Western Digital Corporation: Fiscal Q3 2013 Form 10-Q Summary
Business context and reporting period
Western Digital develops and manufactures storage products under the WD, HGST and G-Technology brands, serving enterprise and cloud data centers, client, consumer electronics, backup, Internet and emerging markets. The filing covers the 13-week quarter and nine months ended March 29, 2013, compared with the periods ended March 30, 2012. Fiscal 2013 ends June 28, 2013.
Results include a full quarter of HGST operations, following the March 8, 2012 acquisition. Regulatory requirements continued to require HGST to operate as an independent competitor for at least two years after closing.
Financial performance and liquidity
| Metric | Q3 FY2013 | Q3 FY2012 | Nine months FY2013 | Nine months FY2012 |
|---|---|---|---|---|
| Revenue | $3.764 billion | $3.035 billion | $11.623 billion | $7.724 billion |
| Gross margin | $1.061 billion; 28.2% | $977 million; 32.2% | $3.313 billion; 28.5% | $2.166 billion; 28.0% |
| Operating income | $417 million; 11.1% | $542 million; 17.9% | $1.487 billion; 12.8% | $963 million; 12.5% |
| Net income | $391 million; 10.4% | $483 million; 15.9% | $1.245 billion; 10.7% | $867 million; 11.2% |
| Diluted EPS | $1.60 | $1.96 | $5.02 | $3.61 |
- Q3 hard-drive shipments were 60.2 million units, up 36% year over year; nine-month shipments were 181.9 million units, up 39%.
- Average selling price was $61 per unit in Q3, down from $68, reflecting the unusually high prior-year pricing after Thailand flood-related supply constraints. Nine-month ASP was $62, compared with $59.
- Non-compute and enterprise markets represented 51% of Q3 revenue, compared with 31% in the prior-year period.
- Q3 operating expenses were $644 million, including $63 million of employee termination and other charges. Research and development expense increased 49% year over year to $396 million.
- Q3 operating cash flow was $727 million. Nine-month operating cash flow was $2.435 billion, compared with $1.938 billion in the prior-year period.
- Nine-month capital expenditures were $816 million. Cash used in investing activities was $834 million, versus $3.934 billion in the prior year, which included the HGST acquisition.
- Cash and cash equivalents were $4.060 billion at March 29, 2013, up from $3.208 billion at June 29, 2012. Approximately $2.6 billion was held outside the United States.
- Balance-sheet debt comprised $230 million of current debt and $1.783 billion of long-term debt. The variable-rate term loan had approximately $2.0 billion outstanding, with $500 million available under the revolving facility; the company was compliant with all covenants.
- The company repurchased $607 million of common stock and paid $121 million of dividends during the first nine months. The remaining repurchase authorization was $2.2 billion at March 29, 2013.
Material changes versus the prior comparable period
- Q3 revenue rose 24%, primarily because the comparative period did not include a full quarter of HGST operations.
- Gross margin declined 400 basis points in Q3 because the prior-year period benefited from elevated ASPs caused by Thailand-related industry supply constraints. Nine-month gross margin increased 50 basis points to 28.5%.
- Operating income declined 23% in Q3 despite higher revenue, reflecting lower ASPs, higher operating expenses, increased R&D investment and $63 million of restructuring-related charges.
- Net income declined 19% in Q3, while nine-month net income increased 44%. The nine-month comparison benefited substantially from the inclusion of HGST and the absence of the prior-year acquisition-related financing and Thailand-flooding effects.
- The Q3 income tax provision decreased to $15 million from $55 million, including a $34 million benefit from the retroactive extension of the U.S. federal R&D tax credit. The nine-month tax provision increased to $207 million, including an $88 million charge related to California Proposition 39.
- The company recorded $130 million of employee termination and other charges for the first nine months, compared with no comparable charges in the prior-year period. Prior-year results included $214 million of net Thailand-flooding charges.
Guidance, outlook, risks and unusual items
- Management expected June-quarter industry hard-drive shipments to be flat to slightly down sequentially and revenue to decrease slightly from Q3 because of demand, pricing and seasonal mix.
- Key operating risks include declining ASPs, volatile demand and margins, PC and consumer-electronics cyclicality, competition from solid-state storage, technology transitions, customer concentration, supplier constraints and manufacturing disruption.
- The company identified ongoing effects from the 2011 Thailand flooding, including potential under-absorption of manufacturing assets, elevated component costs, uncertainty regarding restored equipment and uncertain insurance recovery.
- The company faces significant litigation uncertainty in the Seagate trade-secret matter. A $630.4 million arbitration award was vacated in full by a Minnesota court, but Seagate appealed; a successful appeal could reinstate the award plus statutory interest at 10% from the original award date.
- The IRS has proposed approximately $970 million of adjustments to income before taxes for fiscal 2006 and 2007, primarily involving transfer pricing and intercompany transactions. Management disagrees with the proposed adjustments and states that adequate tax provisions have been recorded. The recorded liability for unrecognized tax benefits was approximately $282 million.
- The company changed the annual goodwill impairment test date to the first day of the fiscal fourth quarter and recorded no goodwill impairment in fiscal 2013 or 2012.
- Variable-rate debt creates interest-rate exposure; a one-percentage-point increase in the term-loan rate would increase annual interest expense by approximately $20 million.
- Management stated that cash, operating cash flow and available credit were sufficient for working capital, debt, dividend, repurchase and capital-expenditure needs for at least the next twelve months.
Important facts for investors to verify
- Whether June-quarter revenue and industry shipments met the stated outlook and whether ASP and gross-margin pressure continued.
- The sustainability and profitability of the higher non-compute and enterprise revenue mix.
- Progress and remaining costs of the operational realignment program, including the expected completion in the first quarter of fiscal 2014.
- Cash generation relative to capital expenditures, debt amortization, dividends and share repurchases.
- The status and potential financial exposure of the Seagate appeal and any related arbitration.
- Developments in the IRS examinations, proposed adjustments and the $282 million unrecognized-tax-benefit liability.
- Compliance with HGST regulatory independence requirements and realization of acquisition benefits after those restrictions expire.