Western Digital Corporation — Fiscal 2013 First-Quarter Form 10-Q
Business context and reporting period
Western Digital develops and manufactures storage products, including hard drives, solid-state drives, networking equipment and home entertainment products, under the WD, HGST and G-Technology brands. The report covers the 13-week quarter ended September 28, 2012, compared with the 13-week quarter ended September 30, 2011. Fiscal 2013 includes the full-quarter results of HGST, acquired on March 8, 2012.
Financial performance and liquidity
| Metric | Q1 FY2013 | Q1 FY2012 |
|---|---|---|
| Revenue | $4.035 billion | $2.694 billion |
| Gross margin | $1.193 billion; 29.6% | $541 million; 20.1% |
| Operating income | $592 million; 14.7% margin | $259 million; 9.6% margin |
| Net income | $519 million; 12.9% margin | $239 million; 8.9% margin |
| Diluted EPS | $2.06 | $1.01 |
| Operating cash flow | $936 million | $352 million |
- Revenue increased 50%, while hard-drive shipments increased 8% to 62.5 million units. Average selling price increased to $62 from $46, reflecting product mix and continuing effects of the Thailand flooding.
- Non-compute and enterprise markets represented 44% of hard-drive revenue, compared with 36% in the prior-year quarter. No customer represented at least 10% of revenue, although the top 10 customers accounted for 44%.
- Operating expenses were $601 million, including $396 million of research and development, $179 million of selling, general and administrative expense, and $26 million of employee termination and other charges.
- Cash and cash equivalents were $3.537 billion at September 28, 2012, up from $3.208 billion at June 29, 2012. Cash conversion cycle was four days, compared with one day in the prior-year period.
- Investing cash outflows were $391 million, including $382 million of capital expenditures. Financing cash outflows were $216 million, including $218 million of share repurchases and $58 million of debt repayment.
- Total reported debt was approximately $2.128 billion, comprising $230 million of current debt and $1.898 billion of long-term debt. The term loan balance was approximately $2.1 billion, and the $500 million revolving facility was undrawn and available. The company was in compliance with its debt covenants.
- Working capital remained strong, with current assets of $7.186 billion versus current liabilities of $3.695 billion. Inventory increased to $1.304 billion from $1.210 billion at fiscal year-end.
Material changes versus the prior comparable period
- The HGST acquisition materially increased revenue, shipments, research and development, selling and administrative costs, intangible amortization and debt relative to the prior-year quarter.
- Gross margin expanded by 950 basis points, primarily from higher average selling prices and product mix, partially offset by $38 million of acquisition-related intangible amortization.
- R&D expense more than doubled to $396 million, and SG&A more than doubled to $179 million, largely due to HGST and increased product-development and market-support activities.
- Operating cash flow increased $584 million year over year, while capital expenditures increased $248 million, principally because of HGST activities and flood-related recovery spending.
- The company initiated a quarterly cash dividend of $0.25 per share and repurchased 5.2 million shares for $218 million during the quarter. The remaining repurchase authorization was $2.6 billion at quarter-end.
- The company recorded $26 million of production-realignment charges and ended the quarter with a related accrual of $19 million.
Guidance, outlook, commentary and risks
- Management expected overall hard-drive industry shipments for the quarter ending December 28, 2012, to remain flat sequentially and expected December-quarter revenue to decline from September-quarter revenue.
- The expected revenue decline reflected muted demand, seasonal weakness in gaming and a planned reduction in 3.5-inch hard-drive shipments to Toshiba under the divestiture agreement.
- Management stated that cash, operating cash flow and available credit were expected to fund working capital, debt service, dividends, repurchases and capital expenditures for at least the next twelve months.
- The HGST integration remained subject to regulatory conditions, including maintaining HGST as an independent competitor for at least two years under requirements imposed by China’s Ministry of Commerce. The company did not expect significant operating-expense synergies while those conditions remained in effect.
- The company continued to face risks from weak or volatile storage demand, price erosion, product mix, alternative storage technologies, customer concentration, component availability, manufacturing concentration, foreign-exchange movements and technology transitions.
- Thailand flooding continued to affect component costs, capacity utilization, equipment reliability, insurance recovery and product development. The company could not predict the amount or timing of insurance proceeds.
- A Minnesota court vacated a $630.4 million Seagate arbitration award in full on October 12, 2012, but ordered a rehearing on three trade-secret claims. Seagate appealed on October 30, 2012; the original award could be reinstated, with statutory interest at 10% from the original award date.
- The IRS had proposed approximately $970 million of adjustments to income before tax for fiscal years 2006 and 2007, primarily involving transfer pricing and intercompany transactions. The company reported approximately $276 million of unrecognized tax benefits and believed adequate provisions had been recorded, but the audit outcome remained uncertain.
- The company’s warranty accrual was $230 million at quarter-end, including an unfavorable exposure if actual product returns, repair costs or customer claims differ materially from estimates.
- A 1% increase in the variable interest rate on the term loan would increase annual interest expense by approximately $21 million.
Important facts for investors to verify
- Whether December-quarter revenue and industry shipments developed as management expected, including the impact of gaming seasonality and Toshiba-related shipment reductions.
- The sustainability of the 29.6% gross margin as Thailand-related pricing benefits fade and industry pricing normalizes.
- HGST integration progress, regulatory compliance, remaining purchase-price-allocation adjustments and realization of expected strategic benefits.
- The outcome of the Seagate appeal and rehearing, including potential reinstatement of the $630.4 million award plus interest.
- Resolution of the IRS examinations and the potential effect on unrecognized tax benefits, cash taxes and earnings.
- Debt repayment requirements, variable-rate exposure, covenant compliance and the balance between dividends, share repurchases, capital expenditures and liquidity.
- Inventory levels, utilization of manufacturing assets, component costs and any continuing effects from the Thailand flooding.
- Warranty claims, product quality trends, customer concentration and competitive pressure from solid-state and other storage technologies.