Western Digital Corporation — Fiscal Q3 2015 Form 10-Q
Business context and reporting period
Western Digital develops and supplies HDDs, SSDs, personal and network-attached storage, and enterprise and cloud data-center storage solutions under the HGST, WD and G-Technology brands. The filing covers the 13-week quarter ended April 3, 2015, and the nine months then ended. Fiscal 2015 is a 53-week year ending July 3, 2015.
Financial performance and liquidity
| Metric | Q3 FY2015 | Q3 FY2014 | 9M FY2015 | 9M FY2014 |
|---|---|---|---|---|
| Revenue | $3.550 billion | $3.703 billion | $11.381 billion | $11.479 billion |
| Gross profit / margin | $1.032 billion / 29.1% | $1.076 billion / 29.1% | $3.291 billion / 28.9% | $3.331 billion / 29.0% |
| Operating income / margin | $421 million / 11.9% | $419 million / 11.3% | $1.356 billion / 11.9% | $1.439 billion / 12.5% |
| Net income / margin | $384 million / 10.8% | $375 million / 10.1% | $1.245 billion / 10.9% | $1.300 billion / 11.3% |
| Diluted EPS | $1.63 | $1.55 | $5.23 | $5.37 |
- Q3 hard-drive shipments were 54.5 million units, down 10% year over year; PC units were 32.3 million and non-PC units were 22.2 million. Average selling price increased to $61 from $58.
- Enterprise SSD revenue increased to $224 million from $134 million.
- Quarterly operating cash flow was $684 million. Nine-month operating cash flow was $1.754 billion, compared with $2.104 billion in the prior-year period.
- Cash and cash equivalents were $4.812 billion at April 3, 2015, and total investments were $522 million. Approximately $3.9 billion of cash was held outside the United States.
- Debt totaled approximately $2.344 billion, including a $2.3 billion variable-rate term loan; no revolving facility borrowings were outstanding. The term loan rate was 1.68%, and the company was compliant with its covenants.
- Capital expenditures were $456 million, acquisitions used $247 million, share repurchases totaled $772 million, and dividends paid totaled $280 million during the first nine months.
Material changes versus prior comparable periods
- Q3 revenue declined 4% as weak macroeconomic conditions reduced client demand, while industry HDD shipments declined approximately 9% to 125 million units.
- Gross margin was unchanged in Q3 but declined modestly for the nine-month period. Operating margin improved in Q3 because lower operating expenses more than offset the revenue decline, but declined for the nine-month period.
- Q3 R&D and SG&A expenses declined due to lower incentive compensation and cost-structure realignment. Nine-month R&D and SG&A increased because of enterprise SSD investments, the inclusion of acquired businesses and an additional fiscal week in Q1.
- Arbitration-related charges fell to zero in Q3 and $15 million for nine months, versus $13 million and $39 million, respectively. The company paid Seagate $773.4 million in October 2014; Seagate is appealing a court ruling that all amounts were paid and is seeking approximately $29 million of additional interest.
- The company repurchased 7.6 million shares during the nine months and authorized an additional $2.0 billion for repurchases, extending the program through February 2020. It had $2.4 billion of authorization remaining at April 3, 2015.
- On March 9, 2015, the company acquired Amplidata for approximately $264 million, including $173 million of preliminary goodwill. The acquisition’s reported revenue and net income contribution was immaterial.
Guidance, outlook, commentary and risks
Management described the demand environment as soft, particularly for client products, and cited weak macroeconomic conditions. The filing discusses expectations for industry demand and shipments in the quarter ending July 3, 2015, but does not provide a clear numerical revenue or earnings forecast.
- Management believes cash, operating cash flow and available credit facilities are sufficient for working capital, debt service, dividends, repurchases and capital expenditures for at least the next twelve months.
- Key operating risks include HDD and PC-market deterioration, competition from NAND and other storage technologies, pricing pressure, volatile demand and gross margins, customer concentration, supply constraints, technology transitions, manufacturing disruptions, foreign-exchange exposure and product-quality or warranty claims.
- Warranty accrual increased to $221 million from $173 million a year earlier; actual returns and repair costs could differ materially from estimates.
- Potential contingencies include German copyright levies with reasonably possible losses of up to $90 million, including accrued amounts, and an IRS dispute involving proposed adjustments of approximately $200 million for fiscal years 2006–2009. Unrecognized tax benefits totaled approximately $332 million.
- The company held $2.0 billion of goodwill related to Amplidata and other acquisitions subject to impairment risk, and acquisition purchase-price allocations remained preliminary for Amplidata.
- The company reported effective disclosure controls and no material change in internal control over financial reporting.
Facts investors should verify
- Whether client and overall HDD demand stabilize or continue to decline after the reported 10% unit-shipment reduction.
- Whether enterprise SSD growth offsets PC-market weakness and supports future revenue mix and margins.
- The pace of term-loan repayments, variable-rate exposure and the company’s continued use of cash for repurchases and dividends.
- The final outcome and financial exposure from Seagate’s appeal and the German copyright-levy proceedings.
- The resolution and cash impact of the IRS tax examinations and the sustainability of foreign tax holidays.
- Amplidata’s integration, goodwill valuation and contribution to future results.
- Inventory levels, warranty trends, customer incentives and the effect of competitive pricing on gross margin.