Western Digital Corporation: Fiscal 2014 Form 10-K Summary
Business Context and Reporting Period
Western Digital develops and manufactures data-storage solutions, principally hard disk drives (HDDs), with growing solid-state drive (SSD) and enterprise-storage offerings marketed under the HGST, WD and G-Technology brands. The company operates through the HGST and WD subsidiaries, which remained operationally separate under Ministry of Commerce of China (MOFCOM) conditions.
The filing covers the 52-week fiscal year ended June 27, 2014. Fiscal fourth-quarter revenue was $3.651 billion, gross profit was $1.029 billion, operating income was $352 million and net income was $317 million, or $1.32 diluted earnings per share.
Key Financial Metrics
| Metric | Fiscal 2014 | Fiscal 2013 | Change |
|---|---|---|---|
| Net revenue | $15.130 billion | $15.351 billion | Down 1% |
| Gross profit | $4.360 billion | $4.363 billion | Down $3 million |
| Gross margin | 28.8% | 28.4% | Up 40 basis points |
| Operating income | $1.791 billion | $1.266 billion | Up 41% |
| Operating margin | 11.8% | 8.2% | Up 360 basis points |
| Net income | $1.617 billion | $980 million | Up 65% |
| Diluted EPS | $6.68 | $3.98 | Up 68% |
| Operating cash flow | $2.816 billion | $3.119 billion | Down $303 million |
| Capital expenditures | $628 million | $952 million | Down $324 million |
| Hard-drive shipments | 249 million units | 242 million units | Up 3% |
| Hard-drive ASP | $58 | $61 | Down $3 |
Net income benefited from lower unusual charges and a lower effective tax rate. The fiscal 2014 tax provision was $135 million, representing an 8% effective tax rate versus 20% in fiscal 2013. Research and development expense increased 6% to $1.661 billion, or 11.0% of revenue.
At June 27, 2014, cash and cash equivalents were $4.804 billion, short-term investments were $284 million and working capital was $4.875 billion. Total debt was $2.438 billion, including $125 million due within one year, leaving approximately $2.4 billion of net cash before considering other investments and liabilities. The company had no borrowings under its $1.5 billion revolving facility and stated that liquidity and operating cash flow were sufficient for at least the next twelve months.
Fiscal 2014 investing cash outflows were $1.936 billion, including $823 million for acquisitions, $628 million for capital expenditures and $561 million for investment purchases. Financing cash outflows were $385 million, including $816 million of share repurchases and $259 million of dividends paid.
Material Changes Versus the Prior Comparable Period
- Revenue declined modestly despite higher shipments because of lower ASPs, modest price erosion and product mix changes.
- Revenue mix continued shifting away from compute toward enterprise, branded products and consumer electronics; these categories represented 53% of revenue versus 50% in fiscal 2013.
- Non-compute shipments increased to 92 million units from 80 million, supported partly by gaming-console demand, while compute shipments fell to 157 million from 162 million.
- Gross margin improved despite lower ASPs, primarily because of higher volume and operational-excellence initiatives.
- Operating income increased substantially as fiscal 2014 arbitration-related charges fell to $52 million from $681 million and employee termination, impairment and other charges fell to $95 million from $138 million.
- Fiscal 2014 included the acquisitions of VeloBit, sTec and Virident, with aggregate purchase prices of approximately $1.0 billion. Management stated that these acquisitions had no material consolidated revenue or earnings impact for the year.
- Goodwill increased to $2.559 billion from $1.954 billion, primarily because of acquisition activity. No goodwill impairment was recorded.
- The company replaced its prior credit facility with a new $4.0 billion unsecured facility consisting of a $2.5 billion term loan and a $1.5 billion revolver.
Guidance, Outlook, Risks and Unusual Items
Management expected overall industry HDD shipments to increase in the September quarter from 138 million units in the June quarter, primarily due to seasonality. It expected revenue to increase slightly, supported by seasonality and an additional week in the first fiscal quarter of 2015. Fiscal 2015 was expected to contain 53 weeks.
Key operating risks include HDD price erosion, volatile gross margins, declining PC demand, competition from SSDs and other storage technologies, customer concentration, technology-transition execution, component availability, manufacturing disruptions, foreign-exchange exposure and global economic conditions. International sales represented 80% of fiscal 2014 revenue, and HP accounted for 11% of revenue.
The most significant contingency was the Seagate arbitration matter. The company had accrued $758 million as of June 27, 2014, representing the $630.4 million arbitration award plus accrued interest. The matter was before the Minnesota Supreme Court after the Court of Appeals reinstated the award; the filing does not establish the ultimate outcome or payment timing.
MOFCOM had not responded to the company's March 2014 request to lift the requirement that HGST and WD operate separately. Continued restrictions could delay integration and expected synergies and require additional costs.
The company had $300 million of unrecognized tax benefits, of which $246 million represented the cash portion. It also reported $8.2 billion of undistributed foreign earnings for which no U.S. tax had been provided; estimated additional U.S. tax upon repatriation was $2.7 billion. Foreign tax holidays supporting earnings were scheduled to expire in whole or in part from 2015 through 2025.
Other unusual items included a $65 million flood-related insurance recovery, $62 million of asset-impairment charges, $27 million of employee termination benefits and a $3 million gain from selling auction-rate securities. The company also had $3.288 billion of purchase obligations, primarily due within one year.
Important Facts for Investors to Verify
- Resolution, payment requirements and any additional interest or exposure related to the $758 million Seagate arbitration accrual.
- MOFCOM's response and the timing of any integration of HGST and WD.
- Sustainability of the 28.8% gross margin amid declining ASPs and intense HDD, SSD and alternative-technology competition.
- Whether enterprise, cloud, branded and consumer-electronics growth offsets continued PC-market weakness.
- Future cash commitments, including the $2.438 billion term loan, $3.288 billion of purchase obligations, dividends and planned share repurchases.
- Potential effects of foreign tax-holiday expirations, tax audits and the $300 million unrecognized-tax-benefit balance.
- Customer concentration, supply-chain dependence, manufacturing-site concentration and exposure to product defects or warranty claims.
- Fiscal 2015 comparability, including the additional fiscal week and any resulting seasonal effects.