Western Digital Corporation — Fiscal 2020 First-Quarter 10-Q
Reporting period: Three months ended October 4, 2019. Fiscal 2020 began with a 14-week first quarter, compared with 13 weeks in the prior-year quarter ended September 28, 2018. Western Digital develops and supplies HDD, flash-based storage, data-center solutions, client devices and client solutions.
Financial performance and position
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Revenue | $4.040 billion | $5.028 billion | Down 20% |
| Gross profit | $758 million | $1.664 billion | Down 54% |
| Gross margin | 18.8% | 33.1% | Down 14.3 percentage points |
| Operating income (loss) | $(129) million | $686 million | Declined $815 million |
| Net income (loss) | $(276) million | $511 million | Declined $787 million |
| Diluted EPS | $(0.93) | $1.71 | Declined $2.64 |
| Operating cash flow | $253 million | $705 million | Down $452 million |
- HDD revenue was $2.408 billion, down from $2.494 billion. Flash-based revenue was $1.632 billion, down from $2.534 billion.
- Data Center Devices and Solutions revenue increased 6% to $1.532 billion, primarily from higher capacity-enterprise-HDD volumes. Client Devices revenue fell 39% to $1.616 billion, and Client Solutions revenue fell 4% to $892 million.
- Cost of revenue was $3.282 billion, or 81.2% of revenue, versus 66.9% in the prior-year period. Lower average selling prices, particularly for flash products, drove most of the margin deterioration.
- Research and development expense was $574 million, essentially flat year over year. SG&A declined 14% to $305 million, reflecting cost-reduction actions.
- Cash and cash equivalents were $3.248 billion at October 4, 2019, compared with $3.455 billion at June 28, 2019. Approximately $2.60 billion was held outside the United States.
- Total debt was $10.374 billion of principal, including $251 million classified as current; long-term debt on the balance sheet was $9.961 billion. The company reported $2.25 billion of additional borrowing availability under its revolving credit facility and compliance with debt covenants.
- Free cash flow is not separately presented in the filing. Operating cash flow of $253 million less capital expenditures of $145 million implies approximately $108 million before other investing activity.
Material changes versus the prior comparable period
- Revenue declined $988 million, largely because lower average selling prices contributed approximately 34 percentage points of year-over-year decline. HDD and flash volumes partially offset the pricing pressure.
- Gross profit fell $906 million and gross margin contracted sharply. The company cited flash pricing pressure and $68 million of charges related to the June 2019 power outage at the Flash Ventures facilities.
- Operating results moved from $686 million of operating income and $511 million of net income to losses of $129 million and $276 million, respectively.
- Operating cash flow decreased from $705 million to $253 million. Financing cash use declined to $492 million from $807 million because the company made no share repurchases, although it repaid $319 million of debt and paid $147 million of dividends.
- The company voluntarily prepaid $250 million of its U.S. Term Loan B-4. No scheduled amortization payments remain on that tranche before its April 2023 maturity.
- Western Digital adopted the new lease standard, recognizing a $221 million increase in lease assets and lease liabilities and a $5 million after-tax reduction to opening retained earnings.
- On September 10, 2019, the company acquired substantially all assets of Kazan Networks for $22 million; the acquisition was not material to current-period revenue or earnings.
Guidance, outlook, risks and unusual items
- Management expects flash pricing to improve during fiscal 2020 if industry supply and demand become more balanced. The filing does not provide a specific revenue, earnings or margin forecast.
- Fiscal 2020 cash used for property, plant and equipment and net Flash Ventures notes receivable and equity-investment activity is expected to be less than $500 million, subject to project timing, completion and financing.
- The K1 flash facility in Kitakami, Japan is expected to begin initial production in the second half of fiscal 2020, with meaningful output not expected until the first half of fiscal 2021. Western Digital expects approximately $660 million of equipment, relocation and start-up costs, primarily through the second half of fiscal 2020, plus approximately $360 million of building-depreciation prepayments over three years.
- The June 2019 Flash Ventures power outage reduced flash wafer availability by approximately 4 exabytes. The company recorded aggregate charges of $68 million in the current quarter and $145 million in the preceding quarter and is pursuing recovery, but no recovery amount can be estimated.
- Western Digital announced the sale of its IntelliFlash business and its strategic intention to exit the Storage Systems business, consisting of IntelliFlash and ActiveScale.
- Flash Ventures-related commitments totaled $6.010 billion in the contractual-obligations table, and Western Digital’s maximum estimable loss exposure from Flash Ventures was $4.682 billion, including a $1.694 billion guarantee obligation.
- Material risks include flash supply and pricing volatility, dependence on Kioxia and Flash Ventures, manufacturing disruptions, technology transitions, customer concentration, international operations, foreign exchange, high leverage, variable-rate debt, tax disputes, product defects and litigation.
- The IRS has asserted approximately $1.065 billion of additional federal tax for fiscal years 2008–2012, plus interest, in disputed transfer-pricing and related matters. The company has petitioned the U.S. Tax Court and believes its positions are properly supported.
- As of October 4, 2019, unrecognized tax benefits were approximately $691 million, with approximately $126 million of accrued interest and penalties; the filing states that approximately $698 million could result in potential cash payments, but timing is not estimable.
- The quarterly dividend was $0.50 per share, or $149 million in aggregate. No shares were repurchased during the quarter; $4.50 billion remained available under the repurchase authorization.
Investor verification priorities
- Verify whether flash pricing and supply-demand conditions improved as anticipated and whether gross margins recovered.
- Track K1 construction, spending, production ramp, yields and the timing of meaningful output.
- Assess the financial effect and potential recovery related to the Flash Ventures power outage.
- Monitor debt repayment, refinancing needs, interest costs, covenant compliance and availability under the revolving facility.
- Reconcile Flash Ventures commitments, guarantees and funding requirements with reported liquidity and cash generation.
- Follow the IntelliFlash sale and Storage Systems exit, including proceeds, restructuring costs and any impairment charges.
- Review the status and potential cash impact of the IRS tax litigation and unrecognized tax benefits.
- Evaluate customer concentration, pricing pressure, inventory levels and the sustainability of data-center HDD volume growth.