Western Digital Corporation FY2017 Form 10-K Summary
Business context and reporting period
Western Digital develops, manufactures and sells HDD, SSD, NAND-flash and storage-system products across Client Devices, Data Center Devices and Solutions, and Client Solutions. The filing covers the 52-week fiscal year ended June 30, 2017. The request references 2017 Q4; the filing is an annual report but includes unaudited fourth-quarter results.
Fiscal 2017 reflects the first full year of SanDisk operations following the May 12, 2016 acquisition. Western Digital also continued integrating its HGST and WD businesses and operated Flash Ventures NAND joint ventures with Toshiba.
Financial performance and liquidity
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Revenue | $19.093 billion | $12.994 billion | +47% |
| Gross profit | $6.072 billion | $3.435 billion | +77% |
| Gross margin | 31.8% | 26.4% | +5.4 percentage points |
| Operating income | $1.954 billion | $466 million | +320% |
| Operating margin | 10.2% | 3.6% | +6.6 percentage points |
| Net income | $397 million | $242 million | +64% |
| Diluted EPS | $1.34 | $1.00 | +34% |
| Cash flow from operations | $3.437 billion | $1.983 billion | +73% |
Fourth-quarter FY2017 revenue was $4.842 billion, gross profit was $1.681 billion, operating income was $652 million and net income was $280 million, or $0.93 diluted EPS.
- Revenue mix was 50% Client Devices, 29% Data Center Devices and Solutions, and 21% Client Solutions. Exabytes shipped increased to 313 from 262.
- R&D expense increased to $2.441 billion from $1.627 billion, primarily due to SanDisk and continued NAND-flash development. SG&A was $1.445 billion.
- Interest and other expense increased to $1.185 billion from $313 million, largely because of acquisition-related debt and debt settlement losses.
- Income tax expense was $372 million, producing a 48% effective tax rate, compared with a $89 million tax benefit in FY2016.
- Cash and cash equivalents were $6.354 billion at year-end, compared with $8.151 billion in the prior year. Total cash, cash equivalents and marketable securities were $6.472 billion.
- Capital expenditures were $578 million. Management expected FY2018 cash use for property, plant and equipment and Flash Ventures-related notes and investments of approximately $1.5 billion to $1.9 billion.
- Total debt principal was $13.356 billion, including $12.918 billion of long-term debt. The company had $1.0 billion available under its undrawn revolving credit facility.
- Working capital was $6.712 billion and shareholders’ equity was $11.418 billion.
- The company declared $2.00 per share of dividends, totaling $579 million, and made no share repurchases during FY2017.
Material changes versus the prior comparable period
- Revenue growth was primarily attributable to a full year of SanDisk NAND-flash revenue, partly offset by lower PC and enterprise HDD shipments.
- Gross margin expanded due to the higher-margin NAND portfolio, manufacturing integration, cost improvements and NAND technology transitions.
- Operating expenses rose substantially because of the SanDisk acquisition, higher R&D investment and integration activities. Reported FY2017 gross profit and operating results included $1.14 billion of amortization, cost-saving, stock-compensation and acquisition-related charges.
- SanDisk-related debt financing increased interest expense, although the company repaid a $3.0 billion bridge loan, made a voluntary $750 million term-loan repayment and repriced certain term loans.
- Operating cash flow improved, but financing activities used $4.595 billion, principally reflecting debt repayments and dividends. Cash declined by $1.797 billion during the year.
- Restructuring, asset impairment and other charges declined to $232 million from $345 million. The HGST/WD Restructuring Plan 2016 was expected to be substantially completed by the end of calendar 2017.
- Revenue became more geographically concentrated in Asia, which represented 56% of revenue versus 47% in FY2016. No customer represented at least 10% of revenue, but the top ten customers represented 36%.
Guidance, outlook, risks and unusual items
- Management stated that existing cash, operating cash flow and available credit facilities were expected to meet working capital, debt, dividend and capital-expenditure needs for at least the next twelve months.
- Strategic priorities included optimizing HDD, expanding NAND-flash and SSD offerings, transitioning to 3D NAND, and developing higher-value storage solutions.
- BiCS3 64-layer 3D NAND was commercialized, a 512-gigabit 64-layer 3D NAND chip was developed, and BiCS4 96-layer technology was developed for future commercialization.
- Toshiba’s financial distress and proposed transfer or sale of its memory business created material uncertainty for Flash Ventures, including funding, supply, technology-roadmap, governance and litigation risks. Western Digital had asserted consent rights and pursued arbitration and related injunctive relief.
- Flash Ventures commitments included $7.510 billion of contractual obligations, and Western Digital guaranteed approximately $968 million of Flash Ventures lease obligations. The company’s maximum reasonably estimable Flash Ventures exposure was $2.682 billion.
- Key operating risks include HDD and NAND price erosion, volatile demand, PC-market decline, technology transitions, inventory obsolescence, supply-chain concentration, customer concentration, foreign exchange exposure, cybersecurity, manufacturing disruptions and intense competition.
- The IRS had proposed adjustments that could increase federal tax expense by $795 million plus interest for prior fiscal years. The company disputed the adjustments; the ultimate outcome was uncertain.
- Unrecognized tax benefits, including interest and penalties, totaled $611 million, of which $493 million could result in potential cash payments, although timing was not estimable.
- Pending Toshiba-related litigation and arbitration involved alleged trade-secret and contract violations, transfer of Flash Ventures interests, access to databases and engineering wafers, and potential damages. German copyright-levy proceedings could result in losses of up to $155 million, inclusive of amounts accrued.
- Goodwill was $10.014 billion and intangible assets were $3.823 billion at year-end. FY2018 estimated intangible amortization was $1.085 billion, creating a significant future earnings charge.
- The company reported effective disclosure controls and effective internal control over financial reporting, with an unqualified KPMG audit opinion.
Most important facts for investors to verify
- Whether NAND pricing, 3D NAND yields and Flash Ventures capacity investments support the reported gross-margin improvement.
- The company’s ability to reduce debt while funding approximately $1.5 billion to $1.9 billion of expected FY2018 capital and Flash Ventures-related cash needs.
- The effect of Toshiba’s financial condition, ownership changes and litigation on NAND supply, technology development and Western Digital’s guarantees and commitments.
- The sustainability of earnings after excluding acquisition-related amortization, restructuring charges, debt-settlement losses and other unusual items.
- The timing and outcome of IRS examinations, Toshiba disputes, remaining litigation and German copyright-levy claims.
- The expiration of foreign tax holidays from 2018 through 2030 and the potential tax cost of repatriating approximately $16 billion of undistributed foreign earnings.