Western Digital Corporation — Fiscal 2021 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended April 2, 2021. Fiscal 2021 consists of 52 weeks; the comparable fiscal 2020 period included an additional week in the first quarter. Results are unaudited and presented in U.S. dollars unless otherwise stated.
Business Context
Western Digital develops and manufactures data-storage devices and solutions across HDD, flash-based products, Client Devices, Data Center Devices and Solutions, and Client Solutions. During fiscal 2021, management began reorganizing the business into separate flash-based and HDD product units; discrete segment reporting was expected beginning in the first quarter of fiscal 2022.
Financial Performance
| Metric | Q3 FY2021 | Q3 FY2020 | Nine Months FY2021 | Nine Months FY2020 |
|---|---|---|---|---|
| Revenue | $4.137 billion | $4.175 billion | $12.002 billion | $12.449 billion |
| Gross profit | $1.091 billion | $1.005 billion | $2.955 billion | $2.698 billion |
| Gross margin | 26.4% | 24.1% | 24.6% | 21.7% |
| Operating income | $317 million | $153 million | $545 million | $74 million |
| Net income (loss) | $197 million | $17 million | $199 million | $(398) million |
| Diluted EPS | $0.63 | $0.06 | $0.65 | $(1.34) |
| Operating cash flow | Not separately provided | Not separately provided | $904 million | $652 million |
Quarterly revenue declined 1%, while gross profit increased 9% and operating income more than doubled. The quarterly gross-margin improvement primarily reflected lower acquired-intangible amortization expense. Nine-month earnings also benefited from a $75 million insurance recovery related to the 2019 Flash Ventures power outage, compared with $68 million of outage-related charges in the prior-year period.
Revenue Mix and Operating Drivers
- Q3 product revenue: HDD revenue was $1.962 billion, down from $2.114 billion; flash-based revenue was $2.175 billion, up from $2.061 billion.
- Q3 end markets: Client Devices revenue rose 10% to $2.012 billion; Data Center Devices and Solutions fell 19% to $1.237 billion; Client Solutions rose 8% to $888 million.
- Nine-month mix: Client Devices revenue increased 16%, Client Solutions increased 3%, and Data Center Devices and Solutions decreased 30%.
- Pricing pressure remained significant, with lower pricing per gigabyte partially offset by higher flash volumes. Data-center results were affected by cloud customer inventory digestion and China shipment restrictions.
- Top-ten customers represented 42% of quarterly revenue and 40% of nine-month revenue; no single customer represented 10% or more.
Cash Flow, Liquidity and Capital Structure
- Cash and cash equivalents were $2.734 billion at April 2, 2021, compared with $3.048 billion at July 3, 2020.
- Nine-month operating cash flow was $904 million. Capital expenditures were $820 million, and net cash used in investing activities was $562 million.
- Financing cash outflows were $662 million, including $673 million of debt repayments. The company voluntarily prepaid $450 million of Term Loan B-4 during the nine months and an additional $150 million on April 30, 2021.
- Total debt was $9.037 billion before issuance costs and discounts; carrying value was $8.929 billion. Long-term debt was $8.678 billion.
- The company had $2.25 billion available under its revolving credit facility and was in compliance with applicable leverage and interest-coverage covenants.
- Fiscal 2021 company and Flash Ventures capital expenditures were expected to total approximately $2.9 billion, with expected net cash use for property, plant and equipment and Flash Ventures notes receivable of approximately $800 million.
- The quarterly dividend remained suspended, and no share repurchases were made during the nine months. The remaining repurchase authorization was $4.5 billion.
Material Changes Versus the Prior Comparable Period
- Revenue decreased modestly in the quarter and 4% for the nine months, but gross margins improved by approximately 2 percentage points in the quarter and 3 percentage points year to date.
- Operating income increased by $164 million in the quarter and $471 million for the nine months.
- Interest expense declined because of lower interest rates and debt paydown.
- Operating cash flow increased $252 million year to date, while capital expenditures increased substantially from $432 million to $820 million.
- Inventory increased to $3.683 billion from $3.070 billion, primarily due to higher HDD stocking and improved Flash Ventures output. The cash conversion cycle increased to 86 days from 69 days.
- Research and development and SG&A expenses declined year to date, while quarterly SG&A increased modestly due to higher variable compensation.
Outlook, Risks and Unusual Items
- Management cited positive indicators from the 5G ramp and gaming growth and expected revenue to increase through calendar 2021, led by 18-terabyte HDDs and broad-based flash growth.
- Management expected flash gross margin to benefit from improved pricing and cost reductions and HDD gross margin to improve as higher-capacity drives ramp.
- COVID-19 resulted in approximately $33 million of quarterly and $94 million of nine-month costs, primarily higher logistics costs. Demand remained generally solid, but supply-chain constraints and component tightness persisted.
- Flash Ventures creates significant commitments and exposure. The company’s maximum reasonably estimable exposure was $4.343 billion, including $1.993 billion of operating-lease guarantees and $1.071 billion of notes receivable.
- Total contractual cash obligations and commercial commitments were $21.019 billion, including $9.037 billion of debt, $5.602 billion of Flash Ventures commitments, and $4.277 billion of purchase obligations and other commitments.
- The IRS has asserted substantial transfer-pricing tax adjustments and penalties for multiple tax years. As of April 2, 2021, unrecognized tax benefits were approximately $750 million, with approximately $133 million of accrued interest and penalties; approximately $743 million could result in cash payments, but timing was not estimable.
- Variable-rate debt exposure remained material. After interest-rate swaps, a 1% increase in applicable variable rates would increase annual interest expense by approximately $36 million.
- Other principal risks include semiconductor supply-chain disruption, pricing and competitive pressure, customer concentration, technology transitions, cyberattacks, foreign-exchange movements, COVID-19 developments, debt obligations, and legal or regulatory matters.
Important Facts for Investors to Verify
- Whether data-center demand recovers as cloud inventory digestion and China shipment restrictions abate.
- The pace and profitability of 18-terabyte HDD qualification and ramp, and the sustainability of flash pricing and cost improvements.
- Fiscal 2021 capital expenditures, Flash Ventures funding requirements, and the company’s ability to continue deleveraging.
- The outcome and potential cash impact of the IRS transfer-pricing examinations and related penalties.
- The effect of higher inventory and the 86-day cash conversion cycle on future cash generation.
- Timing of formal flash and HDD segment reporting and the operational impact of the organizational reorganization.
- Any resumption of dividends or share repurchases as leverage improves.