Western Digital Corporation — Fiscal Q3 2023 Form 10-Q Summary
Business context and reporting period
Western Digital develops, manufactures, and sells flash-based storage products and hard disk drives through its Flash and HDD segments. The filing covers the 13-week quarter and nine months ended March 31, 2023, compared with the periods ended April 1, 2022. Fiscal 2023 ends June 30, 2023.
Key financial metrics
| Metric | Q3 FY2023 | Q3 FY2022 | 9M FY2023 | 9M FY2022 |
|---|---|---|---|---|
| Revenue | $2.803 billion | $4.381 billion | $9.646 billion | $14.265 billion |
| Gross profit | $286 million | $1.181 billion | $1.795 billion | $4.429 billion |
| Gross margin | 10.2% | 27.0% | 18.6% | 31.0% |
| Operating income (loss) | $(472) million | $324 million | $(635) million | $1.829 billion |
| Net income (loss) | $(572) million | $25 million | $(991) million | $1.199 billion |
| Loss attributable to common shareholders | $(581) million | $25 million | $(1.000) billion | $1.199 billion |
| Diluted EPS | $(1.82) | $0.08 | $(3.14) | $3.79 |
- Flash revenue was $1.307 billion in Q3, down 42% year over year, with gross margin of negative 5.0% versus 35.6% in the prior-year quarter.
- HDD revenue was $1.496 billion, down 30% year over year, with gross margin of 24.3% versus 27.7%.
- Cloud, Client, and Consumer revenue declined year over year to $1.205 billion, $975 million, and $623 million, respectively.
- Research and development expense declined 17% in Q3 to $476 million, while selling, general and administrative expense declined 14% to $242 million. Restructuring and other charges increased to $40 million from $4 million.
- Cash and cash equivalents were $2.220 billion at March 31, 2023, compared with $2.327 billion at July 1, 2022. Approximately $1.86 billion was held by foreign subsidiaries.
- Net cash used in operating activities for the first nine months was $340 million, compared with $1.585 billion of cash provided in the prior-year period. Investing cash use was $620 million, including $702 million of capital expenditures and $46 million of net receipts related to Flash Ventures.
- Total debt was $7.100 billion in principal, or $7.073 billion net of issuance costs and discounts. Current debt was $1.175 billion and long-term debt was $5.898 billion.
- The company had $2.25 billion available under its revolving credit facility and an undrawn delayed-draw term loan of up to $875 million available through June 30, 2023.
Material changes versus the prior comparable period
- Revenue decreased 36% in Q3 and 32% for the nine-month period, primarily because of weaker demand, customer inventory reductions, lower shipments, and pricing pressure, especially in Flash.
- Flash pricing and the industry supply-demand imbalance materially reduced profitability. Q3 gross profit included approximately $275 million of manufacturing underutilization and inventory write-down charges, including $213 million in Flash and $62 million in HDD.
- The prior-year quarter included $203 million of contamination-related charges associated with Flash Ventures, partially offsetting the year-over-year decline in reported gross profit.
- HDD exabytes shipped declined 23% in Q3 and 22% for the nine-month period, primarily due to lower Cloud shipments.
- The company reduced operating expenses but increased restructuring charges as it consolidated production lines, reduced bit growth, and adjusted its cost structure.
- On January 31, 2023, Western Digital issued $900 million of Series A convertible perpetual preferred stock, receiving $876 million net of issuance costs. The preferred stock carried $9 million of cumulative dividends at March 31 and would have been convertible into approximately 19 million common shares if conversion were permitted.
- The company adopted ASU 2020-06 at the beginning of fiscal 2023, increasing retained earnings by $91 million and reducing additional paid-in capital by $128 million on adoption.
Guidance, outlook, commentary, and risks
- Management stated that inflation, higher interest rates, recession concerns, and customer inventory adjustments have created a supply-demand imbalance and pressured pricing. The filing does not provide a specific quarterly revenue or earnings forecast.
- Western Digital expects fiscal 2023 property, plant and equipment spending plus its share of Flash Ventures capital expenditures to be approximately $2.2 billion. Expected net cash use for company capital expenditures and Flash Ventures notes receivable activity was reduced to approximately $800 million.
- Management expects to scale back capital expenditures, consolidate production lines, reduce bit growth, and control operating expenses until market conditions improve. It expects a return to profitable operations and positive cash flows when the market normalizes.
- The company continues to evaluate strategic alternatives, including potential separation of its Flash and HDD businesses. No transaction had been completed as of March 31, 2023.
- On March 26, 2023, Western Digital identified a cybersecurity incident involving unauthorized access to systems. A copy of an online-store database containing customer contact information, encrypted hashed and salted passwords, and partial credit card numbers was obtained. Core operations were stabilized, and management stated the incident did not materially affect Q3 financial results; investigation, remediation, and potential future costs remain uncertain.
- Western Digital reached a final agreement with the IRS for tax years 2008 through 2012 and a tentative settlement for 2013 through 2015. Expected tax and interest payments total approximately $720 million to $760 million within the next twelve months, potentially offset by $100 million to $150 million of future tax benefits.
- Liquidity is subject to leverage covenants. The company was in compliance at March 31, 2023, and stated that cash plus available credit capacity exceeded the requirement preventing accelerated maturity of certain debt on November 2, 2023.
- Material exposures include $4.328 billion of estimated maximum loss exposure related to Flash Ventures, including lease guarantees, notes receivable, equity investments, inventory, and prepayments. The company also had $17.016 billion of disclosed future cash requirements, including debt, interest, Flash Ventures commitments, leases, purchase obligations, and taxes.
- Goodwill totaled $10.041 billion. No goodwill impairment was recorded, but management identified sensitivity to macroeconomic conditions, operating performance, forecasts, and stock price changes.
Most important facts for investors to verify
- Whether Flash pricing and industry inventory conditions are stabilizing and whether Flash gross margins recover from the Q3 negative 5.0% level.
- The timing and amount of the expected $720 million to $760 million IRS-related cash payments and the related tax benefits.
- Compliance with leverage covenants and the company’s ability to refinance or otherwise address debt maturities, particularly the 2024 convertible notes.
- The ultimate operational, legal, regulatory, customer, and insurance impact of the March 2023 cybersecurity incident.
- Progress and potential outcomes of the strategic review concerning the Flash and HDD businesses.
- Actual capital expenditures and Flash Ventures funding requirements compared with the approximately $800 million net cash-use expectation for fiscal 2023.
- Potential dilution and dividend obligations associated with the Series A preferred stock, including the approximately 19 million currently convertible-equivalent shares.