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Seagate slam-dunks flood-hit rivals with triple-profit Q2

Ships 47 million disk drives as others sink

Seagate, the world's numero uno disk drive manufacturer, notched up a brilliant second 2012 quarter with revenues and profits soaring up above flood-diminished rival WD.

Revenues were $3.2bn and net income of $563m, which compares to $2.7bn revenue and $150m net income in the year-ago quarter. A 19 per cent increase in revenues, and profits over triple – 3.75 times as much, to be exact – those of the same quarter last year is a heck of a jump... especially in these Thai flood-straitened disk drive times. We guess scarcity of supply and drive price increases account for some of this.

The company shipped 47 million disk drives in the quarter, including 700,000 Samsung drives, and its gross margin was 31.6 per cent.

With Seagate having closed its Samsung HDD business acquisition, the company is the largest disk drive manufacturer and will remain so until, firstly, WD closes its Hitachi GST acquisition and, secondly, the enlarged WD ships more drives and earns more revenue than Seagate.

That's not going to happen soon.

In its equivalent quarter, WD reported revenues of $2bn, net income of $145m, gross margin of 32.5 per cent, and shipped 28.5 million drives – but then it had flooded factories in Thailand, which Seagate did not (although some of its suppliers did).

In the earnings call, Seagate's executive vice president of operations, Dave Mosley, said: "To put the disaster in an economic perspective, it is by some measures the fourth-largest natural disaster in history. So far, estimates are at $45bn of damage, and 13 million lives were disrupted... As a result, all of our 20-plus product platforms experienced some form of supply interruption, and for a few products, the damage brought down the supply lines completely... our average unit costs went up approximately $2.50 in the December quarter."

Interestingly, supply chain management alterations could lead to lasting improvements. CEO, chairman and president Steve Luczo said: "Seagate dramatically reduced product configuration complexity and moved the vast majority of our fulfillment process to direct factory shipments. These efforts have fundamentally altered demand planning dynamics with our customers and have resulted in a much better alignment of supply and demand. We expect that these improvements to supply chain management will become standard practice as our industry fully recovers over the course of calendar 2012, benefiting our industry, suppliers and customers."

With this outlook, stockholders will be perusing the Porsche brochures already.

Prices went up: "Our average selling price per unit for the quarter was approximately $13 higher than they were in the September quarter," but it could have been worse: "We made the business decision to trade a short-term, profit-maximising opportunity for long-term commitments from customers, stronger relationships and more stable margins."

Seagate LTAs

Seagate's relationships with its major customers have changed as a result. Luczo said: "Nearly all of our largest customers have entered into binding long-term agreements or LTAs to ensure continuity of their hard disk drive supply. Some of these LTAs extend for multiple years. ... [These help SEagate and its customers] by improving forecast accuracy, unit volume and pricing visibility, product build planning and logistics. The executed LTAs are expected to account for an excess of 60 per cent of our total production capacity during the calendar year."

Luczo believes the HDD industry is not meeting capacity demand: "There is substantial and growing shortfall in unmet exabyte demand. We believe that the exabyte demand is growing at 40 per cent per year, while areal density growth is increasing at less than 25 per cent per year... We believe the industry will likely exit the calendar year with approximately 100 exabytes of unmet demand."

He reckons this equates to a 150 million unit shortfall for the calendar year. Well, that's nice, LTA agreements or lock-in-lite as we might think of it plus a benign pricing environment looks like business bliss.

Seagate hopes to ship 60 million drives in its next quarter with revenues of $4.3bn and gross margin past 33 per cent; a bumper quarter in other words. The quarter after that should see revenues go past $5bn, making annual revenues of around $14.6bn.

In its 2011 fiscal year Seagate revenues were $10.97bn with profits of $119m. Seagate's profits for fiscal 2012 at the half-way point are $703m and should, for the full year, soar past $1bn. Fiscal 2012 should just kill the fiscal 2011 numbers. And then there is the possible bonanza of the WD arbitration award, another half a billion dollars.

Luczo is engaged in a shareholder love-in, with a new $1bn share repurchase programme and a 39 per cent increase in the quarterly dividend; with this outlook stock-holders will be perusing the Porsche brochures already.

Samsung boost

The Samsung SpinPoint M8 2.5-inch drive could have sold even more units in the quarter. Luczo said: "So Samsung's interesting. It's a great product. It's a high-yielding product. As you know, it's an outsourced manufacturing product currently for us with TDK, SA, Winpoint. And really, they ran into a situation where they were constrained by a component. And other than that, we would've been able to probably produce millions of those drives in the December quarter or they would've. In March, we probably would've been in the 10-plus million range. We've addressed the component shortage, we're ramping it quickly, and I think it's certainly reasonable that if you look over the course of the year that we can hit 50 million units a quarter with that product extending into the fall."

Excuse me? Seagate has just shipped 47 million drives this quarter in total and is thinking it could ship 50 million SpinPoints in the third calendar 2012 quarter? In fact, Luczo expects to exit the calendar year with an 80 million drive a quarter production capacity. This implies quite a shift towards 2.5-inch drives.

All in all, the disk drive industry looks to be a very nice place for Seagate to be at present. It has announced brilliant numbers; the outlook is excellent; the main customers are prizing long-term supply continuity more than shaving a few cents off unit prices; there is unmet demand; and, last but not least, rival WD has its problems. Seagate exec staff must all be smiling, especially the ones with stock options. ®

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