Western Digital Corporation: Fiscal Q2 2024 Form 10-Q Summary
Business context and reporting period
Western Digital develops and manufactures NAND flash and hard disk drive storage products serving Cloud, Client, and Consumer markets. The filing covers the unaudited 13-week quarter and six months ended December 29, 2023, compared with the periods ended December 30, 2022. Fiscal 2024 ends June 28, 2024.
The company manages two reportable segments: Flash and HDD. On October 30, 2023, the Board authorized a plan to separate these businesses into two independent public companies, targeted for the second half of calendar 2024, subject to conditions including final Board approval.
Key financial metrics
| Metric | Q2 FY2024 | Q2 FY2023 | Six months FY2024 | Six months FY2023 |
|---|---|---|---|---|
| Revenue | $3,032 million | $3,107 million | $5,782 million | $6,843 million |
| Gross profit | $492 million | $528 million | $591 million | $1,509 million |
| Gross margin | 16.2% | 17.0% | 10.2% | 22.1% |
| Operating loss | $210 million | $321 million | $806 million | $163 million |
| Net loss | $287 million | $451 million | $972 million | $404 million |
| Net loss attributable to common shareholders | $301 million | $451 million | $1,001 million | $404 million |
| Loss per common share | $0.93 | $1.42 | $3.09 | $1.27 |
| Cash from operating activities | Not separately provided for the quarter | $(718) million | $41 million |
Q2 revenue declined 2%, while six-month revenue declined 16%. Q2 gross margin declined one percentage point; the six-month decline was 12 percentage points. The six-month operating loss widened substantially despite lower operating expenses, principally because of lower revenue, pricing pressure, and manufacturing underutilization charges.
- Flash: Q2 revenue was $1,665 million versus $1,657 million; gross margin was 7.9% versus 14.5%. Six-month revenue was $3,221 million versus $3,379 million, with a negative 0.9% gross margin versus 19.6%.
- HDD: Q2 revenue was $1,367 million versus $1,450 million; gross margin was 24.8% versus 20.7%. Six-month revenue was $2,561 million versus $3,464 million, with a 23.9% gross margin versus 25.2%.
- End markets: Q2 Cloud revenue declined 13%, while Client increased 3% and Consumer increased 6%. Six-month Cloud revenue declined 36%, Client declined 2%, and Consumer increased 7%.
- Operating expenses: Q2 R&D declined 15% and SG&A declined 21%. Business separation costs were $36 million in both the quarter and six-month period, primarily related to establishing new legal entities.
Balance sheet, debt, liquidity, and cash flow
- Cash and cash equivalents were $2,481 million at December 29, 2023, compared with $2,023 million at June 30, 2023. Approximately $1.69 billion was held by foreign subsidiaries.
- Total debt was $8,454 million, or $8,393 million net of issuance costs, compared with $7,100 million and $7,070 million, respectively, at June 30, 2023. Long-term debt was $7,351 million.
- The company issued $1.60 billion of 3.00% convertible senior notes due 2028, repurchased approximately $508 million of 2024 convertible notes, and purchased capped calls for $155 million. The remaining 2024 convertible notes were settled for $592 million plus interest on February 1, 2024.
- The company had $2.25 billion available under its revolving credit facility as of December 29, 2023 and was in compliance with applicable leverage, liquidity, and free cash flow covenants.
- Six-month investing cash flow was positive $24 million, including $274 million of capital expenditures and $193 million of proceeds from property sales. Management expects fiscal 2024 capital expenditures to be below fiscal 2023 levels.
- Six-month financing cash flow was positive $1.151 billion, primarily reflecting new debt proceeds, partially offset by debt repayments, convertible-note repurchases, and capped-call purchases.
- Known material cash requirements totaled $15.424 billion, including debt principal, debt interest, Flash Ventures commitments, operating leases, purchase obligations, and mandatory deemed repatriation tax.
Material changes versus the prior comparable period
- Macroeconomic pressure and customer inventory reductions continued to create a supply-demand imbalance, particularly in Flash, reducing average selling prices.
- Q2 Flash exabytes sold increased 21%, but average selling price per gigabyte declined 17%. Six-month Flash exabytes increased 34%, while average selling price per gigabyte declined 29%.
- Q2 manufacturing underutilization charges were approximately $156 million, including $107 million in Flash and $49 million in HDD. Six-month charges were approximately $381 million, including $249 million in Flash and $132 million in HDD.
- The company received a $36 million insurance recovery related to the 2022 Flash Ventures contamination incident. It continues to pursue additional recovery, but the amount cannot currently be estimated.
- The company recorded $94 million of asset impairments and $29 million of contract termination costs after canceling certain Penang, Malaysia capacity expansion projects. A $85 million gain on the Milpitas sale-leaseback partially offset six-month restructuring and impairment charges.
- Six-month operating cash flow deteriorated from positive $41 million to negative $718 million, partly reflecting $523 million of tax and interest payments related to IRS matters.
- The company revised previously reported comparative financial information for errors involving its Flash Ventures equity-method investments. Management determined the errors were not material to the original periods but that correcting them in the current period was material.
Outlook, commentary, risks, and unusual items
Management stated that supply-demand conditions have shown signs of stabilization, particularly in Client and Consumer, but the market remains dynamic. The company expects near-term results to continue being affected by underutilization, pricing pressure, restructuring actions, and other measures taken to align production and inventory with demand. Management expects long-term storage demand to benefit from digital transformation and believes its actions can improve through-cycle profitability.
The planned Flash and HDD separation is targeted for the second half of calendar 2024. Timing and execution remain subject to Board approval and other conditions, and the separation may increase costs, distract management, affect customer and supplier relationships, and create stock-price volatility.
Key risks include dependence on Kioxia and Flash Ventures, contractual obligations to fund fixed costs and capital investments, approximately $1.609 billion of Flash Ventures lease guarantees, cyclical demand, pricing volatility, customer concentration, supply-chain disruption, cybersecurity incidents, product defects, foreign-exchange risk, higher interest expense, tax examinations, and the company’s elevated debt burden.
The company faces approximately $187 million of remaining IRS-related liability expected to be paid within twelve months. Unrecognized tax benefits totaled $677 million excluding interest and penalties, with approximately $671 million potentially resulting in cash payments. Mandatory R&D capitalization is expected to increase future cash taxes if not modified.
A hypothetical 10% adverse foreign-exchange movement would have resulted in a $283 million fair-value loss at December 29, 2023. A one-percentage-point increase in variable interest rates would increase annual interest expense by approximately $30 million.
Important facts for investors to verify
- Progress, approvals, costs, timing, and expected capital structures for the planned Flash and HDD separation.
- Whether Flash and HDD pricing, demand, utilization, and gross margins continue to stabilize.
- The company’s ability to generate positive operating cash flow while meeting debt maturities, tax payments, and Flash Ventures obligations.
- Remaining 2024 debt obligations and the effect of the February 1, 2024 settlement of the 2024 convertible notes.
- Potential cash payments related to IRS settlements, unrecognized tax benefits, and mandatory deemed repatriation tax.
- Exposure to Kioxia, Flash Ventures operating commitments, lease guarantees, and possible additional capital funding.
- The financial impact of the revised Flash Ventures accounting information and any future revisions.
- Whether cost reductions, capacity cancellations, and lower capital spending impair long-term product development or market share.