Western Digital Corporation: Fiscal 2010 Second-Quarter Form 10-Q
Business context and reporting period
Western Digital designs, manufactures and sells hard drives, solid-state drives, media players and branded external storage products worldwide. The filing covers the 13-week quarter and six months ended January 1, 2010, compared with the periods ended December 26, 2008. Fiscal 2010 is a 52-week year ending July 2, 2010.
Financial performance and liquidity
| Metric | Three months ended Jan. 1, 2010 | Prior-year period | Six months ended Jan. 1, 2010 | Prior-year period |
|---|---|---|---|---|
| Revenue | $2.619 billion | $1.823 billion | $4.827 billion | $3.933 billion |
| Gross margin | $687 million; 26.2% | $290 million; 15.9% | $1.201 billion; 24.9% | $714 million; 18.2% |
| Operating income | $473 million; 18.1% | $16 million; 0.9% | $792 million; 16.4% | $250 million; 6.4% |
| Net income | $429 million | $14 million | $717 million | $225 million |
| Diluted EPS | $1.85 | $0.06 | $3.10 | $1.00 |
- Hard-drive shipments increased 39% year over year to 49.5 million units in the quarter and 25% to 93.6 million units for the six-month period. Quarterly ASP increased to $52 from $51.
- Non-desktop products represented 66% of hard-drive revenue, compared with 65% in the prior-year quarter. Asia represented 50% of quarterly revenue; OEM, distributor and retailer channels represented 48%, 30% and 22%, respectively.
- Six-month operating cash flow was $991 million, compared with $601 million in the prior-year period. Second-quarter operating cash flow was $557 million.
- Capital expenditures were $375 million for the six months. Fiscal 2010 capital-expenditure guidance increased to $650 million-$750 million, and depreciation and amortization guidance increased to approximately $550 million.
- Cash and cash equivalents were $2.435 billion at January 1, 2010, up from $1.794 billion at July 3, 2009. Total assets were $6.585 billion and shareholders’ equity was $3.991 billion.
- Total debt was approximately $444 million, consisting of $94 million current debt and $350 million long-term debt. The company had $250 million available under its revolving facility and was in compliance with covenants.
- Accounts receivable increased to $1.365 billion and inventories to $453 million from $926 million and $376 million, respectively, at July 3, 2009. The cash conversion cycle improved to negative three days from nine days.
Material changes versus the prior comparable period
- Revenue increased 44% in the quarter and 23% for the six months, primarily due to stronger hard-drive demand and higher unit shipments.
- Gross margin expanded substantially, attributed primarily to lower costs, favorable product mix and moderate price declines.
- Operating expenses declined year over year in the quarter despite higher research and development and selling, general and administrative spending, because the prior-year quarter included a $113 million restructuring charge. The restructuring plan was completed in fiscal 2009.
- Research and development expense increased 29% in the quarter and 17% for the six months, reflecting variable incentive compensation and product-development investment. SG&A increased 43% in the quarter and 14% for the six months.
- The company paid down $38 million of debt during the six months and made no common-stock repurchases. Prior-year financing activities included $36 million of repurchases.
- Warranty accrual increased to $155 million at quarter-end from $121 million a year earlier. The filing notes that changes in product-return rates, repair costs or customer quality claims could materially affect future results.
Guidance, outlook, risks and unusual items
- Management expected March-quarter demand to decline sequentially by 1% to 5%, less than the historical 5% to 7% seasonal decline, because December-quarter demand was believed to be partially unsatisfied. Revenue was expected to decrease slightly, while operating expenses were expected to increase slightly as investment in new products and technology continued.
- Management expected strong digital-storage demand to continue through fiscal 2010 and increased planned capital spending accordingly.
- Key risks include hard-drive price erosion and oversupply, weaker consumer or OEM demand, competition from solid-state and other storage technologies, component shortages, concentrated manufacturing facilities in Asia, limited-source suppliers, foreign-currency exposure, customer concentration and product-quality or warranty claims.
- The top 10 customers represented 55% of quarterly revenue. Hewlett-Packard represented at least 10% of quarterly revenue; Dell and Hewlett-Packard each represented at least 10% for the six-month period.
- Unrecognized tax benefits were approximately $178 million, including an estimated cash liability of $84 million; U.S. tax examinations were ongoing. The filing states that the timing and amount of potential changes cannot be reasonably estimated.
- Outstanding legal matters included several patent-infringement actions and an employment-related putative class action. The company intended to defend these matters vigorously; potential exposure was not clearly quantified.
- The company held $15 million of auction-rate securities that might not be readily liquidated at par if credit-market conditions remained weak. Management did not expect these holdings to impair execution of its business plan.
- Accounting-adoption changes for fair value, business combinations and intangible assets had no material impact. The company was evaluating the impact and adoption timing of new multiple-deliverable revenue standards.
Important facts for investors to verify
- Whether elevated demand and the 26.2% quarterly gross margin were sustained after the reported period, particularly amid expected seasonal demand declines.
- Actual unit shipments, ASPs, product mix and pricing trends, including the effect of consumer-driven demand and increasing exposure to non-desktop markets.
- Progress against the $650 million-$750 million fiscal-year capital-expenditure plan and the resulting effect on free cash flow.
- Accounts-receivable growth, inventory levels, customer payment performance and the sustainability of the negative cash conversion cycle.
- Warranty claims, product returns and any changes to warranty accruals that could affect gross margin.
- Developments in patent litigation, the employment litigation, tax audits and the $178 million of unrecognized tax benefits.
- Exposure to customer concentration, component availability, Asian manufacturing disruptions, foreign-currency movements and competition from solid-state storage.