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Good morning and welcome to the Seagate Technology fiscal third quarter 2018 financial results conference call. My name is Amanda, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. As a reminder, this conference is being recorded for replay purposes.
At this time, I would like to turn the call over to Kate Scolnick, Senior Vice President, Investor Relations and Treasurer. Please proceed, Kate.
Thank you. Good morning, everyone, and welcome to today's call. Joining me today from Seagate's executive team are Dave Mosley, Chief Executive Officer, and Dave Morton Executive Vice President and Chief Financial Officer. We've posted our earnings press release and detailed supplemental information for our March 2018 quarter on our Investor Relations site at seagate.com.
During today's call, we will review the highlights for the March quarter, provide the company's outlook for the June quarter, and then open the call for questions. We're planning for the call today to go approximately half an hour, and we will do our best to accommodate your questions following our prepared remarks as time permits. For the June quarter, we would like to note that our quiet period will begin on June 25.
On our call today, we will refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures on our supplemental information available on the Investors section of our website. We have not reconciled our non-GAAP financial measure guidance to the most directly comparable GAAP measures because material items that impact these measures are out of our control and/or cannot be reasonably predicted. Accordingly, a reconciliation of the non-GAAP financial measure guidance to the corresponding GAAP measures is not available without unreasonable effort.
As a reminder, this conference call contains forward-looking statements about: the company's anticipated future operating and financial performance; customer and market demand in the current macroeconomic conditions; industry growth and trends; our technology and product development advancements and our ability to achieve volume shipment for new product development in 2019; demand for our products; continuity of access to long-term NAND supply; consummation of the Bain Capital Private Equity transaction; our ability to execute our roadmap and address supply constraints while maintaining an agile manufacturing footprint; potential impact of trade barriers, such as import/export duties and restrictions, tariffs and quotas; and, general market conditions.
These forward-looking statements are based on management's current views and assumptions and should not be relied upon as of any subsequent date. Actual results may vary materially from today's statements. Information concerning our risks, uncertainties, and other factors that could cause results to differ from these forward-looking statements are contained in the company's SEC filings and supplemental information posted on the Investor section of the company website.
I would now like to turn the call over to Dave Mosley. Please go ahead, Dave.
Thanks, Kate. Good morning, everyone, and thanks for joining us. For today's earnings call, I will cover the high-level results from the March quarter. Our CFO, Dave Morton, will then discuss certain financial highlights, and I will close the call with our outlook for the June quarter.
I am pleased to report Seagate's financial results for the March quarter reflect year-over-year growth in revenue and profitability. We achieved revenues of $2.8 billion, up 5% year-over-year, GAAP gross margins of 30.2%, and a net income of $381 million. GAAP diluted earnings per share were $1.31. On a non-GAAP basis, Seagate achieved gross margins of 30.8%, net income of $424 million, up 29% year over year, and a diluted earnings per share of $1.46, up 33% year over year.
HDD exabyte shipments for the March quarter were 87.4 exabytes, up 34% year over year. The average capacity per drive across the HDD portfolio was a record 2.4 terabytes per drive, up 32% year over year. And the average selling price per unit was $70.50, up 6% year over year.
GAAP operating expenses were $406 million, down 26% year over year. And non-GAAP operating expenses were $385 million, down 13% year over year.
Cash flow from operations for the quarter was $558 million, up 31% year over year. And free cash flow was $489 million, up 48% year over year. Fiscal year to date, we have achieved cash flow from operations of $1.6 billion and free cash flow of $1.4 billion.
Achieving year-over-year revenue and profitability growth and significant cash flow generation in the March quarter reflects Seagate's strong business model execution. I am pleased with the traction we have gained with our mass storage solutions across the enterprise and edge markets and with the competitiveness of our entire HDD portfolio that aligns with trending data growth opportunities.
I'll now turn the call over to Dave Morton to go into more depth on our operational activities.
Thanks, Dave.
For the March quarter, our operational results reflect year-over-year growth in revenues, profitability, and exabyte shipments. We executed well this quarter against strong market demand and exceeded our expectations.
In the March quarter, total revenues were up 5% year over year, and hard disk drive revenues were up 7% year over year. The growth in hyperscale and cloud storage deployments continues to represent an important opportunity for Seagate, and we are confident in our nearline hard disk drive portfolio designed to serve these environments.
For the enterprise hard disk drive market, we shipped a record 43.8 exabytes, with a record average capacity of 4.8 terabytes per drive. In the nearline market, we shipped 41.3 exabytes, and our average capacity per drive reached 6.5 terabytes per drive, up 41% over last year and up 64% from the March quarter two years ago.
Cloud-based enterprise storage demand continues to be extremely persistent and supply remains bit constrained. Our 10-terabyte nearline product was the leading enterprise revenue SKU in the March quarter. In addition, we achieved significant sequential volume and revenue growth in our 12-terabyte nearline product as we ramp for material revenue contribution.
As nearline storage capacity demand grows over the next several years, we expect continued opportunity for our mass storage portfolio that delivers multiple capacity points for different application workloads. In the edge verticals, we've had year-over-year exabyte growth in the March quarter for nearly all end markets, including PC compute, consumer, gaming, and network-attached storage.
The March quarter non-hard disk drive revenues, primarily from the Cloud Systems and Silicon Group, were $217 million, up 2% sequentially. Year over year, the non-hard disk drive revenues were down 13%, primarily due to the planned end of life of some legacy OEM cloud systems products and the divestiture of high-performance computing assets.
Silicon revenues were up a few percentage points year over year, and we continue to be bullish about our opportunities to leverage our supply agreement with the Toshiba Memory Corporation, as we invest in developing a broad-based silicon product portfolio in the SAS, SSD, PCIe, NVMe, consumer, and gaming markets for significant revenue growth and expanding margin contributions.
We believe that our strategic approach to participate in the silicon market allows us to address customer storage portfolio needs and provide for profitable revenue growth opportunities in our business model without the overhang from additional capital requirements and cyclical market exposure.
At the same time, we are actively minimizing our exposure to the sub-1-terabyte client consumer and mission-critical 15K markets, as we believe these application workloads will move over time to either silicon-based memory or cloud storage, where we have or are developing portfolio offerings. In the March quarter, these products represented less than 8% of consolidated revenue.
Critical to supporting the massive growth in data is our ability to continue to provide mass storage solutions that optimize areal density and have the greatest reliability, quality, and total cost of ownership benefits. Seagate has demonstrated technology leadership with generations of storage technologies and products.
Over the last five years, we've been the leader in areal density with our perpendicular, shingled, and two-dimensional magnetic recording areal density solutions. These recording technologies continue to provide measurable total cost of ownership advantages for the mass storage market over other memory-based technologies, particularly for cloud-based environments.
We continue to make progress towards the introduction of our heat-assisted magnetic recording technology. This next-generation recording platform will open up a rich design space for high-capacity nearline drives that will push capacity points up 24 terabytes per drive and beyond and offer great economic value for our customers. We anticipate launching our HAMR portfolio in volume in 2019, and the future investment costs are already contemplated in our existing operating expense and capital expenditure long-term model.
Operating expenses for the March quarter were $406 million on a GAAP basis and $385 million on a non-GAAP basis, down 13% year over year. Capital expenditures were approximately $69 million in the March quarter, which support the continued ramping of our newest highest capacity hard disk drive products and maintenance capital. For fiscal 2018, we anticipate capital expenditures to remain below 5% of total consolidated revenue.
Cash flow from operations in the March quarter was $558 million and free cash flow was $489 million. Year to date, we have generated over $1.6 billion in cash flow from operations and nearly $1.4 billion in free cash flow. Our cash conversion cycle for the March quarter was five days, reflecting a persistent market demand environment coupled with well-managed inventory levels that are in line with customer demand.
Over the last two years, we have made many changes to optimize our operational footprint and supply chain management. Product complexity is a significant challenge in the storage marketplace right now and we believe our agility and manufacturing responsiveness within the component supply chain provides a significant competitive advantage for Seagate.
Our balance sheet remains healthy, and we ended the March quarter with $2.9 billion in cash and cash equivalents and 287 million ordinary shares outstanding. Our board has approved our quarterly dividend payment of $0.63 for the March quarter, which will be payable on July 5, 2018.
Interest expense for the March quarter was $60 million. Our debt structure and level of interest expense continues to be well within our financial capabilities, given our staggered maturities and low interest rates. In the March quarter, we deployed $57 million towards redeeming our November 2018 senior notes. Our net debt to last 12 months EBITDA ratio continues to trend down and is under one times as of the March quarter.
As a global technology company, Seagate has decades of experience in managing complex global supply chains and technology manufacturing operations in nearly every region. We work with technology customers, vendors and suppliers throughout the world. In the area of tax and trade, the U.S. and China have recently announced potential trade actions that could increase tariffs on some products imported into the U.S. Given the fluid nature of the issue, it is too speculative to determine any impact or changes for Seagate's operations. However, we continue to monitor the situation.
Overall, our operational and financial performance in the March quarter reflects solid earnings power and financial leverage within our business model. Looking ahead, we will continue to align our go-to-market operations and product portfolio advancements for growth in the existing mass storage markets. Over the long term, we believe there will be additional growth opportunities with new markets and customers that will leverage our cost-efficient and reliable storage technologies.
I would now like to turn the call back to Dave Mosley.
Thanks, Dave.
Turning to our market outlook, we remain optimistic about Seagate's earnings power, as current macroeconomic conditions and global investments in cloud-based environments persist. Specific to the nearline products, we share the perspective that we are in the early stages of a broad-based global cloud storage transformation.
For the June quarter, we anticipate year-over-year revenue, exabyte, and profitability growth, with continued strong enterprise demand and tight supply for our highest capacity solutions. Within the other markets we serve, we anticipate sequential seasonal unit demand declines, as we would typically see in the June quarter. It is important to note, however, that exabyte demand is growing year over year in nearly all markets.
As a result of these exabyte demand trends, we expect total revenues to be approximately flat, sequentially, from the March quarter, reflecting quarterly year-over-year revenue growth of roughly 17% and total revenue growth of approximately 4% for fiscal 2018.
We expect gross margins to be sequentially in line with the March quarter and continue to be within our 29% to 33% long-term range. Cash flow from operations for the June quarter should be at least $500 million, and we are on track to achieve over $2 billion in cash flow from operations for fiscal 2018.
Based upon our trajectory for our overachievement of our fiscal year 2018 plan, we anticipate an increase in variable compensation for employees for annual performance in the June quarter. We continue to manage our day-to-day operating expenses tightly, and we anticipate overall non-GAAP operating expenses will be down sequentially 1% to 2%.
Looking further ahead, feedback from our largest enterprise customers in all regions indicates strong capacity demand will continue throughout the calendar year. In addition, we anticipate seasonal strength in our other markets, with particularly strong exabyte growth in edge markets in the second half.
Diverse markets that are exhibiting strong data storage requirements translate to continued favorable growth and profitability opportunities for Seagate. We believe these long-term trends will continue with existing customers and that new customers and business vertical opportunities are also on the horizon.
In summary, I'd like to thank our customers, suppliers, business partners, and employees for their alignment and contributions to the March quarter's results.
Thank you for joining us on the call today, and we'll now open up the call for questions and answers.
Thank you. Our first question comes from the line of Steven Fox of Cross Research. Your line is open.
Thanks, good morning. I was wondering if you could talk about the head and disk constraints you might be facing and whether you've had to reallocate some of your supply chain towards faster growing markets. And if that's the case, have you lost any share on client, and how do you think that continues throughout the rest of the calendar year? Thank you.
As you're alluding to, Steven, head and disk lead times can be quite long, and we have to make sure that we have the right capacity in place for the right markets at the right times of the year due to their seasonality. So I think we executed our plan pretty well on client, and enterprise continues to remain strong. That's pulling, frankly, quite a few heads and disks. So I wouldn't say that there was any share loss or anything that was untoward for us.
We pretty much executed the client plan. We knew it was going to be seasonally down. We said that actually going in. And then we'll continue to point more and more heads and media at the high-capacity opportunities throughout the course of the year. And as we continue to see strength there, we'll try to ramp that up and apply more and more resources to it to try to meet that demand.
Thanks. And as a quick follow-up on the client side, as you move away from more of the 1-terabyte and below, is there a chance that maybe you raise that bar and are looking at possibly 2 terabytes and below as your hurdle for getting involved in client?
In some of our comments in the script, especially in the desktop markets, you're seeing fragmentation of the market. And some particular parts of the market, for example, surveillance, it's exhibiting seasonality in units, but the demand for higher capacity keeps going up. So exactly to your point, we are seeing people moving from 1 terabyte and 2 terabytes as their baseline offering to 2 terabytes, 4 terabytes, 8 terabytes, and so on. And we'll have to answer that with technology for areal density technology or heads and media of the same length.
Great, thank you so much.
Thank you. Our next question comes from the line of Ananda Baruah of Loop Capital. Your line is open.
Hey, thank you, guys, for taking the question. Can you guys hear me okay?
Yes.
Okay, great. Hey, congrats on strong performance and executing well in difficult market conditions. Dave, I would just love to get a little more context on the comments around cloud trends and I guess high capacity trends in general. It sounds like maybe the momentum actually continues to pick up there. We are (20:50), but it sounds like momentum may even be a picking up. And you made comments about strength in not just the second half of the year, but I think you made a multiyear comment as well. Could you just – number one, is it accurate that the momentum continues to build? And then, secondarily, any thought process around what's leading to second half conviction? Is an (21:20) even view the strength continues into calendar year 2019 would be really helpful. Thanks.
Good. Thanks, Ananda. So if you remember the history of the nearline markets in the last five years, there's been periods where we misinterpreted it as seasonality, but there were periods of feast and famine, if you will. The market – generally, the exabytes were increasing at about a 35% CAGR, but there were some markets sometimes where the market was much faster than that and other times where it slowed down. We're starting to see that abate and the demand be a lot more predictable, longer lead time visibility. And some of that's because the build-out of major cloud installations pulling really hard on high-capacity drives is not as feast or famine, anymore.
I think behind that, and this is something that is still developing a little bit, are the more legacy technologies for on-prem or smaller data centers where the capacity points aren't necessarily the highest capacity points, so we'll say 8 terabytes and below, but the demand is quite strong and quite diverse, geographically. So from my perspective, that strength actually picked up middle of last year and feels strong through the back half of this calendar year as well.
Looking out into calendar year 2019, I think it may be a little bit premature. We'll see the size of the back half of this year first, but it's certainly feeling like the install patterns that most of the cloud service providers and some of these big on-prem companies are in the middle of are still very healthy. And so, I wouldn't be surprised at all if it does extend for another year.
Okay, thanks for that. I'll (23:24).
Thanks.
Thank you. Our next question is from the line of Katy Huberty of Morgan Stanley. Your line is open.
Thank you, good morning. Enterprise revenue is at record mix, 44% this quarter, and yet gross margins are only up the middle of your long-term range and up just slightly, sequentially. And so, what's holding back gross margins? And then, if in your answer you can comment on whether you saw any improvement in the non-HDD gross margin in the quarter. And I have a quick follow-up.
Hi, Katy, it's Dave Morton. So in regards to our gross margins, I'd also like to remind everybody that sequential quarter we also had some production reductions. We were down total volume build-wise. And this is probably the only time I'll talk absolute units, but build-wise, total volumes were down about 4% to 5%. And so, if you think about the absorption loss from that, that added some headwinds.
If you look at it from a year-over-year basis, though, however, absolute gross margin dollars were up approximately $50 million. And so, that's where you're really starting to see the expansion due to the changes from your client/server more so to the mobility cloud and with the build-out of these workloads and these streams. I'd also remind you that our 12 TB is still ramping aggressively into material volume contributions, and so we had some startup costs associated with that as well. So all in all, great quarter by the team, specifically in operations.
In regards to some of our non-hard disk drive contributors to our top line revenue, we did see some small incremental margin accretion there. However, we still have some further optimization to go. We spoke about the Toshiba Memory Corporation alignment coming online. That will provide us some margin opportunities in the back half of this year. And then, we still have some near-term opportunities within our Systems group as well.
And is there any line of sight in terms of getting the non-HDD gross margins up closer to corporate average? Is that possible in the next 12 months, or is that a longer-term goal?
I think it's a longer-term – this is Dave Mosley, by the way, Katy. I think it's a longer-term goal than that. From our perspective, we're staging a lot of resources to be able to intercept these markets. But I think the growth of those markets, for us at least, will be longer-term than that to hit margin parity.
Okay, thank you very much.
Thank you. Our next question is from the line of Mark Delaney of Goldman Sachs. Your line is open.
Good morning and thanks for taking the questions. The first question is on the nearline market. Certainly, we're seeing the positive view throughout the year and potentially into 2019, but I think there are comments about being capacity constrained as well, and specifically within the nearline market. And I was hoping you could help us understand why you think you may be able to ship bits in line with demand.
I think we're going to have to answer the call – this is to my earlier comments. We're going to have to answer the call with areal density solutions. As far as components, the constraints are pretty tight right now in operations. We can pivot and I think a previous question alluded to this. We can pivot from some of the client markets, but that will be delicate because the lead times are fairly long on some of those decisions. But we're trying our best to go answer it. We'll probably stage not any footprint changes, but a little bit more capital directed at the nearline markets within our budgets and try to answer it as much as we can. The big question for us, the big question for everyone I think that everyone's asking is how long is it going to last and how big is the peak? And I think right now we just see strong demand through the back half of this calendar year.
Okay, that's helpful. And for a follow-up on OpEx, I understood the comments about some investing coming in. The company had a target to get to $375 million of non-GAAP OpEx exiting this fiscal year. Can you just talk about where that stands and to what extent you can still hold disciplined OpEx levels in the back half of the calendar year?
That's good. We've driven all the actions – this is from a time about a year and half ago when we set a bogey and said this is the footprint that we needed to be in. We've driven all the actions to get there, and we're still on that same trajectory. Obviously, with some of these opportunities, there are some near-term, I'll call them, materials challenges around some of the new product launches that we could actually launch faster and get it to market and then answer the question on areal density even quicker to get after revenue.
So we're in that mode right now of looking what our near-term opportunities are. We do want that footprint to be still maintained the same through the back half of this year. So we're trying everything that we can to meet all the market demand, at the same time staying inside the footprint that we worked so hard to get to.
Thank you. Our next question comes from the line of Rob Cihra of Guggenheim Partners. Your line is open.
Great, thanks very much, just a quick question. On the Enterprise SSD business, it's still quite small. I guess it was up a little bit year over year. But what does it take to build momentum there? Is a lot of that tied to the planned Toshiba deal? Is that the big change going forward, or what else can you do there to get that business growing? Thanks.
Yes, from our perspective, one of the things that has hindered us in the past is the fact that we're always changing either the NAND supply from vendor to vendor or even from process node to process node inside of that vendor, and that's fairly disruptive. So I think in general, the customers like us, but they realize the journey we've been on and actually a lot of people have been on with all this disruption to the NAND supply. So having longer-term visibility and a more stable, predictable supply chain is key to growth in that area.
Thank you.
Thank you. And this does conclude today's question-and-answer session. I would like to turn the conference back over to management.
Thanks. I'd like to thank our customers, suppliers, business partners, and employees for their contributions to the March quarter, and we'll talk to everyone on the next earnings call. Thank you.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.