Western Digital Corporation — Fiscal 2021 Second-Quarter Form 10-Q
Business context and reporting period
Western Digital develops, manufactures and sells data-storage devices and solutions across Client Devices, Data Center Devices and Solutions, and Client Solutions, including HDD, flash-based products, and intellectual-property licensing. The reporting quarter ended January 1, 2021, and covers 13 weeks; the six-month period is compared with the six months ended January 3, 2020. Fiscal 2020 included an additional week in its first quarter.
The company began reorganizing into separate flash-based products and HDD business units during fiscal 2021. Discrete operating-segment information had not yet been established and management expected to complete its assessment by the end of fiscal 2021.
Key financial metrics
| Metric | Three months ended Jan. 1, 2021 | Year-over-year change | Six months ended Jan. 1, 2021 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $3.943 billion | Down 7% | $7.865 billion | Down 5% |
| Gross profit | $960 million | Up $25 million | $1.864 billion | Up $171 million |
| Gross margin | 24.3% | Up approximately 3 points | 23.7% | Up approximately 10 points |
| Operating income | $158 million | Versus $50 million | $228 million | Versus $(79) million |
| Net income | $62 million | Versus $(139) million | $2 million | Versus $(415) million |
| Diluted EPS | $0.20 | Versus $(0.47) | $0.01 | Versus $(1.40) |
| Operating cash flow | Not separately provided | Not applicable | $788 million | Versus $510 million |
Quarterly operating margin was 4.0%; six-month operating margin was 2.9%. Quarterly net margin was 1.6%; six-month net margin was approximately breakeven. Interest and other expense declined to $73 million for the quarter and $146 million for the six-month period, primarily because of lower interest rates and debt repayment.
- Quarterly HDD revenue was $1.909 billion, down from $2.396 billion; flash-based revenue was $2.034 billion, up from $1.838 billion.
- Six-month HDD revenue was $3.753 billion, down from $4.804 billion; flash-based revenue was $4.112 billion, up from $3.470 billion.
- Quarterly Client Devices revenue increased 19%, Client Solutions increased 6%, and Data Center Devices and Solutions declined 46%.
- Six-month Client Devices revenue increased 19%, Client Solutions was essentially flat, and Data Center Devices and Solutions declined 36%.
- Cash and cash equivalents were $2.956 billion at January 1, 2021, compared with $3.048 billion at July 3, 2020.
- Total debt was $9.250 billion, or $9.133 billion net of issuance costs and discounts, compared with $9.711 billion at July 3, 2020. Long-term debt was $8.882 billion.
- Inventory increased to $3.576 billion from $3.070 billion. The cash conversion cycle increased to 80 days from 66 days, including inventory days of 109 versus 86.
- Capital expenditures were $576 million for the six-month period. Fiscal 2021 company and Flash Ventures capital expenditures were expected to total approximately $3.1 billion, with related net cash use expected to be approximately $1.0 billion.
Material changes versus the prior comparable period
- Revenue declined despite higher flash volumes, primarily because of lower pricing per gigabyte and lower HDD exabyte volumes, especially in data-center products.
- Profitability improved substantially. Gross margin benefited from a $75 million insurance recovery related to the 2019 Yokkaichi power outage, compared with $68 million of related charges in the prior-year six-month period, lower acquired-intangible amortization, and reduced manufacturing costs.
- Research and development expense declined 7% for the quarter and 5% for the six months; selling, general and administrative expense declined 11% and 14%, respectively, reflecting lower compensation, travel, consulting and marketing costs.
- Operating cash flow increased to $788 million from $510 million, while investing cash flow shifted to a $436 million use from $160 million provided, primarily because of higher capital expenditures and Flash Ventures activity.
- Financing cash use decreased to $450 million from $985 million. The current period included $461 million of debt repayment, including a $300 million voluntary Term Loan B-4 prepayment, but no dividend payments; the prior period included $296 million of dividends.
- The company suspended its dividend in April 2020 and made no stock repurchases during the six months. The remaining stock-repurchase authorization was $4.5 billion.
Guidance, outlook, risks and unusual items
Management expected retail demand to remain solid near term, with potential benefits from 5G, gaming, work-from-home and learn-from-home trends. Management believed data-center cloud digestion was abating, capacity-enterprise HDD revenue had bottomed in the second quarter, and expected a rebound in the third quarter. It also reported completion of qualification for a second-generation enterprise SSD with a major cloud customer and began shipments in the third quarter.
Near-term flash gross margin was expected to benefit from improved pricing and cost reductions. HDD gross margin was expected to remain constrained by pricing for 16-terabyte drives, with longer-term improvement anticipated as higher-capacity drives ramp.
- COVID-19 caused approximately $61 million of additional costs during the six-month period, primarily higher logistics costs. Demand, supply chains, manufacturing, customer qualifications and inventory levels remained exposed to the pandemic.
- Flash Ventures commitments include approximately 50% of variable wafer costs, half of fixed costs, and 49.9% to 50.0% of capital investments when operating cash flow is insufficient. Western Digital’s maximum estimated Flash Ventures exposure was $4.627 billion, including $2.107 billion of lease guarantees.
- The company had $2.25 billion available under its revolving credit facility and was in compliance with applicable leverage and interest-coverage covenants.
- Contractual obligations totaled $22.178 billion, including debt, interest, Flash Ventures commitments, leases, purchase commitments and mandatory deemed repatriation tax.
- The IRS has proposed additional federal tax of approximately $516 million for fiscal years 2008–2009, approximately $549 million for fiscal years 2010–2012, and approximately $343 million for fiscal years 2013–2015, plus potential penalties and interest. The company disputes the positions and intends to contest them.
- Unrecognized tax benefits were approximately $715 million, with approximately $146 million of accrued interest and penalties; approximately $724 million could result in potential cash payments, although timing was not estimable.
- Other ordinary-course legal matters were not considered material by management. The filing reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether anticipated data-center recovery and third-quarter capacity-enterprise HDD rebound occurred.
- Flash and HDD pricing, gross-margin trends, product qualification timing and the pace of higher-capacity-drive production.
- Inventory normalization, cash-conversion-cycle performance and the effect of supply-chain disruptions.
- Progress on deleveraging, debt maturities, variable-rate exposure and the potential resumption of dividends or repurchases.
- Actual fiscal 2021 capital spending and net Flash Ventures cash requirements relative to the approximately $3.1 billion and $1.0 billion expectations.
- Developments in the IRS tax litigation and the timing or amount of any resulting cash payments.
- The final operating-segment structure and related flash-versus-HDD financial disclosures.