Western Digital Corporation: Fiscal 2010 Form 10-K Summary
Business context and reporting period
Western Digital designs, manufactures and sells hard drives, solid-state drives, media players and branded external storage products worldwide. Fiscal 2010 ended July 2, 2010 and comprised 52 weeks; fiscal 2009 ended July 3, 2009 and comprised 53 weeks. The company operates as one reportable segment: the hard drive business.
Key markets include mobile and desktop PCs, enterprise storage, consumer electronics, external storage and emerging solid-state storage applications. Non-desktop sources represented 64% of fiscal 2010 revenue, up from 62% in fiscal 2009.
Financial performance and liquidity
| Metric | Fiscal 2010 | Fiscal 2009 |
|---|---|---|
| Net revenue | $9.850 billion | $7.453 billion |
| Hard drive shipments | 194 million units | 146 million units |
| Average selling price | $50 | $51 |
| Gross margin | $2.401 billion; 24.4% | $1.337 billion; 17.9% |
| Operating income | $1.525 billion; 15.5% | $519 million; 7.0% |
| Net income | $1.382 billion | $470 million |
| Diluted EPS | $5.93 | $2.08 |
| Operating cash flow | $1.942 billion | $1.305 billion |
| Capital expenditures | $737 million | $519 million |
| Cash and cash equivalents | $2.734 billion | $1.794 billion |
| Total debt | $400 million | $482 million |
Fiscal 2010 gross margin benefited from higher volume, lower costs, favorable product mix and a moderate pricing environment. R&D expense was $611 million, up 20%, while SG&A expense was $265 million, including $27 million related to litigation settlements. The effective tax rate was 9%, compared with 6% in fiscal 2009, and tax holidays in Malaysia and Thailand increased fiscal 2010 net earnings by approximately $560 million.
Working capital was $2.697 billion at year-end. The average cash conversion cycle improved to negative three days from six days. The company stated that cash, cash equivalents and operating cash flow were sufficient to meet foreseeable working capital and capital expenditure needs.
Material changes versus the prior comparable period
- Revenue increased 32%, primarily from higher unit shipments and strong mobile PC demand; mobile drive shipments increased to 80 million from 55 million.
- Gross margin expanded by 650 basis points to 24.4%.
- Operating income nearly tripled, reflecting improved volume, cost structure and the absence of fiscal 2009 restructuring and acquisition-related charges.
- Fiscal 2009 included $112 million of restructuring charges, a $14 million in-process research and development charge and an $18 million gain on the sale of assets. No comparable charges were recorded in fiscal 2010.
- Western Digital acquired Hoya’s magnetic media sputtering operations on June 30, 2010 for approximately $233 million in cash. The acquisition was intended to increase media capacity and support anticipated hard drive demand.
- The company entered the traditional enterprise market in November 2009 with the WD S25 SAS drive.
- Cash increased by $940 million despite $737 million of capital expenditures, $253 million of acquisition spending and $82 million of debt repayments.
- International revenue increased to 81% of total revenue from 80%; Asia represented 53% of revenue, compared with 49% in fiscal 2009.
Fourth-quarter results, outlook and unusual items
Fiscal fourth-quarter revenue was $2.382 billion, gross margin was $535 million, operating income was $293 million and net income was $265 million, or $1.13 diluted EPS. The quarter included $27 million of litigation settlement expense.
Management expected September-quarter revenue to be relatively flat with the June quarter because of lower-than-historical demand growth and competitive pricing conditions. For fiscal 2011, capital expenditures were expected to equal 7% to 8% of revenue, plus approximately $200 million for conversion of head wafer facilities from six-inch to eight-inch wafers and optimization of the Hoya operations. Depreciation and amortization was expected to be approximately $650 million.
Principal risks include hard drive price erosion and oversupply, volatile end-market demand, customer concentration and pricing leverage, rapid technology transitions, competition from solid-state storage, dependence on Asian manufacturing facilities and suppliers, foreign currency exposure, product warranty and recall risks, intellectual property litigation, tax audits and the possible loss or expiration of foreign tax incentives.
The company had $4.210 billion of purchase obligations, $400 million of total debt, $135 million of cash liabilities for unrecognized tax benefits and $99 million of operating lease commitments at July 2, 2010. Approximately $4.0 billion of undistributed foreign earnings had no U.S. tax provision; the estimated additional tax on repatriation was approximately $1.4 billion.
KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal control over financial reporting were effective as of July 2, 2010.
Most important facts for investors to verify
- Whether subsequent pricing pressure and slower demand growth reduced gross margin after fiscal 2010.
- The performance, integration costs and capacity benefits of the Hoya acquisition.
- Fiscal 2011 capital spending, wafer conversion costs and depreciation relative to guidance.
- The sustainability of the unusually low 9% effective tax rate, including foreign tax holidays and unrecognized tax benefits.
- Exposure to customer concentration, mobile PC demand, competitive ASP declines and solid-state storage adoption.
- Potential cash requirements from $4.210 billion of purchase obligations, debt maturities and tax contingencies.
- Developments in pending intellectual property and employment litigation and product warranty costs.
- The company’s post-year-end share repurchases: 1.8 million shares for $50 million through August 13, 2010.