Western Digital Corporation — Fiscal 2011 Form 10-K
Business context and reporting period
Western Digital is a global storage company operating in one reportable segment: hard drives. Products also include solid-state drives and home entertainment and networking products. Fiscal 2011 ended July 1, 2011 and comprised 52 weeks; fiscal 2010 also comprised 52 weeks. The filing includes fourth-quarter results for the quarter ended July 1, 2011.
Key financial metrics
| Metric | FY2011 | FY2010 | Change |
|---|---|---|---|
| Net revenue | $9.526 billion | $9.850 billion | Down 3% |
| Gross margin | $1.791 billion | $2.401 billion | Down 25% |
| Gross margin percentage | 18.8% | 24.4% | Down 560 bps |
| Operating income | $781 million | $1.525 billion | Down 49% |
| Operating margin | 8.2% | 15.5% | Down 730 bps |
| Net income | $726 million | $1.382 billion | Down 47% |
| Diluted EPS | $3.09 | $5.93 | Down 48% |
| Operating cash flow | $1.655 billion | $1.942 billion | Down 15% |
| Capital expenditures | $778 million | $737 million | Up 6% |
| Cash and cash equivalents | $3.490 billion | $2.734 billion | Up $756 million |
| Total debt | $294 million | $400 million | Down $106 million |
Hard-drive shipments increased to 207 million units from 194 million, but average selling price declined to $45 from $50. Compute shipments were 151 million, non-compute shipments 46 million, and enterprise shipments 10 million. International sales represented 83% of revenue. Research and development expense increased 15% to $703 million, while selling, general and administrative expense increased 16% to $307 million.
Fourth-quarter 2011 revenue was $2.403 billion, gross margin was $469 million, operating income was $172 million, net income was $158 million, and diluted EPS was $0.67. The quarter included a $25 million litigation accrual, $7 million of HGST acquisition expenses, and $2 million of related debt commitment fees.
Material changes versus the prior comparable period
- Revenue declined despite higher unit shipments because of aggressive pricing and lower ASPs.
- Gross margin fell materially, primarily due to pricing pressure.
- Operating expenses increased to 10.6% of revenue from 8.9%, reflecting higher product-development, sales and marketing spending and $17 million of HGST-related expenses.
- Cash increased to $3.5 billion while total debt declined to $294 million; working capital rose to $3.317 billion from $2.697 billion.
- Fiscal 2011 included $50 million of share repurchases, or approximately 1.8 million shares. No cash dividends were paid.
Guidance, outlook, risks and unusual items
- Management expected September-quarter revenue to increase slightly from the June quarter, primarily due to seasonality.
- Fiscal 2012 capital expenditures were expected at the upper end of a 7% to 8% of revenue range, with depreciation and amortization of approximately $650 million.
- WD announced a planned approximately $4.3 billion acquisition of Hitachi Global Storage Technologies, to be funded with cash, new debt and 25 million newly issued shares. Closing was expected in the second quarter of fiscal 2012, subject to regulatory approvals.
- The proposed acquisition included a potential $250 million termination fee if it failed to close by March 7, 2012 because of specified antitrust or competition issues. A new credit facility of up to $3.0 billion had been negotiated, subject to customary closing conditions.
- Principal risks include pricing erosion, volatile demand and margins, competition from solid-state storage, customer concentration, component shortages, manufacturing disruptions in Asia, foreign-exchange exposure, product warranty claims, intellectual-property litigation, tax audits and acquisition-integration or financing risks.
- The IRS had proposed adjustments involving approximately $970 million of income for WD and $380 million for Komag; the company disputed the unresolved issues. Unrecognized tax benefits totaled $245 million.
- The company accrued $25 million for litigation contingencies in the fourth quarter. A Convolve patent trial ended with a verdict against WD, but the amount was described as immaterial; other litigation outcomes remained uncertain.
Most important facts for investors to verify
- Whether pricing pressure and declining ASPs continued to offset unit-volume growth after fiscal 2011.
- The final regulatory status, financing, share issuance, purchase price and integration costs of the HGST acquisition.
- The effect of the acquisition on leverage, liquidity, covenants, interest expense and dilution.
- The potential cash-tax exposure from the IRS and Komag examinations and the resolution of other uncertain tax positions.
- Whether litigation, warranty claims, component availability, Japan-related supply disruptions or manufacturing concentration resulted in material costs.
- The sustainability of the company’s low effective tax rate, including foreign tax holidays that increased fiscal 2011 net earnings by approximately $362 million.