Western Digital Corporation: Fiscal 2012 Form 10-K Summary
Business context and reporting period
Western Digital designs and manufactures hard disk drives, solid-state drives, external storage, networking equipment and related software under the WD, HGST and G-Technology brands. The filing covers the 52-week fiscal year ended June 29, 2012, with comparisons to fiscal 2011 and 2010. HGST was acquired on March 8, 2012; its results are included only from the acquisition date.
Key financial metrics
| Metric | FY 2012 | FY 2011 | Change |
|---|---|---|---|
| Net revenue | $12.478 billion | $9.526 billion | +31% |
| Gross margin | $3.638 billion; 29.2% | $1.791 billion; 18.8% | Margin +10.4 points |
| Operating income | $1.771 billion; 14.2% | $781 million; 8.2% | +127% |
| Net income | $1.612 billion | $726 million | +122% |
| Diluted EPS | $6.58 | $3.09 | +113% |
| Cash flow from operations | $3.067 billion | $1.655 billion | +85% |
| Capital expenditures | $717 million | $778 million | -$61 million |
| Cash and equivalents | $3.208 billion | $3.490 billion | -$282 million |
| Total debt, including current portion | $2.185 billion | $294 million | +$1.891 billion |
- Total hard-drive shipments declined to 202 million units from 207 million, while hard-drive average selling price increased to $62 from $45.
- HGST contributed $3.056 billion of revenue and $501 million of net income from the acquisition date through fiscal year-end.
- R&D expense increased to $1.055 billion from $703 million; SG&A increased to $518 million from $307 million.
- Working capital was $3.109 billion at year-end, compared with $3.317 billion in the prior year. Total assets increased to $14.206 billion from $8.118 billion, primarily reflecting the HGST acquisition.
- International sales represented 81% of fiscal 2012 net revenue. Hewlett-Packard accounted for 11% of revenue, and the top ten customers accounted for 50%.
Material changes versus the prior comparable period
- The HGST acquisition had a preliminary purchase price of approximately $4.7 billion, funded with existing cash, $2.8 billion of new credit facilities and 25 million newly issued shares. Hitachi received approximately 10% of Western Digital’s outstanding shares and two board-designation rights.
- Thailand flooding materially disrupted production beginning in October 2011. Fiscal 2012 included $214 million of net flood-related charges, comprising asset impairments, recovery costs, inventory write-downs and wage continuation, partially offset by insurance recoveries and reimbursements.
- The company restarted Thailand production, expanded slider production into Malaysia and stated that it had sufficient capability to meet anticipated customer demand. It also recorded $80 million of fourth-quarter impairment and other charges related to manufacturing-capacity realignment.
- Gross margin benefited from higher pricing caused by industry supply constraints, but also included $91 million of costs from selling acquisition-related inventory written up to fair value and $48 million of acquired-intangible amortization.
- Cash used in investing activities rose to $4.167 billion, including $3.526 billion for acquisitions. Financing cash flow was $819 million, reflecting new borrowings, debt repayments and $604 million of share repurchases.
Guidance, outlook, risks and unusual items
- Management expected September-quarter industry shipments to remain flat sequentially, with competitive pricing and a slight revenue decline from the June quarter. Fiscal 2013 industry hard-drive shipments were expected to increase 5% from fiscal 2012.
- HGST was required to remain an independent competitor under Chinese regulatory conditions for at least two years, limiting integration and expected near-term operating synergies.
- The company faces continued risks from industry pricing pressure, volatile demand, customer concentration, alternative storage technologies, technology transitions, component availability, manufacturing concentration and foreign-exchange movements.
- Western Digital was defending a Seagate arbitration award of $630.4 million plus interest. Management had accrued $25 million and stated that an additional loss of up to $605.4 million was reasonably possible if efforts to vacate or overturn the award failed. Interest accrued at a 10% annual statutory rate.
- Unrecognized tax benefits totaled $280 million. The IRS had proposed adjustments to approximately $970 million of income, primarily involving transfer pricing and intercompany transactions; management disputed the proposed adjustments.
- The term loan facility had an outstanding balance of $2.185 billion, including $230 million due within one year. Principal payments of $230 million were scheduled annually through fiscal 2016, with the remaining balance due in fiscal 2017. The company was in compliance with its debt covenants at year-end.
- The company authorized an additional $1.5 billion stock-repurchase program in May 2012 and had used $188 million of that authorization by fiscal year-end. No cash dividends were paid or planned in the foreseeable future.
- Cash, cash equivalents and operating cash flow were expected to be sufficient for working capital, debt and capital-expenditure needs over the next twelve months, although $1.7 billion of cash was held outside the United States and was intended to remain invested in foreign operations.
Most important facts for investors to verify
- Whether supply normalization after the Thailand flooding causes average selling prices and gross margins to decline.
- The pace and economics of integrating HGST while complying with MOFCOM’s independence requirements.
- Debt repayment progress, variable-rate exposure and compliance with leverage and interest-coverage covenants.
- The eventual outcome and financial impact of the Seagate arbitration, including accruing interest.
- The resolution of the IRS examination and the potential cash impact of unrecognized tax benefits.
- Customer concentration, particularly Hewlett-Packard and the top-ten-customer exposure.
- Whether fiscal 2013 demand growth and the company’s guidance offset risks from PCs, mobile devices, cloud migration, SSD competition and pricing pressure.