Western Digital Corporation — Fiscal 2012 Second-Quarter Form 10-Q
Reporting period: 13 weeks ended December 30, 2011; comparable quarter ended December 31, 2010. The six-month period ended December 30, 2011 is compared with the six months ended December 31, 2010. Western Digital provides hard drives, solid-state drives, and home entertainment and networking products.
Financial performance and liquidity
| Metric | Q2 FY2012 | Q2 FY2011 | Change |
|---|---|---|---|
| Revenue | $1,995 million | $2,475 million | Down 19% |
| Gross profit | $648 million | $475 million | Up 36% |
| Gross margin | 32.5% | 19.2% | Up 13.3 percentage points |
| Operating income | $162 million | $240 million | Down 33% |
| Net income | $145 million | $225 million | Down 36% |
| Diluted EPS | $0.61 | $0.96 | Down 36% |
| Operating cash flow | $378 million | The filing does not provide a clear quarterly comparative value |
- For the six months ended December 30, 2011, revenue was $4.689 billion, down 4%; gross margin was 25.4% versus 18.7%; operating income was $421 million versus $451 million; and net income was $384 million versus $422 million.
- Six-month operating cash flow was $730 million, compared with $895 million in the prior-year period. Capital expenditures were $253 million, compared with $450 million, and financing activities used $43 million.
- Cash and cash equivalents were $3.924 billion at December 30, 2011, compared with $3.490 billion at July 1, 2011. Approximately $3.2 billion was held outside the United States.
- Total debt was approximately $231 million, consisting primarily of the variable-rate term loan. The balance required $81 million of principal payments through the remainder of fiscal 2012 and $150 million in fiscal 2013; the facility matures February 11, 2013. The company was in compliance with its covenants.
- Total assets were $7.807 billion and total shareholders’ equity was $5.923 billion at December 30, 2011.
Material changes versus the prior comparable period
- Thailand flooding severely disrupted Western Digital’s manufacturing operations and the broader hard-drive supply chain. Hard-drive shipments fell 45% to 28.5 million units, while average selling price increased 47% to $69.
- Revenue declined despite higher pricing because shipment volume was constrained. Industry shipments were estimated at approximately 119 million units, down 29% year over year and 32% sequentially.
- Gross margin expanded primarily because of higher average selling prices and reduced sales incentives, but was partly offset by lower production volumes, air freight, externally sourced heads, and higher component costs.
- Operating expenses increased to $486 million from $235 million. Research and development expense rose 13% to $191 million, and selling, general and administrative expense rose 45% to $96 million.
- The quarter included $199 million of separately reported flood-related charges: $109 million of property and equipment impairments, $39 million of recovery charges, $28 million of damaged-inventory write-downs, and $23 million of wage continuation.
- SG&A included $11 million of expenses related to the planned HGST acquisition. Six-month acquisition-related expense was $22 million.
Guidance, outlook, commentary, and unusual items
- Management expected fiscal Q3 hard-drive shipments of 31 to 33 million units and revenue to remain flat or increase slightly from the December quarter.
- Management expected approximately $50 million of additional Thailand-flooding charges in fiscal Q3, primarily for recovery work and wage continuation.
- Western Digital targeted a return to pre-flood worldwide hard-drive capacity in the quarter ending September 2012, while stating that industry supply constraints could continue through calendar 2012. The filing’s risk-factor discussion states that production may not return to pre-flood levels until the first quarter of fiscal 2013.
- Expected calendar 2012 capital spending to restore capacity and improve supply-chain infrastructure was approximately $650 million. Fiscal 2012 capital expenditures were expected to total $750 million to $800 million, with depreciation and amortization of approximately $600 million.
- The company maintained property and business-interruption insurance for the Thailand losses, but stated that the claims process was in its early stages and that recoverable amounts and timing could not yet be determined.
- The planned acquisition of HGST had an estimated purchase price of approximately $4.3 billion, funded with cash, new debt, and 25 million newly issued shares. Certain approvals had been received subject to divestitures and technology licensing, but U.S. and Chinese approvals remained outstanding as of January 27, 2012. Closing was targeted for fiscal Q3 2012.
- If the HGST transaction failed to close by March 7, 2012 because of specified antitrust or competition-related issues, Western Digital could be required to pay Hitachi a $250 million termination fee.
- A Seagate arbitration resulted in a final award of $630.4 million, including $105.4 million of pre-award interest. Western Digital petitioned to vacate the award and had accrued $25 million. Management stated that an additional loss of $0 to $605.4 million was reasonably possible, excluding continuing interest at 10% annually.
- The IRS had proposed adjustments to taxable income of approximately $970 million, primarily relating to transfer pricing and intercompany transactions. The company disputed the adjustments and reported approximately $232 million of unrecognized tax benefits.
Most important facts for investors to verify
- Actual recovery of Thailand manufacturing and slider capacity, supplier availability, recovery costs, and insurance proceeds.
- Whether hard-drive pricing remains elevated as industry supply constraints ease, and the resulting effect on gross margin and demand.
- Final outcome of the Seagate arbitration, including any judgment, interest, liability recognition, or cash payment.
- Completion of the HGST acquisition, required divestitures, regulatory approvals, financing terms, share dilution, and the potential $250 million termination fee.
- Execution of the projected $650 million calendar 2012 recovery and infrastructure spending and its effect on liquidity.
- Resolution of the IRS examination and the potential effect of the proposed $970 million tax adjustments.
- Customer concentration, competitive pricing, alternative storage technologies, supplier commitments, warranty exposure, and foreign-currency risks.