Western Digital Corporation: Fiscal Q1 2018 Summary
Business context and reporting period
Western Digital develops and supplies data-storage devices and solutions across Client Devices, Data Center Devices and Solutions, and Client Solutions, including HDD, SSD, NAND-flash and related intellectual-property licensing. The unaudited Form 10-Q covers the 13 weeks ended September 29, 2017, with comparison to the 13 weeks ended September 30, 2016.
Key financial metrics
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Revenue | $5.181 billion | $4.714 billion | Up 10% |
| Gross profit | $1.913 billion | $1.335 billion | Up 43% |
| Gross margin | 36.9% | 28.3% | Up 8.6 percentage points |
| Operating income | $905 million | $232 million | Up 290% |
| Operating margin | 17.5% | 4.9% | Up 12.6 percentage points |
| Net income (loss) | $681 million | $(366) million | Improved by $1.047 billion |
| Diluted EPS | $2.23 | $(1.28) | Improved by $3.51 |
| Operating cash flow | $1.133 billion | $440 million | Up $693 million |
| Capital expenditures | $160 million | $184 million | Down $24 million |
Revenue mix was 52% Client Devices, 26% Data Center Devices and Solutions, and 22% Client Solutions. Asia represented 56% of revenue, the Americas 26%, and Europe, the Middle East and Africa 18%. Exabytes shipped increased to 87 from 80.
Cash and cash equivalents were $6.886 billion at September 29, 2017, while total cash, cash equivalents and marketable securities were $7.015 billion. Total debt principal was $13.327 billion, including $258 million classified as current debt; carrying value after issuance costs and discounts was $13.131 billion. The company had $1.00 billion of additional revolving-credit availability and was in compliance with its financial covenants.
Net cash increased $532 million during the quarter to $6.886 billion. Investing activities used $378 million, including $160 million of capital expenditures, $93 million for acquisitions, and net funding of Flash Ventures. Financing activities used $224 million, including $147 million of dividends and $62 million of debt repayment.
Material changes versus the prior comparable period
- Revenue growth was driven primarily by embedded flash and client SSD products, higher Client Solutions sales, and increased capacity-enterprise HDD and enterprise-SSD sales. Data Center Devices and Solutions revenue was approximately flat.
- Gross-margin expansion reflected favorable flash demand, production-cost improvements from technology transitions, and a higher flash-product mix.
- Research and development expense declined 7% to $592 million, selling, general and administrative expense declined 8% to $364 million, and employee termination, asset impairment and other charges declined 24% to $52 million.
- Interest and other expense declined to $195 million from $503 million, primarily because the prior-year period included a $266 million loss on debt extinguishment and had higher interest expense.
- The effective tax rate was 4%, compared with negative 35% in the prior-year loss period. The current quarter included a $22 million windfall tax benefit from the adoption of ASU 2016-09 and benefits from foreign tax credits and tax holidays.
- The company adopted ASU 2016-09 using the modified retrospective method, increasing beginning retained earnings by $70 million.
- Western Digital acquired substantially all assets of Tegile Systems and Upthere for aggregate cash consideration of $93 million. The acquisitions generated $59 million of goodwill, and their quarterly revenue and earnings were not material.
Guidance, outlook, commentary, risks and unusual items
Management stated that existing cash, operating cash generation and available credit facilities are expected to cover working capital, debt, dividend and capital-expenditure needs for at least the next twelve months. For fiscal 2018, expected cash use for property, plant and equipment and Flash Ventures notes receivable and equity investments was approximately $1.50 billion to $1.90 billion.
Management highlighted the strategic importance of Flash Ventures with Toshiba for NAND supply and 3D NAND technology. Toshiba’s financial difficulties and announced sale of its memory business created uncertainty regarding funding, governance, technology development, capacity expansion and the transfer of Toshiba’s Flash Ventures interests. Western Digital had asserted contractual consent rights and initiated or participated in related litigation and arbitration.
- Flash Ventures notes receivable and equity investments totaled $1.462 billion. The company’s maximum estimable loss exposure, excluding lost profits, was $2.686 billion, including $1.022 billion of operating-lease guarantees.
- Contractual obligations totaled $26.693 billion, including $13.327 billion of debt principal, $4.253 billion of debt interest, $7.146 billion of Flash Ventures and other related commitments, $1.791 billion of purchase obligations, and $176 million of operating leases.
- Western Digital reported a potential IRS adjustment of $795 million, plus interest, involving fiscal 2006–2009 transfer-pricing and intercompany-payable matters. Unrecognized tax benefits, including interest and penalties, totaled $614 million, of which $497 million could result in potential cash payments; timing was not estimable.
- Toshiba and Toshiba Memory Corporation filed a Tokyo court claim seeking injunctive relief and damages of 120 billion Japanese yen. The company also faced other intellectual-property, antitrust, securities, copyright and commercial proceedings. Potential German copyright-levy losses could total up to $166 million, inclusive of accrued amounts.
- Restructuring and integration activities continued, with the 2016 restructuring plan expected to be substantially complete by the end of calendar 2017.
- Key operating risks include NAND supply and pricing volatility, dependence on Toshiba and Flash Ventures, 3D NAND execution, high leverage, customer and supplier concentration, technology transitions, product demand cyclicality, foreign-exchange exposure, litigation, cybersecurity and international operating risks.
Most important facts for investors to verify
- Whether gross-margin gains from flash demand and mix are sustainable as NAND supply, pricing and competition change.
- The outcome of Toshiba-related litigation and arbitration, including the effect on Flash Ventures ownership, governance, capacity investment and NAND supply.
- Progress and cash requirements for the 3D NAND transition, Fab 6 and the stated $1.50 billion–$1.90 billion fiscal-year investment range.
- Debt maturities, variable-rate exposure and refinancing requirements relative to operating cash flow and the $1.00 billion revolving facility availability.
- Resolution and potential cash impact of the IRS examination, unrecognized tax benefits and other legal proceedings.
- Whether SanDisk, HGST and WD integration savings are achieved without additional material restructuring, impairment or execution costs.