Western Digital Corporation Form 10-Q Summary
Business Context and Reporting Period
Western Digital develops, manufactures, and sells data-storage products using Flash and HDD technologies. This fiscal 2023 first-quarter report covers the 13 weeks ended September 30, 2022, compared with the quarter ended October 1, 2021. The financial statements are unaudited and prepared under U.S. GAAP.
Management was conducting a strategic review announced in June 2022, including potential separation of the Flash and HDD businesses, with financial and legal advisers involved as of September 30, 2022.
Key Financial Metrics
| Metric | Q1 FY2023 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $3.736 billion | $5.051 billion | Down 26% |
| Gross profit | $981 million | $1.665 billion | Down 41% |
| Gross margin | 26.3% | 33.0% | Down 6.7 percentage points |
| Operating income | $158 million | $778 million | Down 80% |
| Net income | $27 million | $610 million | Down 96% |
| Diluted EPS | $0.08 | $1.93 | Down 96% |
| Operating cash flow | $6 million | $521 million | Down $515 million |
- Flash revenue was $1.722 billion, down 31%; Flash gross margin declined to 24.5% from 37.0%.
- HDD revenue was $2.014 billion, down 21%; HDD gross margin declined to 28.5% from 30.9%.
- Operating expenses were $823 million, down 7%, including $24 million of employee termination charges.
- Income tax expense was $57 million, producing a 68% effective tax rate versus 13% in the prior-year quarter. The higher rate reflected research-and-development expense capitalization under the Tax Cuts and Jobs Act and the geographic mix of earnings.
- Cash and cash equivalents were $2.049 billion at September 30, 2022, down from $2.327 billion at July 1, 2022.
- Capital expenditures were $320 million. Investing cash outflows were $224 million, and financing cash outflows were $50 million.
- Long-term debt was $7.071 billion, with $2.25 billion available under the revolving credit facility. The company was in compliance with its leverage covenant.
- Total assets were $25.686 billion and shareholders’ equity was $12.107 billion at quarter-end.
- Cash conversion cycle increased to 122 days from 78 days, including inventory days of 128 versus 95 and days sales outstanding of 59 versus 44.
Material Changes Versus the Prior Comparable Period
- Revenue declined across all end markets: Cloud to $1.829 billion from $2.225 billion, Client to $1.229 billion from $1.853 billion, and Consumer to $678 million from $973 million.
- Management attributed the downturn to customer inventory reductions, lower shipments, macroeconomic weakness, inflation, higher interest rates, recession concerns, and pricing pressure from industry oversupply.
- Flash average selling price declined 26%, while HDD exabytes sold declined 12%; both businesses experienced lower average pricing.
- Top-ten customers represented 52% of revenue versus 43% in the prior-year quarter, increasing customer concentration even though no individual customer exceeded 10% of revenue.
- Research and development expense decreased $26 million and selling, general and administrative expense decreased $44 million, partly reflecting cost-control actions.
- Operating cash flow fell sharply because of lower earnings and working-capital requirements, including a $224 million inventory increase.
- The company adopted ASU 2020-06 on July 2, 2022. Adoption reduced additional paid-in capital by $128 million, reduced the debt discount by $48 million, reduced deferred tax liabilities by $11 million, and increased retained earnings by $91 million.
- No stock repurchases were made during the quarter. Approximately $4.5 billion remained available under the authorization expiring July 25, 2023.
Guidance, Outlook, Risks, and Unusual Items
- Management expects demand weakness, reduced shipments, continued Flash pricing pressure, and increased HDD absorption charges in future quarters.
- The company is delaying its BiCS6 transition and reducing 2023 capital expenditures in response to market conditions. It also reduced client HDD production capacity by approximately 40% to reflect the shift from HDD to Flash in PCs.
- Fiscal 2023 company and Flash Ventures capital expenditures are expected to total approximately $2.7 billion. Net cash used for company capital expenditures and Flash Ventures notes-receivable activity is expected to be approximately $1.3 billion.
- Management stated that cash, operating cash flow, and available credit facilities should cover the IRS obligation, working capital, debt, and capital expenditure needs for at least the next twelve months.
- The company and the IRS tentatively agreed to resolve tax matters for 2008 through 2015. Expected tax and interest payments are approximately $600 million to $700 million, partially offset by estimated future tax benefits of $100 million to $150 million. The final agreement and payment timing remained uncertain.
- Unrecognized tax benefits were $1.026 billion, with accrued interest and penalties of $264 million; approximately $1.15 billion could result in cash payments.
- Flash Ventures-related commitments and exposures remain significant. The company’s maximum reasonably estimable loss exposure was $3.925 billion, including $1.684 billion of operating lease guarantees. The company also has substantial wafer purchase, capital funding, and equipment commitments.
- Goodwill impairment testing was performed because of macroeconomic conditions and the decline in the company’s stock price. Estimated fair value exceeded carrying value by 7% for Flash and 32% for HDD; no impairment was recorded. Further deterioration could result in an impairment charge.
- Key risks include semiconductor supply-demand volatility, pricing pressure, customer concentration, supply-chain disruption, foreign-exchange exposure, variable-rate debt, cybersecurity, the strategic review, tax contingencies, and the ability to execute restructuring and technology transitions.
- A hypothetical 10% adverse foreign-exchange movement would have produced an estimated $303 million fair-value loss on the company’s foreign-exchange derivative portfolio at September 30, 2022. A one-percentage-point increase in the Term Loan A-2 variable interest rate would increase annual interest expense by approximately $27 million, partly mitigated by $2 billion of interest-rate swaps through February 2023.
Important Facts for Investors to Verify
- Whether the strategic review results in a separation, sale, or other restructuring of the Flash and HDD businesses.
- The final IRS settlement terms, timing of the estimated $600 million to $700 million payment, and related cash-tax effects.
- Whether demand, pricing, inventory corrections, and HDD absorption charges improve or worsen in subsequent quarters.
- Progress against the approximately $2.7 billion fiscal 2023 capital expenditure plan and the company’s liquidity after tax payments and Flash Ventures commitments.
- Whether goodwill headroom declines further and leads to impairment charges.
- Changes in customer concentration, Flash and HDD gross margins, operating cash flow, and the 122-day cash conversion cycle.
- The company’s ability to maintain debt covenant compliance and manage exposure to variable interest rates and foreign currencies.