Western Digital Corp. 10-Q Summary: Quarter Ended Dec 28, 2007
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended December 28, 2007 (Fiscal Q2 2008) and the six months ended December 28, 2007. Western Digital Corporation designs, manufactures, and sells hard drives for desktop, mobile, enterprise, and consumer electronics markets. A significant event during this period was the completion of the acquisition of Komag, Inc. (renamed WD Media, Inc.) on September 5, 2007, for approximately $995 million. This acquisition vertically integrated Western Digital's media manufacturing capabilities.
Key Financial Metrics
| Metric | Three Months Ended Dec 28, 2007 | Six Months Ended Dec 28, 2007 |
|---|---|---|
| Net Revenue | $2,204 million | $3,970 million |
| Gross Margin | $513 million (23.3%) | $836 million (21.1%) |
| Operating Income | $332 million (15.1%) | $467 million (11.8%) |
| Net Income | $305 million | $374 million |
| Diluted EPS | $1.35 | $1.66 |
| Cash from Operations (6mo) | $738 million | |
| Cash & Equivalents (End of Period) | $917 million | |
| Short-Term Debt | $760 million (Bridge Facility) |
Material Changes vs. Prior Period
- Revenue Growth: Net revenue increased 54% year-over-year for the quarter and 48% for the six-month period. This growth was driven by a 40% increase in hard drive unit shipments (34.2 million units in Q2) and a shift in product mix toward higher-capacity drives.
- Margin Expansion: Gross margin percentage improved to 23.3% from 17.9% in the prior-year quarter. This was attributed to improved product mix, favorable demand/supply conditions, and operational efficiencies from the Komag acquisition.
- Operating Expenses: Total operating expenses rose 36% year-over-year. This included a one-time $49 million charge for acquired in-process research and development (IPR&D) related to the Komag acquisition and increased R&D spending to support new programs.
- Debt Structure: The company drew $760 million on a $1.25 billion bridge facility to fund the Komag acquisition. It also repurchased $250 million of convertible debt assumed from Komag.
Guidance, Outlook, and Risks
Outlook: Management expects revenue and gross margin for the March quarter to be lower than the unusually strong December quarter. They view the combination of volume growth, mix improvement, and pricing in the December quarter as extraordinary and unlikely to fully repeat. Operating expenses are anticipated to remain consistent as investment in new products continues.
Financing: The company is in the process of obtaining long-term financing (approx. $750 million) to replace the bridge facility, which matures in 364 days.
Risks and Contingencies:
- Investment Liquidity: The company holds auction-rate securities ($43 million at period end). Due to credit market conditions, these securities may be illiquid, and the company has recognized $8 million in losses ($3 million realized, $5 million other-than-temporary) on these investments.
- Legal Proceedings: Ongoing litigation includes patent infringement claims (StorMedia, Reiber) and derivative actions regarding historical stock option grants. Management believes the financial impact will not be material.
- Integration Risk: Success depends on the timely integration of Komag's media technology with Western Digital's head technology to realize cost synergies.
Investor Verification Checklist
- Verify the status of the long-term financing arrangement intended to replace the $760 million bridge loan.
- Monitor the liquidity and valuation of the remaining auction-rate securities portfolio given credit market volatility.
- Assess the realization of cost synergies and operational efficiencies from the Komag integration in upcoming quarters.
- Review the impact of the $49 million IPR&D charge on future R&D capitalization policies.
- Track the progress of patent litigation (StorMedia and Reiber) for potential injunctions or damages.