Western Digital Corporation — Fiscal 2020 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Western Digital develops and manufactures data-storage devices and solutions across Client Devices, Data Center Devices and Solutions, and Client Solutions. Products include hard disk drives, flash-based storage, and related intellectual-property licensing.
The filing covers the three and six months ended January 3, 2020. Fiscal 2020 contains 53 weeks, with a 14-week first quarter and 13-week remaining quarters; the comparable fiscal 2019 periods contained 13 weeks each.
Financial Performance and Key Metrics
| Metric | Three Months Ended January 3, 2020 | Prior Comparable Period | Six Months Ended January 3, 2020 | Prior Comparable Period |
|---|---|---|---|---|
| Revenue | $4.234 billion | $4.233 billion | $8.274 billion | $9.261 billion |
| Gross profit | $935 million | $1.044 billion | $1.693 billion | $2.708 billion |
| Gross margin | 22.1% | 24.7% | 20.5% | 29.2% |
| Operating income (loss) | $50 million | $176 million | $(79) million | $862 million |
| Net income (loss) | $(139) million | $(487) million | $(415) million | $24 million |
| Diluted EPS | $(0.47) | $(1.68) | $(1.40) | $0.08 |
- HDD revenue was $2.396 billion in the quarter and $4.804 billion year to date. Flash-based revenue was $1.838 billion in the quarter and $3.470 billion year to date.
- Data Center Devices and Solutions revenue increased 39% year over year in the quarter to $1.489 billion, driven by higher capacity enterprise HDD and SSD volumes. Client Devices revenue declined 19% to $1.797 billion, primarily due to lower flash pricing.
- Six-month revenue declined 11% year over year, principally because lower average selling prices, especially for flash products, more than offset volume growth.
- Six-month operating cash flow was $510 million, compared with $1.174 billion in the prior comparable period. Capital expenditures were $305 million, and net cash provided by investing activities was $160 million.
- Cash and cash equivalents were $3.137 billion at January 3, 2020, down from $3.455 billion at June 28, 2019. Cash held outside the United States was $2.28 billion.
- Total debt principal was $9.986 billion, including $286 million classified as current debt. The company had $2.25 billion of additional borrowing availability under its revolving credit facility and was compliant with its debt covenants.
- Shareholders’ equity was $9.379 billion at January 3, 2020. Inventories were $3.122 billion and accounts receivable were $1.791 billion.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue was essentially flat, but gross profit declined $109 million and gross margin fell 2.6 percentage points because of lower average selling prices, particularly in flash.
- For the six-month period, revenue decreased $987 million, gross profit decreased $1.015 billion, and gross margin declined 8.7 percentage points.
- Quarterly R&D expense increased $39 million to $578 million, while SG&A decreased $11 million to $298 million. Six-month R&D increased $37 million, while SG&A decreased $62 million.
- Interest expense declined as a result of debt repayments and lower index rates. The company repaid $707 million of debt during the six months and made voluntary Term Loan B-4 prepayments totaling $575 million through January 3, 2020.
- The prior-year tax expense included substantial discrete effects from the Tax Cuts and Jobs Act, including deemed repatriation tax and a change in the indefinite reinvestment assertion. The current-year six-month tax expense included a $33 million derecognition of certain deferred tax assets.
- Western Digital completed the sale of IntelliFlash for $28 million, payable over three years, and recorded an approximately $17 million gain. It also announced an exit from the Storage Systems business and subsequently agreed to sell ActiveScale; those businesses were not material and were not classified as discontinued operations.
- The company adopted the new lease standard at the beginning of fiscal 2020, increasing lease assets and liabilities by $221 million and reducing opening retained earnings by $5 million.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- Management stated that flash pricing had stabilized compared with the prior quarter and expected flash pricing to improve during fiscal 2020 if supply and demand became more closely aligned.
- Fiscal 2020 company and Flash Ventures capital expenditures were expected to total $2.0 billion to $2.5 billion. Management expected net cash used for company capital expenditures and net Flash Ventures notes-receivable activity to be close to zero after considering joint-venture financing and operating cash flow.
- The K1 flash facility in Kitakami, Japan began initial production in the second half of fiscal 2020, but meaningful output was not expected until the first half of fiscal 2021. Western Digital expected approximately $660 million of equipment, relocation, and start-up costs, with approximately $500 million remaining as of the filing. Remaining committed K1 prepayments were $265 million.
- A June 2019 power outage at Flash Ventures reduced flash wafer availability by approximately 4 exabytes. The company recorded aggregate charges of $68 million in fiscal 2020 and $145 million in fiscal 2019, and was pursuing recovery for which no amount could be estimated.
- Flash Ventures-related commitments totaled $5.939 billion in the contractual-obligations table, and the company’s portion of lease guarantees was approximately $1.746 billion. The maximum reasonably estimable Flash Ventures loss exposure was $4.529 billion.
- Long-term contractual obligations totaled $22.106 billion, including debt, interest, Flash Ventures commitments, operating leases, purchase obligations, and mandatory deemed repatriation tax.
- The IRS is seeking additional federal tax of approximately $1.065 billion, before interest, for fiscal years 2008 through 2012. Western Digital disputes the proposed adjustments and is contesting the matter in U.S. Tax Court. The company reported approximately $696 million of unrecognized tax benefits and $131 million of related interest and penalties; timing of potential payments was not estimable.
- Key risks include declining storage prices, volatile demand, technology transitions, dependence on Kioxia and Flash Ventures, supply-chain disruption, international operations and currency exposure, customer concentration, product defects, cybersecurity, regulatory and tax changes, and substantial debt.
- Management believed cash, operating cash flow, and available credit facilities would be sufficient for working capital, debt, dividends, and capital expenditures for at least the next twelve months. The company declared $1.00 per share of dividends for the six months and made no share repurchases; $4.50 billion remained available under its repurchase authorization.
Important Facts for Investors to Verify
- Whether flash pricing and gross margins improve as expected and whether HDD and data-center volume growth offsets pricing pressure.
- The timing, cost, yield, and customer qualification of the K1 facility and the company’s continuing funding requirements for Flash Ventures.
- Progress and ultimate resolution of the IRS tax litigation, including potential cash payments and interest.
- Debt reduction, variable-rate exposure, refinancing needs, covenant compliance, and the availability of revolving credit.
- Whether operating cash flow can support capital expenditures, Flash Ventures commitments, dividends, and potential share repurchases.
- Potential recovery related to the Flash Ventures power outage, which the filing states cannot currently be estimated.
- The financial and operating effects of the Storage Systems exit and the ActiveScale sale.