Western Digital Corporation: Fiscal 2021 First-Quarter 10-Q Summary
Business Context and Reporting Period
Western Digital develops and sells data-storage devices and solutions across client devices, data-center devices and solutions, and client solutions. Products include hard disk drives (HDD), flash-based products, and related intellectual property.
The filing covers the 13 weeks ended October 2, 2020. The comparable prior-year quarter ended October 4, 2019 and contained 14 weeks. During the quarter, management announced a reorganization into separate flash-based products and HDD business units; discrete reporting for the new structure had not yet been established.
Financial Performance and Key Metrics
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Revenue | $3.922 billion | $4.040 billion | Down 2.9% |
| Gross profit | $904 million | $758 million | Up $146 million |
| Gross margin | 23.0% | 18.8% | Up approximately 4 percentage points |
| Operating income (loss) | $70 million | $(129) million | Improved $199 million |
| Operating margin | 1.8% | (3.2%) | Improved approximately 5 percentage points |
| Net loss | $(60) million | $(276) million | Improved $216 million |
| diluted loss per share | $(0.20) | $(0.93) | Improved $0.73 |
| Cash flow from operations | $363 million | $253 million | Up $110 million |
Revenue by product was $1.844 billion from HDD, down from $2.408 billion, and $2.078 billion from flash-based products, up from $1.632 billion. Revenue by end market was $1.946 billion from Client Devices, $1.129 billion from Data Center Devices and Solutions, and $847 million from Client Solutions.
Gross-margin improvement primarily reflected the absence of prior-year power-outage charges, a $30 million insurance recovery related to that incident, lower acquired-intangible amortization, and reduced manufacturing costs. These benefits were partly offset by approximately $28 million of COVID-19-related costs, primarily higher logistics expenses.
Operating expenses were $834 million, compared with $887 million in the prior-year quarter. Research and development expense was $555 million, selling, general and administrative expense was $256 million, and employee termination, asset impairment, and other charges were $23 million.
Liquidity, Capital Resources, and Debt
- Cash and cash equivalents were $2.995 billion at October 2, 2020, compared with $3.048 billion at July 3, 2020.
- Net cash used in investing activities was $166 million, including $337 million of property, plant, and equipment purchases and net cash activity with Flash Ventures.
- Net cash used in financing activities was $253 million, including $213 million of debt repayment and no dividend payment.
- Total debt was $9.498 billion principal amount, or $9.372 billion net of issuance costs and discounts. Long-term debt was $9.086 billion.
- The Company made a voluntary $150 million prepayment on Term Loan B-4. The 0.50% convertible notes due 2020 were settled in full after the quarter-end.
- Western Digital had $2.25 billion available under its revolving credit facility and was in compliance with its leverage and interest coverage covenants.
- The quarterly dividend remained suspended, and no share repurchases were made. The remaining stock-repurchase authorization was $4.5 billion.
Management believes cash, operating cash flow, and available credit facilities will satisfy working-capital, debt, and capital-expenditure needs for at least the next twelve months. Fiscal 2021 company and Flash Ventures capital expenditures are expected to aggregate approximately $3.1 billion, with estimated net cash use for property, plant and equipment purchases and Flash Ventures notes receivable activity of approximately $1.3 billion.
Material Changes Versus the Prior Comparable Period
- Revenue declined modestly as lower HDD volumes and more competitive pricing outweighed higher flash volumes.
- Client Devices revenue increased 20%, driven by flash-based client-compute SSD demand, work-from-home and remote-learning trends, and gaming. Data Center Devices and Solutions revenue decreased 26% as customers absorbed prior capacity purchases and new products were being ramped.
- Operating results improved substantially because of lower manufacturing costs, reduced operating expenses, prior-year power-outage charges not recurring, and the current-year insurance recovery.
- Interest expense declined $38 million to $84 million due to debt paydowns and lower index rates.
- Operating cash flow increased to $363 million, although the cash conversion cycle lengthened to 79 days from 66 days, reflecting higher days sales outstanding and inventory levels.
- HDD inventory increased as the Company built stock to mitigate COVID-19-related supply-chain disruption and reduce reliance on higher-cost air freight.
Guidance, Outlook, Commentary, and Risks
Management reported generally solid demand and expected near-term retail demand to remain solid. It cited positive indications from 5G and gaming, expected HDD improvement as customers absorb prior purchases, and anticipated sales growth as new products complete qualification. Near-term gross margin is expected to be constrained by lower-margin retail products, with longer-term improvement expected from new product qualifications and higher-capacity drive production.
The COVID-19 environment remained dynamic. Risks include renewed restrictions, supply-chain disruption, higher logistics costs, uncertain customer demand, and potential effects on operations and financial results. The Company also highlighted competitive pricing, technology transitions, manufacturing execution, customer concentration, cybersecurity, global economic conditions, and its high debt level as significant risks.
Flash Ventures with Kioxia creates material funding and guarantee obligations. Western Digital’s maximum reasonably estimable Flash Ventures exposure was $4.325 billion, including $2.004 billion of operating-lease guarantees. Remaining committed K1 building-depreciation prepayments were $178 million, and Flash Ventures-related commitments totaled $6.420 billion in the contractual-obligations table.
Unusual and contingent items include $23 million of business-realignment charges, a $30 million insurance recovery related to the 2019 power outage, and significant tax disputes. The IRS has proposed approximately $1.336 billion of additional federal tax for fiscal years 2008–2015, plus $340 million of asserted penalties for fiscal years 2008–2012, before interest. The Company disputes the proposed adjustments. Unrecognized tax benefits were approximately $711 million, with approximately $141 million of related interest and penalties; timing of potential payments was not estimable.
Important Facts for Investors to Verify
- Whether the separate flash and HDD operating structure produces improved product-level profitability and disclosures in subsequent quarters.
- Whether HDD demand, data-center volumes, pricing, and new-product qualifications support management’s outlook.
- The pace and total cost of fiscal 2021 capital spending, including Flash Ventures funding and K1/Y7 investments.
- Progress on debt reduction, covenant headroom, dividend reinstatement, and any resumption of share repurchases.
- The duration and financial impact of COVID-19-related supply-chain, logistics, and demand effects.
- The outcome and cash implications of the IRS tax proceedings and other unrecognized tax benefits.
- Western Digital’s continuing obligations and potential exposure under Flash Ventures lease guarantees and purchase commitments.