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STX > SEC Filings for STX > Form 10-K on 8-Aug-2014All Recent SEC Filings

Show all filings for SEAGATE TECHNOLOGY PLC

Form 10-K for SEAGATE TECHNOLOGY PLC


8-Aug-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion of the Company's financial condition, changes in financial condition and results of operations for the fiscal years ended June 27, 2014, June 28, 2013, and June 29, 2012.

You should read this discussion in conjunction with "Item 6. Selected Financial Data" and "Item 8. Financial Statements and Supplementary Data" included elsewhere in this Annual Report on Form 10-K. Except as noted, references to any fiscal year mean the twelve-month period ending on the Friday closest to June 30 of that year.

Some of the statements and assumptions included in this Annual Report on Form 10-K are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 or Section 21E of the Securities Exchange Act of 1934, each as amended, including, in particular, statements about our plans, strategies and prospects and estimates of industry growth for the fiscal year ending July 3, 2015 and beyond. These statements identify prospective information and may include words such as "expects," "plans," "anticipates," "believes," "estimates," "predicts," "projects" and similar expressions. These forward-looking statements are based on information available to us as of the date of this Annual Report on Form 10-K and management's current views and assumptions. These forward-looking statements are conditioned upon and also involve a number of known and unknown risks, uncertainties and other factors that could cause actual results, performance or events to differ materially from those anticipated by these forward-looking statements. Such risks, uncertainties and other factors may be beyond our control and may pose a risk to our operating and financial condition. Such risks and uncertainties include, but are not limited to: uncertainty in global economic conditions, as consumers and businesses may defer purchases in response to tighter credit and financial news; the impact of variable demand and the adverse pricing environment for disk drives, particularly in view of current business and economic conditions; our ability to successfully qualify, manufacture and sell our disk drive products in increasing volumes on a cost-effective basis and with acceptable quality, particularly new disk drive products with lower cost structures; the impact of competing product announcements; possible excess industry supply with respect to particular disk drive products and our ability to achieve projected cost savings in connection with restructuring plans. Information concerning risks, uncertainties and other factors that could cause results to differ materially from those projected in such forward-looking statements is also set forth in "Item 1A.Risk Factors" of this Annual Report on Form 10-K, which we encourage you to carefully read. These forward-looking statements should not be relied upon as representing our views as of any subsequent date and we undertake no obligation to update forward-looking statements to reflect events or circumstances after the date they were made. The following is a discussion of the financial condition and results of operations for the fiscal years ended June 27, 2014, June 28, 2013, and June 29, 2012.

Our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying consolidated financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. MD&A is organized as follows:


Our Company. Discussion of our business.


Business Overview. Discussion of industry trends and their impact on our business.


Fiscal Year 2014 Summary. Overview of financial and other highlights affecting us for fiscal year 2014.


Results of Operations. Analysis of our financial results comparing fiscal year 2014 to 2013 and comparing fiscal years 2013 to 2012.


Liquidity and Capital Resources. An analysis of changes in our balance sheets and cash flows, and discussion of our financial condition including the credit quality of our investment portfolio and potential sources of liquidity.


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Contractual Obligations and Off-Balance-Sheet Arrangements. Overview of contractual obligations and contingent liabilities and commitments outstanding as of June 27, 2014 and an explanation of off-balance-sheet arrangements.


Critical Accounting Estimates. Accounting estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results.

Our Company

We are a leading provider of electronic data storage solutions. Our principal products are hard disk drives, commonly referred to as disk drives, hard drives or HDDs. Hard disk drives are devices that store digitally encoded data on rapidly rotating disks with magnetic surfaces. Disk drives continue to be the primary medium of mass data storage due to their performance attributes, high quality and cost effectiveness. In addition to HDDs, we produce a broad range of electronic data storage products including solid state hybrid drives ("SSHD") and solid state drives ("SSD").

Our products are designed for enterprise servers, and storage systems in mission critical and nearline applications; client compute applications, where our products are designed primarily for desktop and mobile computing; and client non-compute applications, where our products are designed for a wide variety of end user devices such as digital video recorders ("DVRs"), personal data backup systems, portable external storage systems and digital media systems.

We continue to make strategic investments in order to expand our storage solutions, enter new market adjacencies, and expand our technical expertise. As a result of recent acquisitions, our product and solution portfolio for the enterprise data storage industry includes storage enclosures, integrated application platforms and high performance computing ("HPC") data storage solutions. Our storage subsystems support a range of high-speed interconnect technologies to meet demanding cost and performance specifications. Our modular subsystem architecture allows us to support many segments within the networked storage market by enabling different specifications of storage subsystem designs to be created from a standard set of interlocking technology modules.

In addition to our data storage products and subsystems, we provide data storage services for small to medium-sized businesses, including online backup, data protection and recovery solutions.

Business Overview

Our industry is characterized by several trends and factors that have a material impact on our strategic planning, financial condition and results of operations.

Industry Supply Balance

From time to time the industry has experienced periods of imbalance between supply and demand. To the extent that the disk drive industry builds capacity based on expectations of demand that do not materialize, price erosion may become more pronounced. Conversely, during periods where demand exceeds supply, price erosion is generally muted.

In early October 2011, floodwaters north of Bangkok, Thailand inundated many manufacturing industrial parks that contained a number of the factories supporting the HDD industry's supply chain. The HDD industry had concentrated a large portion of its supply chain participants within these industrial parks in an effort to reduce cost and improve logistics. As a result, the inundation of floodwaters into these industrial parks had caused the closure or suspension of production by a number of participants within the HDD supply chain.

During the supply chain disruption in fiscal year 2012, we believe demand exceeded supply due to the impact from the flooding in Thailand, resulting in an increase in the average selling price ("ASP").


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The industry's ability to manufacture and ship drives had substantially recovered as of the end of fiscal year 2012. In fiscal years 2013 and 2014, we believe the HDD industry's capacity to manufacture HDDs exceeded demand. However, following the impact of the flooding in Thailand and further industry consolidation in fiscal year 2012, the HDD industry has maintained improved pricing discipline resulting in benign price erosion in fiscal years 2013 and 2014.

Demand Trends for Disk Drives

We believe that continued growth in digital content requires increasingly higher storage capacity in order to store, aggregate, host, distribute, manage, backup and use such content. We also believe that as architectures evolve to serve the growing commercial and consumer user base throughout the world, the manner which hard drives are delivered to market and utilized by our customers will evolve as well.

We believe that in the foreseeable future the traditional enterprise and client compute markets that require high capacity storage solutions, as well as the data intensive client non-compute markets, will continue to be best served by hard disk drives due to the industry's ability to deliver cost effective, reliable and energy efficient mass storage devices. Furthermore, the increased use of client non-compute devices that consume media-rich digital content streamed from the cloud increases the demand for high capacity disk drives in nearline applications.

Price Erosion. Historically, our industry has been characterized by price declines for disk drive products with comparable capacity, performance and feature sets ("like-for-like products").

Disk drive manufacturers typically attempt to offset price erosion with an improved mix of disk drive products characterized by higher capacity, better performance and additional feature sets and/or product cost reductions.

Seasonality

The disk drive industry traditionally experiences seasonal variability in demand with higher levels of demand in the second half of the calendar year. This seasonality is driven by consumer spending in the back-to-school season from late summer to fall and the traditional holiday shopping season from fall to winter. In addition, corporate demand is typically higher during the second half of the calendar year.

Fiscal Year 2014 Summary

During the fiscal year 2014, we shipped 220 million units totaling 202 exabytes, generating revenue of $13.7 billion and gross margins of 28% of revenue. Our operating cash flow was $2.6 billion. We issued $1 billion of 4.75% Senior Notes due 2025 and $800 million of 3.75% Senior Notes due 2018 during the June 2014 and December 2013 quarters, respectively. We repurchased approximately 41 million of our ordinary shares during the year for approximately $1.9 billion, paid dividends of $0.6 billion, paid $0.7 billion for the early redemption and repurchase of debt with a principal value of $0.7 billion. Additionally, we acquired all of the outstanding shares of Xyratex Ltd ("Xyratex"), a leading provider of data storage technology, for approximately $0.4 billion. During the June 2014 quarter, we entered into an agreement to acquire LSI's Accelerated Solutions Division and Flash Components Division from Avago for approximately $0.5 billion. The LSI acquisition is expected to close in the first quarter of the fiscal year 2015.


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Results of Operations

We list in the table below summarized information from our consolidated statements of operations by dollars and as a percentage of revenue:

                                                        Fiscal Years Ended
                                                 June 27,    June 28,    June 29,
     (Dollars in millions)                         2014        2013        2012
     Revenue                                     $  13,724   $  14,351   $  14,939
     Cost of revenue                                 9,878      10,411      10,255


     Gross margin                                    3,846       3,940       4,684
     Product development                             1,226       1,133       1,006
     Marketing and administrative                      722         635         528
     Amortization of intangibles                        98          79          38
     Restructuring and other, net                       24           2           4


     Income from operations                          1,776       2,091       3,108
     Other expense, net                               (220 )      (260 )      (226 )


     Income before income taxes                      1,556       1,831       2,882
     (Benefit from) provision for income taxes         (14 )        (7 )        20


     Net income                                  $   1,570   $   1,838   $   2,862

                                                         Fiscal Years Ended
                                                 June 27,      June 28,    June 29,
    (as a percentage of Revenue)                   2014          2013        2012
    Revenue                                            100 %         100 %       100 %
    Cost of revenue                                     72            73          69


    Gross margin                                        28            27          31
    Product development                                  9             8           7
    Marketing and administrative                         5             4           4
    Amortization of intangibles                          1             1           -
    Restructuring and other, net                         -             -           -


    Income from operations                              13            14          21
    Other expense, net                                  (2 )          (2 )        (2 )


    Income before income taxes                          11            12          19
    (Benefit from) provision for income taxes            -             -           -


    Net income                                          11 %          12 %        19 %


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The following table summarizes information regarding revenue, volume shipments, exabytes, average selling prices (ASPs) and revenues by channel and geography:

                                                              Fiscal Years Ended
                                                       June 27,    June 28,    June 29,
(In millions, except percentages, exabytes and ASPs)     2014        2013        2012
Net Revenue                                            $  13,724   $  14,351   $  14,939
Unit Shipments:
Enterprise                                                    31          30          29
Client Compute                                               144         151         156
Client Non-Compute                                            45          45          39


Total Units Shipped                                          220         226         224
ASP (per unit)                                         $      61   $      63   $      66
Exabytes Shipped                                             202         185         150
Revenues by Channel (%)
OEM                                                           68 %        68 %        72 %
Distributors                                                  20 %        21 %        21 %
Retail                                                        12 %        11 %         7 %
Revenues by Geography (%)
Americas                                                      27 %        27 %        26 %
EMEA                                                          19 %        19 %        19 %
Asia Pacific                                                  54 %        54 %        55 %


Fiscal Year 2014 Compared to Fiscal Year 2013

     Revenue

                                               Fiscal Years Ended
                                    June 27,    June 28,                 %
            (Dollars in millions)     2014        2013      Change    Change
            Revenue                 $  13,724   $  14,351   $  (627 )      (4 )%

Revenue in fiscal year 2014 decreased approximately 4%, or $0.6 billion, from fiscal year 2013 as a result of a 3% decrease in units shipped and a $2 decrease in the ASP due to price erosion, partially offset by a more favorable product mix.

     Gross Margin

                                                 Fiscal Years Ended
                                      June 27,    June 28,                 %
           (Dollars in millions)        2014        2013      Change    Change
           Cost of revenue           $    9,878   $  10,411   $  (533 )      (5 )%
           Gross margin              $    3,846   $   3,940   $   (94 )      (2 )%
           Gross margin percentage           28 %        27 %

For fiscal year 2014, gross margin as a percentage of revenue increased to 28% from 27% in the prior fiscal year, as a result of improved product mix and cost savings due to increases in operational efficiencies, offset by modest price erosion.


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     Operating Expenses

                                                    Fiscal Years Ended
                                        June 27,     June 28,                  %
        (Dollars in millions)             2014         2013       Change    Change
        Product development            $    1,226   $    1,133   $     93         8 %
        Marketing and administrative          722          635         87        14 %
        Amortization of intangibles            98           79         19        24 %
        Restructuring and other, net           24            2         22     1,100 %


        Operating expenses             $    2,070   $    1,849   $    221

Product Development Expense. Product development expenses for fiscal year 2014 increased from fiscal year 2013 due to increased investments in HDD and alternative storage technologies of approximately $35 million and headcount related costs of approximately $36 million, net of a decrease in variable performance based compensation expenses of $26 million. In addition, the consolidation of Xyratex, acquired on March 31, 2014 contributed approximately $23 million to Product development expense.

Marketing and Administrative Expense. Marketing and administrative expenses for fiscal year 2014 increased from fiscal year 2013 due to a $40 million increase in headcount related expenses due to annual focal increases and increased investments in certain strategic initiatives as well as enhancement of core businesses of $25 million. In addition, the consolidation of Xyratex contributed approximately $15 million to Marketing and administrative expense.

Amortization of Intangibles. Amortization of intangibles for fiscal year 2014 increased from fiscal year 2013 due to the commencement of amortization of certain in-process research and development assets acquired from Samsung's HDD business in December of 2011 and LaCie in August of 2012.

Restructuring and Other, net. Restructuring and other, net for fiscal years 2014 increased from fiscal year 2013 primarily due to a restructuring charge recorded during the December 2013 quarter associated with a reduction in work force.

     Other Expense, net

                                                Fiscal Years Ended
                                    June 27,     June 28,                 %
           (Dollars in millions)      2014         2013      Change     Change
           Other expense, net      $     (220 ) $     (260 ) $    40        (15 )%

Other expense, net. Other expense, net for fiscal year 2014 decreased by $40 million from fiscal year 2013 due to a $60 million decrease in losses from the early redemption and repurchase of debt and a decrease of $18 million in interest expense due to a reduction in the average interest rate on our outstanding debt. These decreases were partially offset by insurance proceeds of $25 million received during fiscal year 2013 for equipment damaged during the severe flooding in Thailand in October of 2011 and $17 million lower gains on sales of our available for sale securities and strategic investments.

     Income Taxes

                                                          Fiscal Years Ended
                                              June 27,     June 28,                 %
 (Dollars in millions)                          2014         2013      Change     Change
 (Benefit from) provision for income taxes   $      (14 ) $       (7 ) $    (7 )      100 %


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We recorded an income tax benefit of $14 million for fiscal year 2014 compared to an income tax benefit of $7 million for fiscal year 2013. Our fiscal year 2014 benefit from income taxes included $58 million of income tax benefits related to the reversal of a portion of the valuation allowances recorded in prior periods and a net decrease in tax reserves related to audit settlements offset by tax reserves on non-U.S. tax positions taken in prior fiscal years. Our fiscal year 2013 benefit for income taxes included $52 million of income tax benefit from the reversal of a portion of the U.S. valuation allowance recorded in prior periods.

Our Irish tax resident parent holding company owns various U.S. and non-U.S. subsidiaries that operate in multiple non-Irish tax jurisdictions. Our worldwide operating income is either subject to varying rates of tax or is exempt from tax due to tax holidays or tax incentive programs we operate under in Malaysia, Singapore and Thailand. These tax holidays or incentives are scheduled to expire in whole or in part at various dates through 2020.

Our income tax benefit recorded for fiscal year 2014 differed from the provision for income taxes that would be derived by applying the Irish statutory rate of 25% to income before income taxes, primarily due to the net effect of
(i) tax benefits related to non-U.S. earnings generated in jurisdictions that are subject to tax holidays or tax incentive programs and are considered indefinitely reinvested outside of Ireland and (ii) a decrease in valuation allowance for certain deferred tax assets. The acquisition of Xyratex is not expected to have a material impact on our effective tax rate in future periods. Fiscal year 2014 included a valuation allowance release associated with post-acquisitions restructuring. Our income tax benefit recorded for fiscal year 2013 differed from the provision for income taxes that would be derived by applying the Irish statutory rate of 25% to income before income taxes, primarily due to the net effect of (i) tax benefits related to non-U.S. earnings generated in jurisdictions that are subject to tax holidays or tax incentive programs and are considered indefinitely reinvested outside of Ireland, and
(ii) a decrease in valuation allowance for certain U.S. deferred tax assets. The acquisition of a majority interest in the outstanding shares of LaCie did not have a material impact on our effective tax rate in fiscal year 2013.

Based on our non-U.S. ownership structure and subject to (i) potential future increases in our valuation allowance for deferred tax assets; and (ii) a future change in our intention to indefinitely reinvest earnings from our subsidiaries outside of Ireland, we anticipate that our effective tax rate in future periods will generally be less than the Irish statutory rate.

At June 27, 2014, our deferred tax asset valuation allowance was approximately $888 million.

At June 27, 2014, we had net deferred tax assets of $615 million. The realization of these deferred tax assets is primarily dependent on our ability to generate sufficient U.S. and certain non-U.S. taxable income in future periods. Although realization is not assured, we believe that it is more likely than not that these deferred tax assets will be realized. The amount of deferred tax assets considered realizable, however, may increase or decrease in subsequent periods when we re-evaluate the underlying basis for our estimates of future U.S. and certain non-U.S. taxable income.

As of June 27, 2014, the use of approximately $376 million and $90 million of our total U.S. net operating loss and tax credit carry forwards, respectively, is subject to an aggregate annual limitation of $46 million pursuant to U.S. tax law. If certain ownership changes occur in the foreseeable future, there may be an additional annual limitation on our ability to use our total U.S. federal and state net operating loss and credit carryforwards of $2.9 billion, $1.8 billion and $429 million, respectively. It is reasonably possible that such a change could occur. If these ownership changes were to occur, we estimate a one-time charge for additional U.S. income tax expense of approximately $400 million to $500 million may be recorded in the period such change occurs. This additional income tax expense results from a decrease in our net U.S. deferred tax assets recorded through a combination of the write off of deferred tax assets and associated changes to our valuation allowance. We also estimate that the ensuing additional annual limitation on our ability to use our tax attribute carryovers may result in increased U.S. income tax expense associated with such change of approximately $70 million to $85 million each year.


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As of June 27, 2014 and June 28, 2013, we had approximately $115 million and $157 million, respectively, of unrecognized tax benefits excluding interest and penalties. The unrecognized tax benefits that, if recognized, would impact the effective tax rate is $115 million and $157 million as of June 27, 2014 and June 28, 2013, respectively, subject to certain future valuation allowance reversals.

It is our policy to include interest and penalties related to unrecognized tax benefits in the provision for taxes on the Consolidated Statements of Operations. During fiscal year 2014, we recognized a net tax expense for interest and penalties of $8 million as compared to a net tax expense for interest and penalties of $2 million during each fiscal year 2013 and fiscal year 2012. As of June 27, 2014, we had $27 million of accrued interest and penalties related to unrecognized tax benefits compared to $19 million in fiscal year 2013.

During the fiscal year ended June 27, 2014, our unrecognized tax benefits excluding interest and penalties decreased by approximately $42 million primarily due to (i) net decreases in prior years unrecognized tax benefits of $54 million, (ii) increases in current year unrecognized tax benefits of $13 million, (iii) decreases associated with the expiration of certain statutes of limitation of $3 million, (iv) increases from other activity, including non-U.S. exchange gains, of $2 million.

During the 12 months beginning June 28, 2014, we expect that our unrecognized tax benefits could be reduced anywhere from $3 million to . . .

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