAM was approximately 177 million units, which was above our expected range.

Seagate reported revenue of $2.8 billion and non-GAAP diluted earnings per share of $0.34. We shipped 50.7 million units during the quarter, and our gross margin was 19.5%. We ended the quarter with $3 billion in cash. Revenue was slightly below our outlook for the September quarter, and we managed cost effectively while optimizing our product mix to slightly exceed our margin and non-GAAP earnings per share projection. We lost approximately three points of market share in the September quarter for three primary reasons. One, we elected to not participate in aggressive pricing in the mission-critical market, especially at a time when we were attempting to pass through costs associated with the rare earth increases. Two, in the notebook market, we raised prices based on anticipated demand. However, these price increases unexpectedly dampened demand for our notebook product.

Three, aggressive pricing in the Asia distribution channel caused us to lose some share, which was offset by gains in North America. Macroeconomic issues, particularly surrounding the eurozone debt crisis, continued to create a high degree of volatility for global demand and resulted in additional stress on consumer confidence and spending in general. Despite these issues, the HDD industry shipped a record 177 million units and continued its record 45% year-over-year petabyte growth, reflecting the sustained fundamental demand for hard drive storage. As expected, the cost of the components using rare earth metals are five to eight times higher than historical norms and impacted our gross margin by approximately 100 basis points as compared to the June quarter. Rare earth price increases impact mission-critical products more acutely due to the relatively larger amounts of rare earth elements used in those products.

Our effort to pass through temporary rare earth surcharges to our customer to offset these cost increases was largely unsuccessful due to aggressive pricing from a competitor in the mission-critical market. We expect an incremental impact to cost of goods in the December quarter as the cost increases are fully absorbed throughout the supply chain. Recently, prices for rare earth metals have abated about 20% from peak levels. Assuming no further increases from today's prices, we expect some relief in cost of goods for rare earth metals in the March quarter since these price changes tend to take over a quarter to work their way through the supply chain. Regarding our discussion last quarter on product transitions being slower than planned, recall we are transitioning eight products in fiscal 2012.

As indicated last quarter, two of the most substantial product transitions targeted for early in the fiscal year were pushed to the second half of fiscal year 2012. With respect to the two products, component and drive yields improved on the 300 gigabyte per platter two and a half inch mission-critical product line, and we will begin an aggressive ramp in the December quarter. The one terabyte per platter three and a half inch desktop drive also lagged behind our initial plans and is now beginning the volume transition. We expect to ship millions of units on this platform by the end of the quarter. Seven of the eight platforms are industry-leading products, and as such, we continue to expect significant margin accretion with these product transitions by the fiscal fourth quarter.

With respect to the Samsung transaction, we are pleased to report that the European Commission has approved our transaction, concluding that Seagate's proposed acquisition of Samsung's hard drive assets does not raise competitive concerns in the region. We are continuing to work with the regulatory agencies and other jurisdictions to reach the same conclusion. The European Commission's decision to end its investigation is a significant step in closing the proposed acquisition, which Seagate anticipates will occur before the end of the calendar year. The NAND supply agreement and cross-licensing agreements with Samsung have been executed. We expect to execute the HDD supply agreement with Samsung in the near future. Provided we receive all necessary regulatory approvals, we expect to begin the integration of Samsung's HDD business during the March 2002 quarter and to complete the operational integration by the end of the calendar year.

Importantly, upon completion of the acquisition, our product portfolio will include a market-leading notebook product from Samsung that delivers 500 gigabytes per platter in one and two disk configurations. We believe this is the industry's leading notebook platform, shipping approximately 4 million units in the September quarter. With respect to our December quarter outlook, the flood disaster in Thailand is having a widespread impact on individuals and businesses of all types, including the hard drive industry, disrupting transportation, logistics, power generation, and the availability of labor. Specific to the hard drive industry, this is a serious and highly volatile situation which has shut down component manufacturers as well as drive assembly operations in the flooded regions.

The severity of the impact on the component manufacturers and drive assembly operations ranges from inundated factories and submerged equipment at one extreme to the inability to get people into the workplace on the other. Seagate's component and drive assembly factories in Thailand are operational, accessible to all our employees, and are running at full production. As previously reported, this is not the case for some of our component suppliers. Our business priority is to work with our external component suppliers, supporting their efforts to rebuild the supply chain as quickly as possible. We expect to experience significant impacts to our production levels while our suppliers work to get their businesses up and running.

Given the severity of the situation and the extensive supply constraints caused by the disruption, including those described by our primary competitor, the effects on our industry are likely to be substantial and will extend over multiple quarters. As we strengthen our supply chain and optimize our output, we are engaged with customers to realign build schedules, product mix, and to reset delivery expectations. Prior to the flood, our TAM expectations for the December quarter were unconstrained demand for 180 million units, and Seagate expected to regain the market share it lost in the September quarter. Based on our current assessment of the external component supply chain, we expect to ship between 40 and 50 million units in the December quarter. Given the volatility in the supply chain, which will impact mix and volume, we cannot provide a meaningful revenue estimate at this time.

As noted already, our production is not constrained by either internal component supply or by our ability to assemble finished product. Rather, we are constrained by the availability of specific externally sourced components. If these component constraints are resolved by the end of the December quarter, we expect to exit the quarter with a production capacity of at least 60 million units for the March quarter, excluding any additional capacity from the Samsung acquisition. Assuming no component constraints, we would expect additional capacity of at least 10 million units associated with the Samsung acquisition. Finally, relative to our dividend policy, it remains unchanged from when we established our dividend in April. The board and the management team have confidence in the company's ability to generate free cash flow on a continued basis, and the quarterly dividend reflects the strength of our balance sheet.

Francine, we're now ready to open up the call for questions.

Speaker 2

Thank you, sir. As a reminder, if you'd like to ask a question, that's star one. Our first question comes from the line of Jason Nolan from Baird.

Speaker 1

Okay. Thank you. Our sympathies to your employee base in Thailand, Steve. Maybe if you could talk more about where you are with tier two and tier three suppliers in the supply chain and your handle on the situation right now.

Speaker 8

Yeah. Thanks very much. Obviously, in any of these answers we give, even though it's been stated in the safe harbor and other comments, you know we're trying to be as transparent as we can here and give the best information that we have right now. As you might imagine, it's been a daily event. The teams have been pretty much working 20 hours a day for the last 14 days. Bear with us. We're going to give you the best information we can right at this moment. I'm going to turn that question over to Dave Mosley since he's been the most deeply involved with what we're doing with our supply chain and our factories.

Speaker 4

Yeah. Jason, my response to the question would start with the impact at the start, which is, you know, over 10 days ago now, of some factories. We've been able to assess some of those factories to the sub-suppliers. The problem is that, as time has gone by, there's been more and more impacts to the supply chain, different parts. As you can well imagine, it's a fairly complex problem that just continues even until now. There continues to be disruption to people who are actually doing the assessment because the region's still quite disrupted. People's homes are affected. They can't get into certain regions. It's quite tentative at this point.

That's how we've come up with the expectations that we laid out before about the mix, given the impact that we have in this region for the factories that we have in that region for the factories that we have globally. We have second sources in some cases for some products. It's still a very highly volatile situation, as you can well imagine, not knowing exactly what we're going to get four or six weeks from now based on a lot of assumptions about how fast people can or can't come back from some of these challenges.

Speaker 1

Okay. Last question from me on the mission-critical side. Is there a chance that we've seen a reset on the profitability level of those drives given there's a new competitor out there?

Speaker 8

Who's the new competitor?

Speaker 1

We've got, what, Western Digital?

Speaker 8

I mean they're buying Hitachi. I guess I don't view that as a new competitor if that merger goes through. The mission-critical space has been competitive for a long time, and Seagate really tends to differentiate itself with the breadth of the portfolio. When we get long in a portfolio and we're transitioning new products like we are now is clearly where customers are maybe more willing to sell share, if you will. That's why it's so critical for us to continue with these transitions to the next generation. As we do, then we believe we can regain the market share to the level that we traditionally hold, which are 58 to 62%.

Speaker 1

Okay, thanks and good luck.

Speaker 8

Thank you.

Speaker 2

Our next question comes from the line of Aaron Rakers from Stifel Nicolaus.

Speaker 6

Thanks, guys, and our sympathies as well to your employees. I guess the first question is on, you know, just looking at the acquisition of the Samsung hard drive business. Obviously, the European Commission has approved that. Where do we stand with the FCC? As far as the European Commission is concerned, were there any remedies or remedial things that you guys had to do to basically get that deal done?

Speaker 8

I don't know what, Kenneth Massaroni answered the question.

Speaker 3

We're working cooperatively with the regulators at the FTC and other jurisdictions around the globe. We're comfortable that we're being responsive promptly to their requests for information, and that we're on track to close the transaction before the end of the calendar year.

Speaker 6

Okay. As it relates to your comments on the supply chain, are you telling us that it is your expectation at this point that the supply chain should be back to production levels by the end of December? I guess I just want to understand what the message here is. Do you fully anticipate everything to be back online, and therefore operating at a 60 million full-capacity run rate in March?

Speaker 8

First of all, there were no remedies on the European Commission.

Speaker 6

Okay, thank you.

Speaker 8

That's a question. No, I think what we're saying is, you know, the disruption in the supply chain is, you know, kind of multi-threaded in either, you know, certain component suppliers just can't get to their building, but we believe the factories are, you know, dry and ready to produce once people can get there. Others obviously have damaged the equipment. Some of those are longer lead time and shorter lead time, and some of those, their second sources are not. I think that at this point, it's unlikely to assume that everything would be back to normal by the end of December. Although, I don't think it's improbable that parts will be flowing, you know, in the month of December, you know, to a much greater degree than they will be when, you know, parts stop arriving at factory doors sometime in the next three weeks.

I think as that recovers, the point is, you know, Seagate doesn't have factories affected, and so we can start taking those points, those parts and start building drives as quickly as possible.

Speaker 6

Final question.

Speaker 8

We have that level of productive capability, which obviously could change as a function of mix, which is what we're working with our customers on. Is there ways that we can basically even increase that output by, you know, working with them on mix?

Speaker 6

What is the lingering overhang on the gross margin related to rare earth material costs going into this next quarter?

Speaker 3

The next quarter we've talked about is increasing another 100 basis points. We have about 200 basis points that we look at this quarter, and it should abate, pending where our assumptions where the prices are today, and they don't go back up. In March quarter, we should start getting relief from that, which would be better than what we thought in September quarter. That 200 basis points that we talked last quarter is fully going to be baked in.

Speaker 8

Just to give it this way, there's a one-quarter lag in what's happening in pricing in the rare earths and how it hits the drive industry. The rare earth prices were increasing all through the September quarter and didn't start abating until the December quarter. If you look back to the June quarter, they were not rising the entire time or certainly not at the rate that they were in the September quarter. The September quarter for us was a big hit. The December quarter will be a full impact, if you will. Starting in the March quarter is when we'll start seeing the relief that we're actually seeing in the spot market today. Does that make sense?

Speaker 3

Thank you.

Speaker 2

Our next question comes from the line of Rich Kugele from The Benchmark Company.

Speaker 7

Good afternoon. Good to see the progress on the yields. I just want to touch on two different areas. One, in terms of looking at margins in the first half of next year, I mean, you've got rare earths likely to come down because of the lag. You've got utilization clearly maximized, supplies diminished, at least according to Clark Checks, prices are going up. At least in terms of 2012, should we think about a different type of gross margin profile? You know, any comments you can make there?

Speaker 8

You know, Rich, I think right now, like we said, if we could, if we can make a revenue prediction, we could probably make a gross margin prediction, right? I think it's a pretty volatile situation right now, and really, all of the dynamics you just described are occurring. To kind of calculate what that means, I think is just something that's more appropriate to do in a few weeks when we have better visibility on what our output and our mix and our volume is going to be. I don't disagree with the general statements that you're making. Yes, we believe that they're multi-quarter and certainly extending into the first half of the year, and I believe likely through the calendar year.

Speaker 7

Okay. In terms of your footprint, we're getting asked all kinds of questions, as you would imagine, about how your footprint might differ in terms of component supply versus Western Digital and others. Is there anything you can just talk about how you've structured it, and how maybe even Samsung's footprint is different and why it has affected you less?

Speaker 8

Starting at the drive level, the company's drive factories, as you know, are in China and in Thailand. We'll go out in Thailand as well. We're moving on the flooding situation. Our wafer facilities are in Minnesota and Springtown. We have two wafer facilities. Our slider facilities are Penang and Korat in Thailand, so two slider facilities. Media is in Singapore. Our R&D capabilities are in Minnesota, Colorado, Fremont, Springtown, Shrewsbury, Massachusetts, and Singapore. We've got a pretty diverse base on the development side as well. I think from that, the factory and the development side of it. On the sourcing side, I'll let Dave talk to it.

As you know, we've articulated our belief that we have a pretty deep and robust and strategic supply chain, which is one of the reasons why we feel that as soon as parts start flowing, we're able to achieve some of the output goals that we mentioned earlier, Dave.

Speaker 4

Yeah, Rich, I talked about the complexity a little earlier on all of our products. We have roughly 25 product lines that are going. Some of them, from a mechanical standpoint, have numerous different configurations, largely capacity-based. The supply chain that feeds that is, you know, there's some places that feed our China factory, for example, that are specific to China. There's numerous other suppliers in different locations as well. That's something that we're going to have to factor through. The impact, what the suppliers that are in the affected region is, is very substantial to us, very substantial to our whole industry. That's where we're focusing our concern. We do have some opportunities to move equipment. We have some opportunities to keep lines going that are in unaffected regions.

To Steve's point about mix, that's why we have to rework the mix to make sure that the customers are getting what we can build and what they need, tie those things together. It's going to be a very volatile quarter.

Speaker 7

Most of Samsung's stuff comes through TDK, correct?

Speaker 8

Oh, yeah. Sorry, Rich. I didn't mean to avoid that question. Yeah. I mean, Samsung is, you know, generally, you know, doesn't have internal components. I want to stress that at least on the internal component side of wafer, slider, and media, we have a productive capacity, and we feel good about our ability to flow those parts, which will, I think, tie into when other parts in the supply chain are available. We're going to be probably best positioned to take advantage of that to provide output. With respect to Samsung, they're obviously not vertically integrated like we are. However, a lot of their supply chain is in Korea, although they do depend on certain parts out of Thailand, as does everyone. Yes, they do have a strong relationship with TDK and FE Windsor.

Speaker 7

Okay, thanks a lot. Good luck, guys.

Speaker 2

Our next question comes from the line of Shanye Hudson.

Speaker 7

Thank you very much. It looks like in the December quarter, the impact from rare earths is going to be more muted. If you hit the high end of your 40 to 50 million, it's going to be roughly flat sequentially. Pricing, according to checks, has gone up, you know, maybe 10% to 20% in the past week alone. Why wouldn't you have a meaningful improvement in your gross margin in the December quarter?

Speaker 8

I don't know. I don't know that we didn't say we would. I mean, that's for the analysts to determine. All we said is what the rare earth impact would be against whatever the gross margin is.

Speaker 7

Clearly, part of this is aligned to the mix of our customers. We certainly have to do that. There is a big range of outcomes on there. We are working closely with our customers to see what they want us to maximize, and we will work with them. Certainly, directionally, everything you say is in that way. Given we are talking a $10 million range of units, we certainly have a wide range of outcomes.

Speaker 8

Okay. Can you also talk about opportunities to gain share? Clearly, I think you will gain share over the next few quarters. Talk about the opportunities for these share gains to linger over the next several years. Basically, how can you take advantage of the situation? Yeah. I'd hate to use the words take advantage as much as, you know, we're obviously going to try and respond to the customer needs that are out there and also the supplier needs that are out there. What we're really doing is trying to align our capabilities, which are very substantial, with the suppliers that we have partnerships with and that need our help to regain footing, as well as then delivering the maximum amount of products to our customers.

The customer dialogue, as you might imagine, given the description of the impact to the industry given by Western Digital yesterday, has been one of a desire to align for certainly an extended period of time. We've had customer calls with several strategic customers and several large customers in both the OEM field as well as the distribution field that are willing to do multi-quarter alignment with Seagate. Okay. Last one from me. Have you discussed specifically the key components which are most constrained, in your view affecting Seagate? We can do it a little bit. I'll let Dave touch on that. Obviously, we're not going to talk about specifics in terms of companies or anything like that.

To give you an idea of where some of the constraints are so you can get a sense of if through your own work you see relief to those, you can get a sense of when we can address the market opportunity. I think that's fair.

Speaker 4

Good. I think it's very, so this is Dave. I think it's very specific to product lines, timing based on the amount of inventory that we had in certain chains. It's also very dependent upon second sources or in some cases, dual sites that individual component vendors had. Then the amount of reaction that's happened during the disaster. If there's been some factories that have been able to respond differently than others, just based on a lot of logistics issues. It's a pretty complicated equation, obviously. I think the biggest impacts tend to be around our ability to build head stacks for all the subcomponents for head stacks. In particular, there are a lot of mechanical piece parts vendors in these regions that we're going to have to go, you know, the solution as we try to put the supply chain back together.

Speaker 8

Okay, thank you.

Speaker 2

Our next question comes from the line of Katie Huberty from Morgan Stanley.

Speaker 0

Thanks. Good afternoon. Given the share loss in enterprise this quarter and the higher margin in that category, is there any reason why you wouldn't do everything to protect or to maximize the production in that segment so that you can manage those long-term relationships with enterprise customers and maximize mix and margins in the near term as well as your ability to take back share? Are there limitations as it relates to needs in other segments that would force you to not shift production in that direction?

Speaker 8

No. Again, I think the issues around share in enterprise are more related to us continuing to ramp our new product lines. The breadth of our portfolio is, you know, significantly more expensive than our next biggest competitor. As long as we get the portfolio out there, then, you know, we'll gain the share that we need. I think in terms of how we allocate our productive resources, Katie, that's clearly going to be a function of, again, working with our suppliers and then, you know, working with our customers to see how we can optimize what they're trying to solve right now, not what we're trying to solve. You know, Seagate is going to do fine through this in terms of, you know, being able to make drives and blow the parts. I think, to me, it's the question of how do we mix that for our customers?

Obviously, our customers drive a lot of margin from enterprise. They drive a lot of margin from nearline and business-critical. They drive a lot of margin from high cap. Those are all areas that have been hit very hard. Obviously, yes, we're going to be mixing in that area. I think it's really the optimize with our customers and with our suppliers.

Speaker 0

Okay. Just a quick follow-up. Have you thought yet about whether you're willing to order new equipment and take on more capacity if, in a few months, you believe that the issues at your competitors will last and you have an opportunity to take even more market share than what you could take given the March quarter capacity?

Speaker 8

Yeah, I think the issue is, as we get more definition around what the constraints are and what the longer-term impacts are with the industry structurally, then we can make those decisions. Right now, we're obviously just trying to solve equations for the customers and suppliers in the December quarter. We're extending those conversations in terms of the first half of the year and in some cases for the calendar years with the assets that we have. We do have capacity, and we do have the ability to drive more capacity through yield improvement depending on what our mix is. That's our first order of focus, aligning with our customers on that. If it looks like there's sustained shortfalls after that, then we'll consider that.

Speaker 2

Okay. Great. Much luck over the next few months. Thank you. Our next question comes from the line of Ananda Baruah from Baird.

Speaker 5

Hey, thanks, guys, for taking the question. Good luck to you and your team in the coming months. Steve, I guess just going back in, you know, sort of around the topic of potential mix of capacity this quarter, maybe next quarter, depending on components. Do you guys have a visibility to tell if you have access to sort of the mix of components you need to, I guess, give you generous capacity around what you guys and your customers ultimately choose to choose that they want? Or are you sort of, you know, I mean, is there a ceiling to what you could do on enterprise or a ceiling to what you could do on PCs?

Speaker 4

I'm going to let Dave answer the question. I'm not sure I quite understood it, so if you did, Dave. Here's the way I'd say it. We have ceilings, so to speak, on our production capabilities for some of those different product lines. I think the nature of this problem and the vendors that are impacted are, it's a wide swath of different parts. The various impacts of the different product lines is pretty broad. I would say that we can't shift for a lot more enterprise, for example, versus what our production capacity is for ourselves internally. The question really is what do the end customers need and then what can the suppliers produce? Those are the two ends of the supply chain that we're going to have to struggle to tie together.

I think that's going to be a very dynamic question, especially because we can't yet assess some of the impacts that some of the sub-supplier factories have just occurred literally in the last 72 hours. We continue to assess. It's a very dynamic situation, and we're going to have to figure out and shift our capacity within the boundaries of what our manufacturing capability is very quickly.

Speaker 5

Thanks. That's quite helpful. Just a follow-up for me, I guess in terms of absolute units of PC drives that seem to be out there in the collective distribution channel, plus any comments you might have about what brokers are holding, is there any estimate you can give us as we try to get our arms around what the actual impact to the PC production might be in the coming months? Thanks.

Speaker 8

Yeah. I think it's hard to speculate. There wasn't a lot of inventory, you know, in the OEM hubs. There wasn't a lot of inventory in the channel, and as you might imagine, all of that has been pulled in the last, you know, 48 hours. I think the impacts are really probably going to be, you know, felt in about four or five weeks. It's just going to be a function of really when are we able to basically start shipping drives again, at what volume. In terms, it's going to have a skew in the quarter, I think, is the complexity. We're obviously building drives today and shipping drives, and we're going to be able to do that at capacity for a couple more weeks. Then we'll start being impacted and then how quickly we can recover.

Again, if it turns out that we're having access to parts in December, then we're going to be able to build as many drives as we can in December, and hopefully, our customers can incorporate those. The channel might be able to take them later in the quarter, and the OEMs clearly need them earlier in the quarter. That's another thing we're trying to optimize right now. Again, I think the bigger issue is really the impact in the first six months of the year. As much of this is an issue about December. Given the structural issues that were described yesterday, I think, in a certain way, you're right. The discord is actually cushioned a bit by we have a product that was on boats.

I mean, Western Digital described that they actually had, you know, actually put a greater than normal product into finished goods and out of the boats. They'll obviously be able to draw down from that in the next couple of weeks. Then, given the structural impact to the productive capability, I think the real issue is around March and June, and that's what we're really lining up for as much as we can.

Speaker 5

Great. Thanks a lot. Yeah, and good luck to you and your employees.

Speaker 2

Our next question comes from the line of Ben Reitzes from Barclays.

Speaker 1

Thanks a lot. Just a couple here. I wanted to ask you specifically about motors. It would seem like that would be the big bottleneck here. Did you find something out over the last 48 hours that plenty of motors could be available for you to do 40 to 50 million drives and then have units up sequentially in the March quarter?

Speaker 4

I think we're staying in tight contact with all suppliers that we have and watching, you know, all aspects of the supply chains that they have. I wouldn't say there's any real new news in the last 24 to 48 hours.

Speaker 7

Okay. Do you think that, Ben, this is Pat, the other thing is that, you know, the motor suppliers are not all in Thailand as well. There are other diversified supply chains. Given, as Steve talked about earlier, with us being China, we have some flex there. You know, there's going to be tightness there. I don't think there's any newfound parts. It's just we're optimizing how we use what's there and what factory it comes from.

Speaker 1

Okay. With regard to, you know, Western Digital talked about some special charges as well as some special expenses to expedite materials. There's all sorts of things going on behind the scenes. I'm sure even at your place, even though your plants are operational, is there any special charges, any increased OpEx over the next quarter or two that you can project that result from this? Or is it more business as usual the way it'll flow out in the P&L?

Speaker 8

Yeah, I mean, maybe incrementally, but nothing that we're calling out right now.

Speaker 1

Okay. I just got to ask you again. I mean, the gross margin guidance, or I guess you don't have official, but it sounds like you're saying the gross margin could be up sequentially in the December quarter. I just want to make sure that that's clear. What gross margin should we model? It sounds like you were open to the idea that it could be up sequentially due to the better mix of enterprise and some share gains, even on lower volume.

Speaker 8

I think you're going to have to model that depending on if we can build 40 or 50, or we just gave you a range based on what we know today and told you that it's not something to change. Obviously, a 20% range is a pretty big range, which means it could even go in or out of that range. I think it's hard to say. At 50 million units, that's a completely different answer. At 40 million units, given the absorption associated with the additional 10 million units, I'm not trying to be cagey or not transparent, but that's how dynamic the situation is right now.

Speaker 7

Yeah. Multivariate equation there. As you get up to that 50 million, everything that everyone's characterized, short supply, demand imbalance, those things certainly push a margin upwards. That would imply that we could hit the mix our customers want and, you know, keep our factories full. That's a very good equation. At 40 million, depending on what that mix is, when it comes, there may be period expenses that just can't cover. As Steve said, we're not trying to be less than clear. It's just when you're talking 40 million, it's a much different outcome than 50 million.

Speaker 1

Hey, thanks. That was pretty good color.

Speaker 2

Our next question comes from the line of Scott Craig from Bank of America.

Speaker 7

Hey, thanks. Good afternoon. Hey, Steve. I think some people are a little confused by the $40 to $50 million number from the standpoint where, you know, like what sort of impact are you expecting on your Thailand operations? In other words, what's the output there that you could do and what sort of assumptions are you making there? I know there's a lot of moving parts because you're assuming to gain some share in other spots, and then you've got other factories that can fill. I think that $40 to $50 million number has kind of caught people by surprise based on some emails I've gotten already. Maybe start there, and then I have one follow-up. Thanks.

Speaker 8

Okay. I think, again, the 40 to 50 million is not contingent upon what the factories can do, whether they're in Thailand or China. We have two drive factories in China, and we have one drive factory in Thailand. We also have component factories that are in Thailand that can continue to manufacture. The 40 or 50 million is contingent upon how much and what mix of supply that we can actually get of components that are coming from these many, many affected factories. Some of those factories are still impacted today. They can't. The assumptions about how fast they come back up are wide, and they're assumptions. You know, some of them we need the water to recede. Some of them are still being damaged today. Some of them have different levels of equipment damaged. I think this is a very volatile situation right now.

Expecting accuracy on some of that is very. If I think the implied question is, why is your number so high relative to Western Digital? I think you need to understand that Western Digital's numbers, best we understand their business, is being driven by a superset of slider, lappage slider. Regardless of what their, or if you could say it a different way, if they had full access to slider, what their number would be would probably likely be much higher than 22 to 26 shifts. That would include assuming whoever was in inventory. That's a hard constraint that they have that they know that they can't resolve this quarter. Hopefully, they'll be working to resolve it in the next several quarters as they indicated.

Seagate doesn't have that type of hard constraint either on the factory side, which Western Digital also has on the factory side as does Toshiba and marginally Hitachi because they can't get people to order. We don't have another component side other than non-captive components. For us, it's a function of our assumptions based on our conversations to date with our key suppliers about what parts we think we can get when.

Speaker 7

Okay. Thanks. Just as a quick follow-up, Steve, from a long-term basis, when you look at the mission-critical enterprise business, is there any concern there from what you saw this quarter from a longer-term basis that that market is potentially less profitable as other competitors maybe ramp up a little bit there in trying to gain market share?

Speaker 8

It's always been a highly competitive market. Whenever you're in a product cycle where we're transitioning, the TAM wasn't going aggressively, and that competitor decided to use it as an opportunity to take market share. If you want to be aggressive on price and buy market share and it's in a cycle where the customers are willing to do that, then you can do that. That's the same way to take market share in that way of the quarter. That's why we're convinced that as long as we keep our heads down and deliver these new programs, which are making good progress, that portfolio is what the enterprise customer wants.

It's part of the portfolio that we think we can, again, return to what we believe is the kind of balanced market share, kind of 58% to 62%, which then obviously allows our customers to diversify their supply base with one or two other suppliers in the form of Hitachi or Toshiba, who are both very good suppliers.

Speaker 7

Thank you.

Speaker 8

The end of the mission-critical business still drives enormous margins for our customers. Therefore, they're highly valued products that have to have certain reliability and quality of service features that basically take more to develop, take more to test, and take more to service. The operating side of supporting an enterprise business goes well beyond the gross margin side. That's the point we continue to make, that one of the reasons our operating model is different than people going into the enterprise is it takes a lot more to support that.

Speaker 2

Our next question comes from the line of Keith Brockman of Bank of Montreal.

Speaker 7

Hi. Thank you. Steve, if the demand side of the equation in December, you talked about 180 million units. If you, what's your perspective on what the collective supply side is? You heard Western Digital's numbers last night. We have yours. Any guesses or views on, against that 180 million demand, what the industry can generate this quarter?

Speaker 8

Not really because, you know, we really don't have a good view into what's going on with Toshiba other than they've said that their factory is closed. I believe they said that one of Hitachi's factories is closed. It just depends how long are they, you know, kept away from building drives. Even if parts are starting to show up, it's very difficult to say right now.

Speaker 7

Okay. Let me try the second part against that. Whatever number it comes about, for this December quarter, based on your comments, will there be greater production capabilities you think in the March quarter, flat, down, or up relative to whatever occurs in December?

Speaker 8

That's a really interesting question because if you're talking about Seagate, Samsung clearly re-indicated up.

Speaker 7

Yep.

Speaker 8

You know, buying a fairly substantial amount.

Speaker 7

Right.

Speaker 8

I think with Toshiba and Hitachi, it's harder to say. My sense is Hitachi would be up, just because from what we understand, their factory has not been affected by water. It's just a function of getting people back to work. It's not an easy task, by the way, but you know, it's certainly a lot easier than drying off equipment first.

Speaker 7

Right.

Speaker 8

Toshiba, I think, is, I don't know. It's just hard for me to speculate. Let's just say it's flat. I think the Western Digital question is better for them to answer. Like I indicated, if they've lost slider fab and they're working through inventories and WIP now, I think that's a question for them to answer. That number could actually go down, I suppose.

Speaker 7

Right.

Speaker 8

Depending on how they fill that gap, they're doing everything they can, I'm sure, to figure out how to hit HPA and HSA and slider output.

Speaker 7

Right. Okay.

Speaker 8

It's a strong, good, well-executing company. I won't underestimate their ability to recover.

Speaker 7

Okay.

Speaker 8

I think it's better for them to answer, but it's hard to say.

Speaker 7

Okay. The difference in March would be presumably all the collective industry would have used up their inventory buffer. The last one I have is on the enterprises. You guys are going through and you're going to make your priorities about how you want to allocate your production capabilities. Presumably, enterprise will bubble up there at the top of the list. As we think about your prioritization, should we think about prices remaining stable, or is there a chance that you guys might look to raise prices in a particular category? I know they're already going up in desktop and notebooks, but how about enterprise? Is there a chance that prices go up, or do they remain stable and you guys gain share or try to regain share with your new platforms?

Speaker 8

I think we'll try and regain share with our new current platforms. I think it depends on the enterprise customer. There's very few enterprise customers who only take mission-critical. There may not be any even. You know, they seem to obviously either need mission-critical and/or business-critical or the entire product line. Clearly, for the customers that need the entire product line, those are the ones that we're trying to address with the portfolio. I don't even think about it in terms of pricing per unit as much as what can we deliver to the customer and what does that look like in terms of our supply chain and what does that look like for them in terms of achieving their business goals.

Speaker 7

Okay. Great. Thanks. I will cede the floor.

Speaker 8

Okay. I think we're going to wrap it up there. I'd like to thank all our employees and certainly our suppliers and our customers for their ongoing support. I thank you all for joining us on the call today, and we look forward to speaking to you next quarter. Thanks very much.

Speaker 2

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great day.