Western Digital Corporation — Fiscal 2022 Second-Quarter Form 10-Q
Reporting period: Three and six months ended December 31, 2021, compared with the periods ended January 1, 2021. Fiscal 2022 ends July 1, 2022. Results are unaudited and presented under U.S. GAAP.
Business context
Western Digital develops, manufactures, and sells data-storage devices and solutions through two reportable segments: hard disk drives (HDD) and flash-based products (Flash). End markets are Cloud, Client, and Consumer.
Key financial metrics
| Metric | Q2 FY2022 | Q2 FY2021 | Change |
|---|---|---|---|
| Revenue | $4.833 billion | $3.943 billion | Up 23% |
| Gross profit | $1.583 billion | $960 million | Up 65% |
| Gross margin | 32.8% | 24.3% | Up 8.5 percentage points |
| Operating income | $727 million | $158 million | Up $569 million |
| Net income | $564 million | $62 million | Up $502 million |
| Diluted EPS | $1.79 | $0.20 | Up $1.59 |
| Operating cash flow | Six months: $1.187 billion, versus $788 million |
| Segment | Q2 revenue | Q2 gross margin | Prior-year revenue / margin |
|---|---|---|---|
| HDD | $2.213 billion | 30.6% | $1.909 billion / 25.6% |
| Flash | $2.620 billion | 36.1% | $2.034 billion / 27.1% |
Six-month revenue was $9.884 billion, gross profit was $3.248 billion, operating income was $1.505 billion, and net income was $1.174 billion. Six-month consolidated gross margin was 32.9%, compared with 23.7% in the prior-year period. The effective tax rate was 13% for both the quarter and six-month period, compared with 27% and 98%, respectively, in the prior-year periods.
Balance sheet, cash flow, debt, and liquidity
- Cash and cash equivalents were $2.531 billion at December 31, 2021, down from $3.370 billion at July 2, 2021.
- Total debt principal was $7.400 billion; carrying value was $7.308 billion, including current debt of $251 million. Long-term debt carrying value was $7.057 billion.
- Six-month investing cash outflow was $569 million, including $551 million of capital expenditures. Financing cash outflow was $1.456 billion, primarily reflecting $2.425 billion of debt repayments, partially offset by $998 million of new debt proceeds.
- The company issued $500 million of 2.85% senior notes due 2029 and $500 million of 3.10% senior notes due 2032. It repaid the remaining $1.09 billion of Term Loan B-4 and prepaid approximately $1.21 billion of Term Loan A-1.
- On January 7, 2022, the company replaced Term Loan A-1 with a $3.0 billion Term Loan A-2 maturing in January 2027 and replaced its $2.25 billion revolving facility with a new facility maturing in January 2027. Management stated that more than 85% of principal debt would mature in 2026 or later.
- Management believes cash, operating cash generation, and available credit facilities will meet working-capital, debt, and capital-expenditure needs for at least the next twelve months. The company expects fiscal 2022 property, plant and equipment expenditures, including its share of Flash Ventures capital expenditures, to total approximately $3.0 billion, with related net cash use estimated at approximately $1.5 billion.
Material changes versus the prior comparable period
- Revenue growth was driven by higher HDD and Flash exabytes sold, especially in Cloud, partly offset by lower average price per gigabyte and product-mix changes.
- HDD revenue increased 16% in Q2 and 27% for the first six months; Flash revenue increased 29% and 24%, respectively.
- Cloud revenue increased to $1.920 billion in Q2 from $1.014 billion. Client revenue was modestly lower and Consumer revenue was broadly flat year over year.
- Gross-margin improvement reflected production cost reductions, ramping newer products, a higher-margin Flash mix, and lower acquired-intangible amortization. Q2 corporate amortization charges were $26 million versus $109 million in the prior year.
- Operating expenses increased 7% in Q2 and 7% for the six-month period, principally from higher compensation, headcount, engineering costs, and professional services.
- Top-ten customers represented 46% of Q2 revenue and 44% of six-month revenue, compared with 43% and 41%, respectively, in the prior-year periods. No customer represented 10% or more of revenue.
- No share repurchases occurred during the six months. The remaining authorization was $4.50 billion as of December 31, 2021.
Guidance, outlook, risks, and unusual items
- Management expects supply-chain disruptions, component constraints, and elevated logistics and factory-related costs to continue in the near term and primarily pressure HDD gross margins through the first half of calendar 2022. Q2 incremental COVID-related costs were approximately $70 million, versus $33 million in the prior-year quarter.
- Management expects demand to remain supported by Cloud, work-from-home, distance learning, gaming, 5G mobile devices, and at-home entertainment. Product initiatives include enterprise SSD qualifications, 20-terabyte HDD shipments, BiCS5 products, and initial consumer shipments based on 162-layer BiCS6.
- Flash Ventures remains a significant commitment. The company’s maximum reasonably estimable loss exposure was $4.382 billion, including $1.964 billion of operating lease guarantees, $947 million of notes receivable, $606 million of equity investments, and $865 million of inventory and prepayments.
- Contractual obligations totaled $19.262 billion, including $7.400 billion of debt principal, $6.049 billion of Flash Ventures commitments, $3.770 billion of purchase obligations, and $819 million of mandatory deemed-repatriation tax obligations.
- The IRS has asserted proposed transfer-pricing adjustments of approximately $1.26 billion for fiscal years 2008–2012, plus $340 million of penalties, and approximately $343 million for fiscal years 2013–2015, plus $109 million of penalties. The company disputes the proposed adjustments and intends to contest them.
- Unrecognized tax benefits were approximately $772 million, with approximately $135 million of accrued interest and penalties; the timing of potential payments could not be estimated.
- Key risks include COVID-19 and supply-chain disruptions, pricing and competitive pressure, technology transitions, customer concentration, substantial debt, foreign-exchange and interest-rate exposure, cybersecurity, joint-venture obligations, tax proceedings, and legal and regulatory developments.
- On February 1, 2022, CFO Robert K. Eulau entered into a separation agreement and agreed to remain in an advisory role through May 1, 2022. The filing does not provide the dollar amount of the related severance benefits.
Most important facts for investors to verify
- Whether supply-chain constraints and component costs continue to pressure HDD margins after the reported quarter.
- The sustainability of the substantial gross-margin improvement, including the effect of lower amortization and product mix.
- Execution of the fiscal 2022 capital-spending plan and the cash requirements of Flash Ventures.
- Debt refinancing, maturity extension, interest-rate exposure, and compliance with the amended credit agreement.
- Potential outcomes and cash-tax consequences of the IRS transfer-pricing proceedings and unrecognized tax benefits.
- Progress of enterprise SSD, BiCS5, BiCS6, 20-terabyte HDD, and SMR product ramps.
- Customer concentration, demand trends in Cloud, Client, and Consumer markets, and the effect of declining average price per gigabyte.