Welcome to Seagate Technologies Fiscal Second Quarter 2011 Financial Results Conference Call. My name is Melanie, and I'll be your coordinator for today. Session. Future operating and financial performance in the March 2011 quarter and thereafter and include statements regarding customer demand for disk drives 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.
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 ks, Form 10 ksA and Quarterly Report on Form 10 Q as filed with the U. S. Securities and Exchange Commission on August 20, 20 10, October 6, 2010 and November 3, 2010, 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. I would now like to turn the conference over to our host, Mr.
Steve Lusso, CEO. Please go ahead.
Thank you, Melanie. Good afternoon, everyone, and thank you for joining us today. On the call with me today are Pat O'Malley, our Chief Financial Bob Whitmore, our Chief Technology Officer and Head of Research and Development and Manufacturing Operations and Dave Mosley, Executive Vice President of Sales, Marketing and Product Line Management. As we've done for the past 2 quarters, detailed supplemental information about the quarter has been posted on our Investor Relations website. In addition, we recently completed a number of studies that represent Seagate's point of view on on tablets and mobility, SSDs and flash, cloud computing and the demand for storage over the next decade.
In total, there are 8 documents that provide an excellent basis for important emerging storage trends. You can find these documents now on Seagate's Investor Relations website on seagate. Com. I will review the results for the December quarter, address a few of questions that we know many of you have and then we'll open up the call to question and answer. As you may recall, we reported our 2nd quarter business outlook in November as opposed to providing it with our 1st quarter results in October.
In our outlook for the December quarter, we noted the following: Demand for hard disk drives had improved from the summer early fall Expectations for the total available market was approximately 170,000,000 units and supply and demand appeared to be well balanced with the company's inventory across all challenge atorbelowtargetedlevels. Across all challenge at or below targeted levels. As a result, we forecasted at least $2,700,000,000 in revenue and gross margins as a percent of revenue of at least 19.5%. While the total available market for the quarter was in line with expectations at approximately 168,000,000 units, disk drive shipments had a greater than seasonal slowdown in the last 2 weeks of the quarter. In particular, Seagate experienced a slowing of demand in the Asia Pacific distribution channel during the last 2 weeks of the quarter and elected to reduce shipments and maintain our pricing discipline.
Seagate met its revenue and gross margin target of $2,700,000,000 19.5 percent, respectively due primarily to a greater than expected increase in the average storage capacity for DRiVESHIFT in all markets. The December quarter results also included the impact of additional customer support costs associated with our long term supply agreements. The negative impact to gross margin percentage was approximately 170 basis points and we are confident that the impact is truly reflected and contained within the December quarter results. For the December quarter, we also reported non GAAP diluted earnings per share of 0 point anticipated provision for income tax. With respect to our capital structure, the focus of the Board and management continues to be on regularly evaluating ways to optimize the balance sheet in light of current and future capital market conditions and the current and future operating environment.
Importantly, Seagate continues to focus on maximizing shareholder returns, while maintaining the flexibility for continued investment in a broad range of storage technologies as required by our existing and evolving customers. Pursuant to this plan, the Board in November authorized the company to repurchase an additional $2,000,000,000 of ordinary shares. In December, we used $305,000,000 to purchase 21,000,000 shares. Also during the quarter, we issued $750,000,000 of senior unsecured notes. The Board and management are continuing to evaluate alternatives beyond the stock buyback, including for example, increase shareholder value from our company's consistent and significant cash flow.
This reflects our long term confidence in the demand for disk drives in the Internet based computing environment that is positively impacting both commercial and consumer storage demand. As an example, in the December 2010 quarter, Seagate experienced a 31% increase per drive average capacity shift year over year. We believe this is further evidence of the need for the company's affordable mass storage products for the expanding user base that utilizes media and data rich content. Cash, cash equivalents, short term investments and restricted cash totaled $2,900,000,000 and long term debt including current portion also stood at $2,100,000,000 with most maturity dates evenly distributed approximately every 2 years from 2014 to 2020. As we look forward to the next quarter and into calendar year 10, we continue to strive to provide guidance that accounts for the global macroeconomic environment and the changing competitive dynamics in our industry.
With that perspective, we expect the following conditions to shape the March quarter. The industry has marginal excess capacity. The industry has limited volume of new products, continued muted consumer demand for PCs, strengthening commercial demand for PCs against the backdrop of the typical seasonal patterns of a March quarter and strengthening enterprise demand. For the March quarter, we are planning for the industry TAM to be between 155,000,001 100 and 65,000,000 units. We expect revenue of $2,550,000,000 to 2.7 18% to 19%.
The outlook for the quarter is influenced by less visibility and demand post Chinese New Year. In addition, gross margins remain under pressure as cost of many upstream materials have not declined at rates equal to the price erosion experienced in calendar 2010 and expected in calendar 2011. On a longer term basis, we believe that the commercial and enterprise markets will be strong throughout calendar 2011, especially as the commercial refresh continues in large enterprises. In addition, we believe that the demand for consumer and commercial mass storage will continue to accelerate as required by the introduction of many more devices creating and consuming real time data and rich content. Finally, we are encouraged with our new product offerings in every market we serve and we expect those new products will 11.
Before we open up the call for questions, we will address the questions I referenced earlier. The first is when does the company return to its targeted gross margin range? There are 3 primary factors that will influence when we return to our targeted margin range. The timing of Seagate's transition to new products, the timing of component cost declines approximate to HDD price declines and overall industry supply demand alignment. Since we have most direct control over our new product introductions and they are most likely to result in gross margin expansion, I will address the calendar year leading products for both mission critical and business critical applications, as well as our 2nd generation SSD products.
In addition to
form factors. And finally, we have just
released a new line of GoFlex form factors. And finally, we have just released a new line of GoFlex products designed for the Mac community and announced a certified GoFlex storage system, which provides a standard that allows device manufacturers to build a wide variety of consumer products such as media players, set top boxes, computers and televisions with a slot to support removable Go Flex external hard drives. We expect contributions from our new product transitions in the second half of calendar twenty eleven. With respect to the cost of supplied materials, we believe that the biggest opportunity for cost reduction occurs at the time of our product transition. Although based on yesterday's WD call, we clearly have work to do with respect to our supply base and calls to our suppliers, as you might imagine, began this morning.
With respect to supply demonstrated its focus on this alignment by having slightly lower shipments against the TAM that slightly increased. The second question is what is your view on tablets and how they may be impacting negatively or positively the HDD industry? Long term, we believe tablets and other mobile devices like smartphones are having are and have been net positives for the hard drive industry. During the last the storage industry. In this case, smartphones and tablets need to stream data and a significant portion of that data will be consumer generated content, mostly video.
Therefore, as these new devices consume significant amount of data and content, users will expect the same experience that they've grown accustomed to with other consumption devices. It seems clear that in order to deliver that overall experience, the most affordable and proven solution is the utilization of disk drives as a caching device throughout the network. Whether the storage is in a NAS box in your home, in the cloud or in a local cloud, Seagate provides products for all those markets. The final question is how aggressive will the company be buying stock back given the outlook for the March quarter? The Board authorized a share repurchase plan based on its confidence in the company's long term prospects.
Based on our current view of the March quarter, you can expect that at the current price range, the company will be actively repurchasing shares. Melanie, we're now ready to open up the call for questions.
Thank you, And our first question comes from the line of Sherry Skradner with Deutsche Bank. Go ahead.
Hi, thank you. Thank you, Steve, for providing like the operating expenses would do in some of the other lines and if you'd be willing to give an EPS number. I'm coming out somewhere around, I don't know, dollars 0.22 at the midpoint, I wanted to make sure I was in the right ballpark.
I'll let Pat respond on that.
I think Sherry, our models, I think Steve gave all the elements to it. I wouldn't expect a major change in your operating expense given the taxes. I won't discount your model on the margin maybe slightly different, but I think you're using the right data elements.
Okay. And then Steve, I was hoping you could give us an outlook for the full year. I think Western Digital commented last night that they thought industry units would be a little below 700,000,000 which doesn't seem like very strong growth, it's, I don't know, 6% or 7%. Do you guys have similar views on growth this year or do you think it will be closer to something like 10%?
I think it's too early to say really. I mean, I think there's a lot of variability around calendar 2011 that runs probably in a few different vectors. One clearly is when and if and how strong the consumer demand picks up. And I think that's just a function of overall economic environment. I think the refresh cycle that's occurring in the enterprise has the potential for remaining at the pace today or potentially accelerating.
We're seeing strength in the enterprise market and we have and it seems to be building. So I just think depending on how those things play out through the summer, it's just hard to make a call here in January what 2011 looks like given the dynamics at the macro level that are still present in the world. I think the way I think about it is visibility has probably gotten better, but most of the OEMs are still they're pretty nervous and if they see any sort of slowdown, they pretty much cut back on the supply chain quickly. So I think until we get a lot more confidence that there is a sustained recovery, it's really hard to make a 2011 projection. And right now, we would probably look more towards the Gartners of the world and see what they're saying and probably play our planning off of
that. Our next question comes from the line of Rick Kugli with Needham and Company. Go ahead.
Thank you. Good afternoon. A couple of questions. I guess, first, when it comes to the hybrid drives in particular, what do you see as the market opportunity now that you've had a product out there for a bit? What percentage of your mix do you think ultimately is appropriate for hybrids just in general?
Yes, thanks. Well, I think clearly the experience that we've had with the devices to date has been very favorable. Ahead of expectations. The interest by a wide breadth of OEMs is fairly substantial and that goes in a wide variety of devices whether or not it's notebook or desktop or even tablet or even external. So I think the issue around delivering performance that has kind of SST performance, but just drive cost and capacity is a pretty compelling proposition.
And I think the 2nd generations of products that we'll be launching about hybrid is you can actually get performance that exceeds SSD with cooperation on the OS level or system level with some of the hardware or systems companies and that's starting to develop as well. So I think longer term, Rich, you're going to see that in 5 years or 7 years or something like that, probably more than 80% of our products are going to be some form of hybrid drive. And that by the way isn't just driven by a need for the user experience, but there's a lot of advantages from an aerial density perspective that have us pursuing that technology as well.
Okay. And then in that vein, you've highlighted a lot of detail on your new product introductions for later this year. Can you give sense on what you think maybe the merchant supply market is able to deliver relative to your technologies? And any thoughts on the timing of the rest of the space and whether or not that's going to lead to a greater period of margin expansion for you for a period of time?
Merchant meaning the competitors?
Yes, I guess there's just one, right?
Well, I think the trick on hybrid, which once you start using these systems and integrating them, it's not as simple as obviously just putting a piece of silicon between the DRAM and the HDD. There's a lot of work that has to do with how you or at more at the system level. So we've been at this for a few years. Or more at the system level. So we've been at this for a few years.
So while I would expect our competition will likely introduce some sort of product to take advantage of the performance attributes of hybrid, we feel pretty good about our technical lead right now. So I don't know that we see a big competitive threat on the horizon. On the other hand, I'll tell you that we're approaching this market in a way that makes it attractive for our customers to utilize the technology, because I said there's lots of advantages from an aerial density perspective as well. So point being that there's not markup on top of markup in terms of the cost associated with these drives. It's basically an opportunity for us to just increase the user experience as opposed to expanding the overall margin.
Okay. Then just one last one for me is, can you elaborate a little bit on the long term supply arrangement hit to gross margins, which looks one time in nature. I don't know how the streets going to can deal with it, but any color that you could provide?
Yes, I'll let Dave go into that a
little more detail. Sorry, Rich, you're talking about the
The additional customer relate
to
relate to certain customers with whom we have long term supply arrangements and who are not satisfied with performance of a limited dry family shipped over 2 years ago. When we've accrued for these costs associated with this issue and it's all focused on keeping that high level of customer support. So, that's why we're fairly confident as Steve said in his comments about it being contained last quarter.
So, it's really almost just a warranty expense?
More reverse logistics expense, I would
say. Yes.
Okay. That's very helpful. Thank you.
Thanks.
Our next question
around what drove the demand shortfall late in the quarter?
I'll let Dave talk to that again. We kind of pointed out that we seem to feel it mostly in Asia. And I'll let kind of Dave talk to
it and in the channel. Yes, I'd say that first of all October November were fairly strong. Seasonally, we could get into arguments November were fairly strong. Seasonally, we could get into arguments about calendar Q4 and how they usually end relative to the next calendar Q1. But what I would say is that our view is the channel continue to move that's long term demand, but I do think there are some temporary issues that people are getting through in that region around Chinese New Year and how much do we have to build around some competitive industry is going to have to get through that with frankly, industry is going to have to get through that with frankly larger than what we would desire inventory in the channel in Asia.
It may blow through in 3 weeks, it may take a little bit longer than that, but there's certainly that uncertainty. Now we're less exposed to that because of our OEM share than maybe some other people, but it's certainly something that we noticed started in early December.
Okay. And I
don't think it's long term demand in Asia. I mean, you've got to subscribe to a really different thesis if you think that this goes out 6 to 9 months in APAC demand.
And it's consistent with the IDC Gartner commentary about the Q4 as
well? Yes.
And then just a follow-up for Pat, as it relates to the lower declines for upstream components. Is that a function of tight supply or is it just a limited ability to ride down the cost curve this late in your product cycles?
Yes, it's the second. That's what I'm saying. The bigger opportunity obviously for us is, as we transition our new products, that's obviously move down price curves. That notwithstanding, have the opportunity to obviously move down price curves. That notwithstanding, apparently we have work to do in the quarter on our current cost of supplies as well.
And as we go, just on a follow-up to that, as we get into the calendar Q4, any estimate for what percentage of the products you ship will be the new products?
Yes, not till the second half of twenty eleven. They in qualification in a lot of the portfolio right now and that continues through the 1st 6 months of this year. But in terms of starting to really ramp across the portfolio, it's really the second half of the calendar year and that's again it's kind of Seagate strength is the ability to really ramp across an entire portfolio that expands all the markets that we do. Some it comes now, some of it comes in the June quarter, but until it's really hitting on all cylinders, it's the second half of the year.
And could you be 50% plus of shipments in
December platform? I'd say akin to what we talked about a couple of years ago, where we called the desktop transition for example quarter over quarter in these calls we would tell you how much of the product that transitions to Steve's point. We won't begin that until probably late 2nd or 3rd calendar quarter.
Okay.
But either all our products will at
least be in qualification, all our new products by that time
and the vast majority will be in volume shipments by the Q4 2011.
That's helpful. Thank you very much.
Our next question comes from the line of Mark Moskowitz with JP Morgan. Go ahead.
Yes. Thank you. Good afternoon. Two quick questions here, 1 near term, 1 long term focus. Steve, could you talk a little about how we should think about the March quarter in terms of is it going to be more front end loaded?
I heard you talk about Chinese New Year. So can you just talk about, is it more front end loaded than usual? And how should we think about that plan?
Yes, sorry, Mark. I think how we're thinking of it is, it feels more front end loaded because we don't have a lot of post Chinese New Year's visibility. Whether or not it ends up being front end loaded or not, hard to say, right. But right now, I would say it feels more front end loaded.
And with that said, how are the fulfillment rates in terms of customer A1's 100 drives, are they taking 100 drives, are they taking less, are they asking for more actually?
I'm not sure I understand the question.
Just in terms of when you say it's front end loaded, I'm just trying to get a sense of current demand. Are you seeing any structural nuances or changes to your fulfillment rates in terms of, let's say, a major OEM tells you 6 weeks ago they wanted to get 100 disk drives, for example, in the 3rd week of January. When the 3rd week of January comes around, are they taking 100 disk drives or are they asking for less? It really depends on which product we're talking about,
Mark, this is Dave by the way. But I would say broadly in enterprise and business critical, the answer to your question is yes. The pull are very strong. I think as we go into notebook, there are other dynamics up against building out and by the way, Chinese New Year is 3 weeks earlier than it was last year relative to the quarter. So we have to watch those dynamics as people do builds.
And then frankly, line changeovers during the time that the downtime in Chinese New Year, if you will. There's a lot of dynamics around that. I think notebooks probably less predictable there. And the PS OEM pull rates are about what we expected. So, January is coming at the same the predictable clip, I'll say with one caveat on the upside and one caveat to watch for.
And then the longer term question, we're getting a lot of questions from investors around enterprise, particularly business critical, not so much mission critical, but business critical in terms of the opportunity to move more and more away from fiber channel to SATA or SaaS. Can you talk a little about how investors should think about the competitive dynamics potentially changing here, where Seagate had the runway for a long time? Can you still run the table going forward?
Yes, it's a good question. I'm going to let Dave answer, but I think what we've seen in the last couple of quarters, we feel pretty good about in terms of the transition, I would say to SaaS, I think versus SATA. And I'll let Dave talk to it, but we're encouraged by the trends because SaaS obviously is an interface where we have a lot of expertise. Yes, I mean, obviously, we led interface where we have a lot of expertise.
Yes, I mean obviously we led fiber channel, we led SaaS, we led the 2.5 inches transition from 3.5 inches and so we have this history of leading products in the enterprise. I feel really good about the diversity of our spin speed and things like this. Spin speed and things like this. Relative to SATA versus SaaS, I would say that people get confused by the quality of service of the drive, the expectations of the end user, not just the interface. So there's a lot of people that see expectations for the drives and its duty cycle, if you will, over a long period out in the field and that's something to watch out for.
We feel pretty good about our portfolio right now. We think we're launching leading products all the way across the portfolio, 15 ks, 10 ks products. We feel really good about our business critical offerings as well on 2.5 and 3.5 on SaaS already, which basically there's other people who've announced, but we're basically the only person shipping SaaS in large volume across business critical. So, it's not to discount any competition, but we've made the investments and we feel really good about the new products we're launching.
Thank you.
Our next question comes from the line of Ana Goshko with Bank of America Merrill Lynch. Go ahead.
Hi. I wanted to ask you for your updated thoughts on capital structure and structure strategy. I know in the past particularly after the kind of events of 2,009, you had talked about the target leverage as being a total dollar amount of debt given the cyclical nature of the business and the industry. So wondering where you are now in terms of thinking of how levered you're willing to take the company and how much cash you believe you need to keep on hand?
Sure. I think in terms of how much in cash is what we feel is more than adequate to have on hand to run the business and whether actually not just short term downturns or probably even longer than the short term downturn. I think in terms of the debt level that the company can carry, I mean, I there's no question that the company at today's interest rates that the company could carry $3,000,000,000 to 4 $1,000,000,000 of debt depending on maturity structure. And so I think today we're at 2 point $9,000,000,000 with $560,000,000 coming due in November of next year. That means we have debt capacity if we feel that the debt markets are attractive fund stopped our dividend and scrambled pretty hard was really more a function, not really of our view on long term cash flow as much as there was just big slugs of debt coming due in very short periods of time, obviously then against the backdrop of not a lot of liquidity debt or equity in the world.
Today, I think we've done a lot of work over the last 2 years to restructure the balance sheet. I mentioned the maturities extend every 2 years starting in 2014. There's no massive wall of debt. The debt markets certainly are healthy. I learned that through our privatization exercise.
And I think we feel good about being able to manage what we have and opportunistically doing more if we feel like we have to.
Okay, thanks. And then if I could ask a second, just on the comment on considering the recurring dividend. Obviously, the downside to that is it's more difficult to dial up and dial down depending upon industry conditions. So just wondering how advanced you are in your maybe potential commitment to recurring dividend and if so, kind of what size or magnitude you've considered?
Well, I've been doing a lot of work on this and it just seems, again, if you believe that the company has the ability to consistently generate cash flow, which if you look at us over the last 5 or 10 years, on any quarter to quarter or rolling 4 quarter basis, I mean the company generates a lot of cash through, by the way, a couple of pretty hairy downturns in and a couple of acquisitions that ate up a lot of capital. And a lot of what it seems that investors are asking for decent percentage of that should probably return to shareholders and that's what we're investigating. Investigating. What is the current research saying?
It kind of gets somewhere between 25% and 50% of free cash flow is what shareholders would like
to see return. I'm not saying that we're of free cash flow is what shareholders would like to see return. I'm not saying that we're going to come out at the high end of that range, but I think this is under consideration enough where I mentioned it in the call and we feel pretty confident that we can return to shareholders in various ways. Whether or not it comes in a dividend or not, we're not prepared to stay just yet, but it's certainly on the table and we think it's an attractive alternative.
Okay. Thank you very much.
Our next question comes from the line of Bill Hsu with Goldman Sachs. Go ahead.
Okay, great. Thanks guys. I have a quick cash question as well. WD is obviously talking about potentially using their cash for strategic purposes or strategic acquisitions. And you guys are obviously clearly focusing on returning cash to shareholders with leverage.
Are there Are there potentially strategic opportunities for Seagate to use their cash for or you feel your current R and D pool is pretty much adequate for your longer term
goal? No, I mean I think there could be. I think the point is we feel that we have a lot of usable cash, we have the capacity to raise money through the debt markets and we generate cash. So I don't think we're limiting any alternative that we have strategically, whether or not that's investing in the company or acquiring other technologies. It's just that I think that when you take all that into consideration, there's still the potential for return to shareholders.
That being said,
I guess that's all I'll say on that.
Okay. And maybe I missed this earlier, but can you comment on what you're seeing with HDD inventory management amongst your OEM partners?
Yes, we were not going to comment on our customers.
Okay. Thank you.
Our next question comes from the line of Keith Bachman with Bank of Montreal. Go ahead.
Hi, guys. Thanks. Pat, could you comment on the inventory levels that you guys think is out there, both at the channel as well as the OEMs? I know the OEMs is a bit murky, but I just wanted to get your thoughts there, particularly against some of the comments that WD made last night. And I have follow ups, please.
So I'll take the first pass and hand off to Dave. But we generally manage our channel in a tight range and we feel fairly comfortable with where that is. As Steve and Dave both alluded, we actually slowed down our push into the end of December channel inventory in Asia Pac to manage that as opposed to go after a pricing to maintain our discipline, our supply chain management. So but we monitor that and we feel that the channel level is appropriate. Could it come down?
Obviously, it's run lower, but we don't think it's in a danger zone that would impact our ability to manage that channel reasonably well. On the OEMs, we have many of them have hubs in front of them and we monitor that very closely. So that part we feel very comfortable. Now they're holding it on the back end. Don't really get all that visibility, but we do get signals from our OEMs.
And as Steve said, they're cautious, but we're tied into their supply chain and we work that fairly aggressively with them. So if folks are holding excess inventory, that's there can be there, it should imagine it will manifest it. But from our standpoint, we keep a pretty tight eye on what they have or believe they have and stay very close to them to make sure we're lined up with that.
Yes, maybe to state it a little clearer on with respect to the OEMs and we don't see an OEM situation of some millions of units of PCs of excess inventory.
We don't see that. Okay.
Okay. Thanks, Steve. And how about I don't think you talked about what your pricing considerations or anticipated pricing for the March quarter and I just want to get your thoughts there.
Clearly, it has muted from where it's been. So that's the good news. I think that lines up with the supply and demand getting in and better. But obviously, it's on the backdrop of 2 heavier than usual pricing quarters. In front of us, it's typically slower.
So it goes back to Steve's comment of you still have margin pressure or longitude to not be able to take aggressively cost out, but it has muted down and it's probably a seasonal average.
Yes. I think that the analyst community just
has to take a hard look at what happened last summer still in terms of the quarter to quarter price takedowns and what that would have been relative to more typical price takedowns. So that even if you have things flattening, if you have them flattening after 6% versus 3%, you're still fighting an uphill battle and against the backdrop of no new products really that the industry is offering. And so against the TAM that's flat and no new products, it's just tough to be looking at share gains. People should obviously be managing their P and Ls to keep their factories as full as possible, watch capital and it's going to until we get to the next set of products, it's going to be tough to see big margin expansion.
Okay. Well, can I sneak in one
more just on CapEx, Pat, is how should we be thinking about usually you guys provide some range of CapEx and just want to hear your thoughts if not for the first half of the year, maybe just for the March quarter?
I think our model is 6% to 8% is still intact. That's how we try to manage the business. And obviously, with some of the lack of visibility Steve talked about, we'll be little tighter on that, but we'll certainly monitor to grow where appropriate, but we're keeping in that range of 6% to 8% still in our model.
Okay. Thanks very much guys.
Our next question comes from the line of Rob Quiro with Karas and Company. Go ahead.
Hi. Thanks very much. Maybe even playing off that last CapEx question. It seems like there have been some CapEx cuts, either a lot or a little, including on the components side ever since really, I don't know, like a summer. Do you think there's a chance that even with a soft PC market by the second half of this calendar year, you actually see the industry back to being pretty tight just given the CapEx cuts?
Or do you think CapEx has been cut enough that that's too optimistic?
It's a really good question and it's kind of one of the reasons that I said the industry is, I think I said, has marginal excess capacity. I think that there's probably too much focus on an assumed drive capacity by the industry as opposed to what's really going on at the component level. And when you think about at least our experience of 30% increase in average capacity of driveship that means a lots of heads and disc had to go into that. And so to your point, a lot of capacity is being utilized at the component level. And if we have a continuation of that type of capacity growth against even some marginal end demand growth in units, it's going to strain, I think, the component area quicker than people probably have modeled.
Right. Okay. Thank you.
Our next question comes from the line of Jason Nolan with Robert Baird. Go ahead.
Thank you. Steve, any more color you can give regarding
2011? I mean, I think just in general, I think we start talking about it in the fall quarter or even maybe a touch even in the June quarter that we saw a pickup as the commercial refresh expanded into the server market and storage. And we're starting to see more evidence of it even on the client side, both desktop and notebook. And there just seems to be no indication right now that that's slowing down. And if anything, maybe budgets are getting a little freer on the IT side and people are starting to do kind of full company deployment of new assets on their IT infrastructure.
I don't know, David, if you
want to add anything. No, I'd say that as we got through year end budgets, the spend was based on 2010 budgets and now we've got to get a good look into the New Year of what 2011 IT budgets are for what that's going to mean for enterprise systems and so on. I think on the PC side, the notebook side, the commercial refresh there, we've commented before, it's always ongoing to some extent. There's ancillary data out there that says it's accelerating and I think everyone likes to believe that because the new systems are compelling price points and capabilities with operating system refreshes and so on. A lot of people are running on older PCs, but I would say quantitatively it's really hard to pin that one down the PC went down in particular.
We hear the same ancillary data that other people do.
Okay. Thank you. And last question for me on areal density. Is it fair to say you guys are comfortable with a 30% to 40% annual gain if you look out 3 to 5 years plus without a transformational CapEx investment?
Yes. Fair enough. Thank you. And Melanie, we'll take one more question.
Yes, sir. Our next question comes from the line of Aaron Rakers with Stifel Nicolaus. Go ahead.
Yes, thanks guys for fitting me in. First question for me would be on the gross margin line. I just want to be clear, you guys are talking about a 170 basis point impact that will be contained in this quarter, but you're guiding to an 18% to 19%. So at the midpoint, you're effectively guiding close to a 300 basis point drop of a like for like basis on gross margin into the March quarter. I'd like to understand if that's how you want us to see that and in particular what the puts and takes are in particular to that level of a decline on gross margin like for like.
Matt, do you have a follow-up?
I think that is a fair way to look at it. And where the vast majority of that erosion comes from on the margin compression really is almost all prices fall into the bottom line as we have very limited ability to really is almost all prices fall into the bottom line as we have very limited ability to continue to mix up. We mixed up very strong already and also cost takedowns. As Steve said, we'll continue to push that and see what we can get out of that. But that's the large vast majority, over 2 thirds of the compression.
Maybe just stated this a different way. That outlook is with a view of not a lot of takedowns in cost of supplies and not a view of continued mix up in capacity. If either one of those things happen, obviously, then that would change the margin structure.
Great. Thank you for that color. The final question, a follow-up for me. I know you guys talked about a slowdown in the final couple of weeks of the quarter and a conscious effort to not participate in some market segments. The one thing that sticks out to me is that you guys have fallen down to a 6 year even depending on what Matthew is a sub-sixty percent share position in the enterprise mission critical space.
Is that a space that you guys actually decided consciously to step out of some enterprise market?
No, Aaron, we didn't step back from it. I think the competitive dynamics about the same as it's been for the prior couple of quarters. I think if you go back all the way to the front of last year, we had some competitive stumbles that caused us to be way above profile. I think we're kind of at profile right now. Again, the products are getting the entire product set, not just the Seagate products, but the entire product set are getting long in the
tooth and need these new refreshes. So Yes, I think we've been pretty consistent saying that we think our enterprise market share given the nature of our customer base and our product offering is probably in the 58% to 62% range. And if it gets way above that, it's usually because of an execution issue on behalf of our competitors and if it gets way below that, it's probably an execution issue on us. So we feel that we're kind of in our range and we might even argue, there's a lot of confusion about what the right TAM was for mission critical enterprises last quarter. So I think we still feel we're in the 60% range and we feel comfortable in that range.
Okay. Thanks guys.
Okay. I'd
like thank our employees for their ongoing commitment and hard work and also of course our customers, our suppliers and our partners for their ongoing support and confidence in Seagate. Thank you all for joining us on the call today and we look forward to seeing you speaking with you next quarter.
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