Western Digital Corporation — Fiscal 2016 First-Quarter 10-Q Summary
Business context and reporting period
Western Digital develops and supplies data-storage solutions, including hard disk drives, solid-state drives, direct-attached storage, personal-cloud products and data-center storage systems under the WD and HGST brands. The quarter ended October 2, 2015, comprised 13 weeks, compared with 14 weeks in the prior-year quarter ended October 3, 2014. Fiscal 2016 is a 52-week year ending July 1, 2016.
Key financial metrics
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Revenue | $3.360 billion | $3.943 billion | Down 15% |
| Gross profit | $955 million | $1.149 billion | Down 17% |
| Gross margin | 28.4% | 29.1% | Down 70 basis points |
| Operating income | $322 million | $469 million | Down 31% |
| Net income | $283 million | $423 million | Down 33% |
| Diluted EPS | $1.21 | $1.76 | Down 31% |
| Cash flow from operations | $545 million | $827 million | Down 34% |
- Enterprise SSD revenue was $233 million, up from $156 million.
- HDD shipments were 51.7 million units, down 20% from 64.7 million units; industry shipments were estimated at approximately 119 million units, down 19% year over year.
- HDD average selling price increased to $60 from $58, but product mix reduced gross margin.
- Research and development expense was $385 million, and selling, general and administrative expense was $192 million.
- Employee termination, asset impairment and other charges increased to $56 million from $9 million, primarily reflecting employee termination benefits and equipment impairments.
- Cash and cash equivalents totaled $5.081 billion at October 2, 2015, with $347 million of short-term investments and approximately $356 million of long-term investments.
- Total debt was approximately $2.5 billion, including $255 million drawn on the revolving facility and approximately $2.3 billion outstanding under the term loan facility. The company was in compliance with its debt covenants.
- Capital expenditures were $151 million. Net cash used in investing activities was $273 million, while net cash used in financing activities was $215 million.
- The company declared a quarterly dividend of $0.50 per share, totaling $116 million, and repurchased 0.7 million shares for $60 million during the quarter.
Material changes versus the prior comparable period
- Revenue declined primarily because of weaker demand, particularly in the PC market, despite a higher HDD average selling price.
- Operating and net income declined because of lower revenue, lower gross margin and higher realignment charges. The comparison also benefited from the absence of the prior-year $14 million Seagate arbitration-related charge.
- Operating cash flow declined by $282 million, primarily due to lower net income. The company also sold $200 million of trade receivables under a factoring agreement during the current quarter, compared with no such sales in the prior-year period.
- Sales incentives and marketing programs represented 11% of gross revenue, compared with 9% in the prior-year period.
- Cash increased by $57 million during the quarter, compared with a $355 million increase in the prior-year period.
- MOFCOM permitted the company to integrate substantial portions of its HGST and WD subsidiaries, subject to maintaining separate WD and HGST sales teams for two years from October 19, 2015. Integration is expected to occur in phases through October 2017.
Guidance, outlook, commentary, risks and unusual items
- Management characterized the demand environment as soft, with accelerated deterioration in the PC market and continued volatility in the HDD industry. The filing does not provide a specific quarterly revenue or earnings forecast.
- Western Digital announced a planned acquisition of SanDisk valued at approximately $18.9 billion. The transaction is expected to close in the first quarter of fiscal 2017, subject to shareholder, antitrust, foreign regulatory and potentially CFIUS approvals.
- The SanDisk transaction is expected to be financed with cash, stock and approximately $18.1 billion of new debt facilities. The proposed financing would materially increase leverage and could constrain liquidity, dividends, capital expenditures and strategic flexibility.
- Unis agreed to make a $3.8 billion equity investment by purchasing 40.8 million newly issued shares at $92.50 per share. Closing was expected in the second or third quarter of fiscal 2016 and remained subject to CFIUS, regulatory and other approvals.
- The company suspended its share-repurchase program effective October 21, 2015, in connection with the planned SanDisk acquisition. The remaining authorization was approximately $2.1 billion at quarter-end.
- The IRS has proposed adjustments that could increase federal tax expense by approximately $795 million, subject to interest, primarily involving transfer pricing and intercompany balances. The company disputes the adjustments. Unrecognized tax benefits were approximately $360 million, of which $299 million could result in potential cash payments.
- German copyright-levy proceedings could result in losses of up to $101 million, including accrued amounts. The exact judgment amount had not been determined.
- The company maintained a $218 million warranty accrual at quarter-end. Actual product returns, repair costs or customer claims could differ materially from estimates.
- Principal operating risks include PC-market contraction, HDD price and margin pressure, competition from NAND and SSD technologies, supply-chain and manufacturing concentration, product defects, foreign-exchange movements, customer concentration, cybersecurity, regulatory approvals and transaction-integration risk.
Important facts for investors to verify
- Whether the Unis investment and SanDisk acquisition received all required regulatory and shareholder approvals and closed on the expected timetable.
- The final financing structure, incremental debt, interest expense, covenant requirements and post-acquisition liquidity.
- HDD industry shipments, PC demand, product mix, ASP trends and gross-margin performance.
- Progress, cost and realized benefits from integrating HGST and WD while maintaining separate sales teams through October 2017.
- Resolution of the IRS proposed adjustments, unrecognized tax benefits and German copyright-levy proceedings.
- Whether restructuring charges, warranty costs, inventory exposure or customer incentives increase as demand weakens.
- The sustainability of the $0.50 quarterly dividend after the proposed acquisition and debt financing.