Western Digital Corporation — Fiscal Q2 2023 Form 10-Q Summary
Reporting period: 13 weeks ended December 30, 2022; six months ended December 30, 2022. The comparable prior-year periods ended December 31, 2021. Results are unaudited and reported under U.S. GAAP. Western Digital develops and sells Flash-based storage products and hard disk drives through its Flash and HDD segments.
Financial performance and position
| Metric | Q2 FY2023 | Q2 FY2022 | Six months FY2023 | Six months FY2022 |
|---|---|---|---|---|
| Revenue | $3.107 billion | $4.833 billion | $6.843 billion | $9.884 billion |
| Gross profit | $528 million | $1.583 billion | $1.509 billion | $3.248 billion |
| Gross margin | 17.0% | 32.8% | 22.1% | 32.9% |
| Operating income (loss) | $(321) million | $727 million | $(163) million | $1.505 billion |
| Net income (loss) | $(446) million | $564 million | $(419) million | $1.174 billion |
| Diluted EPS | $(1.40) | $1.79 | $(1.32) | $3.73 |
- Segment revenue: Flash revenue was $1.657 billion, down 37% year over year; HDD revenue was $1.450 billion, down 34%. Flash gross margin was 14.5%, compared with 36.1% in the prior-year quarter; HDD gross margin was 20.7%, compared with 30.6%.
- Operating expenses: R&D was $523 million and SG&A was $250 million. Employee termination, asset impairment and other charges were $76 million in the quarter and $100 million year to date, primarily reflecting restructuring and cost-reduction actions.
- Cash flow: Six-month operating cash flow was $41 million, compared with $1.187 billion in the prior-year period. Capital expenditures were $578 million, and investing cash flow was $(482) million.
- Liquidity: Cash and cash equivalents were $1.871 billion at December 30, 2022, down from $2.327 billion at July 1, 2022. Total current assets were $8.381 billion versus $4.382 billion of current liabilities.
- Debt: Total debt was $7.100 billion principal, with $7.071 billion carrying value, including $38 million classified as current. The company had $2.25 billion available under its revolving credit facility and was compliant with its leverage covenant at quarter-end.
- Balance sheet: Inventories increased to $3.773 billion from $3.638 billion at fiscal year-end, while accounts receivable declined to $1.905 billion from $2.804 billion.
Material changes versus the prior comparable period
- Revenue declined 36% in the quarter and 31% for the first half, driven by lower HDD exabytes sold, customer inventory reductions, weaker demand and lower Flash average selling prices.
- Consolidated gross margin declined 15.8 percentage points in the quarter and 10.8 percentage points for the first half. Flash pricing pressure and approximately $100 million of HDD manufacturing underutilization charges were major drivers.
- The company moved from prior-year profitability to losses, with quarterly net loss increasing by $1.010 billion year over year.
- R&D and SG&A declined as management reduced variable compensation, outside services, material usage and other operating costs.
- The cash conversion cycle increased to 134 days from 86 days, primarily because days in inventory rose to 133 from 102.
- The company adopted ASU 2020-06, reducing additional paid-in capital by $128 million and increasing retained earnings by $91 million on adoption.
Outlook, management commentary and risks
- Macroeconomic conditions, inflation, higher interest rates, recession concerns and customer inventory reductions have weakened demand. Management expects Flash pricing pressure to continue for the next few quarters.
- The company reduced Flash wafer starts by 30% as of January 2023, consolidated production lines, reduced bit growth and scaled back capital expenditures. Additional Flash underutilization charges are expected to affect near-term results.
- Fiscal 2023 aggregate capital expenditures for Western Digital and its share of Flash Ventures capital expenditures were reduced from $2.7 billion to $2.3 billion. Expected net cash usage for property, plant and equipment and Flash Ventures notes receivable was reduced to below $1 billion.
- Management continues a strategic review announced in June 2022, including potential separation of the Flash and HDD businesses. The filing does not provide a definitive transaction timetable or outcome.
- At December 30, 2022, the fair value of each reporting unit exceeded carrying value by 9% for Flash and 28% for HDD. No goodwill impairment was recorded, but further deterioration in operating conditions or stock price could result in an impairment charge.
- Western Digital and the IRS tentatively agreed to resolve tax matters for 2008–2015. Expected tax and interest payments are approximately $720 million to $760 million, partially offset by estimated future tax benefits of $100 million to $150 million. Timing remains uncertain.
- Flash Ventures creates significant commitments and exposure, including a maximum reasonably estimable loss exposure of $4.380 billion and lease guarantee obligations of $1.895 billion.
- Subsequent to quarter-end, the company entered into an $875 million delayed-draw term loan facility and issued $900 million of Series A convertible perpetual preferred stock. The preferred stock carries a 6.25% initial dividend rate and is convertible at an initial price of $47.75 per common share.
- Key risks include demand and pricing volatility, supply-chain disruptions, customer concentration, technology transitions, leverage and covenant requirements, foreign exchange exposure, cybersecurity, tax contingencies, strategic-review execution and potential goodwill impairment.
Important facts for investors to verify
- Whether demand and pricing in Flash and cloud HDD markets stabilize, and the pace of customer inventory normalization.
- The amount and timing of additional manufacturing underutilization, restructuring and impairment charges.
- Compliance with leverage covenants and the conditions that could accelerate credit facility maturities to November 2, 2023.
- The final IRS settlement, expected cash payment timing and resulting tax benefits.
- The outcome and financing implications of the strategic review, including any separation of Flash and HDD.
- Cash generation relative to $7.1 billion of debt, Flash Ventures commitments and planned capital expenditures.
- Potential goodwill impairment, particularly given the limited 9% valuation cushion for the Flash reporting unit.
- The dilution, dividend and redemption implications of the $900 million Series A preferred stock issuance.