Western Digital Corporation — Fiscal Q1 2012 Form 10-Q
Reporting period: Three months ended September 30, 2011, compared with three months ended October 1, 2010. Both quarters comprised 13 weeks. Western Digital provides hard drives, solid-state drives, and home entertainment and networking products.
Financial performance and position
| Metric | Q1 FY2012 | Q1 FY2011 | Change |
|---|---|---|---|
| Revenue | $2.694 billion | $2.396 billion | +12% |
| Gross margin | $541 million; 20.1% | $437 million; 18.2% | Margin up 190 bps |
| Operating income | $259 million; 9.6% margin | $211 million; 8.8% margin | +$48 million |
| Net income | $239 million | $197 million | +21% |
| Diluted EPS | $1.01 | $0.84 | +$0.17 |
| Operating cash flow | $352 million | $390 million | -$38 million |
| Capital expenditures | $134 million | $200 million | -$66 million |
- Hard drive shipments increased 14% to 57.8 million units from 50.7 million; average selling price remained approximately $46 per unit.
- Gross-margin expansion primarily reflected improved product mix.
- Research and development expense rose 16% to $193 million. Selling, general and administrative expense increased 51% to $89 million, including $11 million of HGST acquisition costs and $7 million of litigation accruals.
- Cash and cash equivalents were $3.675 billion at September 30, 2011, up from $3.490 billion at July 1, 2011. Approximately $3.0 billion was held outside the United States.
- Total assets were $8.467 billion and shareholders’ equity was $5.723 billion at quarter-end.
- Total debt was $263 million, consisting of $163 million current debt and $100 million long-term debt. The variable-rate term loan requires $113 million of principal payments through the remainder of fiscal 2012 and $150 million in fiscal 2013; the company was in compliance with covenants.
- Net cash used in financing was $33 million, primarily reflecting $31 million of debt repayment. No shares were repurchased during the quarter.
Material changes versus the prior comparable period
- Revenue, gross profit, operating income, net income, and diluted EPS all increased, driven principally by higher unit shipments and improved product mix.
- Operating cash flow declined despite higher net income, primarily because working capital used $71 million versus providing $24 million in the prior-year quarter. Accounts receivable and inventories increased.
- Capital expenditures declined to $134 million from $200 million.
- Operating expenses increased faster than revenue because of greater R&D investment, acquisition-related spending, litigation accruals, and expanded sales and marketing activity.
- Sales incentive and marketing programs declined to 9% of gross revenue from 11%.
- The company recorded a $14 million net decrease in unrecognized tax benefits, primarily related to resolution of an IRS audit of Komag. The recorded liability for unrecognized tax benefits was approximately $231 million, including approximately $150 million expected to be paid in cash over one to five years.
Outlook, unusual items, and principal risks
- Thailand flooding: After quarter-end, severe flooding suspended production at all Thailand facilities and damaged equipment. Approximately 60% of the company’s September-quarter hard drive production came from Thailand, and the facilities supplied a substantial majority of magnetic-head slider requirements.
- Management expected production suspensions and supplier shortages to continue into the March quarter and possibly beyond. It forecast December-quarter shipments of 22 million to 26 million units versus 58 million in the September quarter.
- Management expected December-quarter revenue to be substantially lower, negative gross margins, and a significant loss before flood-related unusual charges. Expected charges included asset impairments, inventory write-downs, purchase-order cancellations, recovery costs, under-absorption, expedited freight, and foreign-exchange losses; the filing does not provide a clear estimate of the amount.
- Management expected December-quarter cash flow, and possibly subsequent-period cash flow, to be negative. Capital expenditures were expected to exceed the normal 7% to 8% of revenue range because of equipment repair and replacement. Despite these pressures, management believed available cash and operating cash flow would cover the next 12 months of working capital and capital needs and the cash-funded portion of the HGST acquisition.
- Flood-related insurance was expected to cover some losses, but management anticipated damage would exceed the policy limit and had not determined recoverable business-interruption amounts.
- HGST acquisition: The planned acquisition of Viviti Technologies/HGST had an estimated purchase price of approximately $4.2 billion, to be funded with existing cash, new debt, and 25 million newly issued shares. Closing was targeted for the second quarter of fiscal 2012 and remained subject to regulatory approvals. A $250 million termination fee could apply if specified antitrust conditions prevented closing by March 7, 2012.
- The planned acquisition financing contemplated up to $3.0 billion of new facilities, including a $500 million revolving facility and up to $2.5 billion of term loans, subject to closing conditions.
- Legal proceedings included multiple intellectual-property matters and a Seagate arbitration. The Convolve verdict was not material, and the company continued to defend other matters. The filing states that aggregate exposure from other matters was not expected to be material, but outcomes remain uncertain.
- Foreign-exchange contracts hedged the Thai baht, Malaysian ringgit, euro, and British pound. The Thailand shutdown could require recognition of gains or losses on contracts exceeding current requirements.
- Management concluded that disclosure controls and procedures were effective as of September 30, 2011, with no material change in internal control over financial reporting.
Most important facts for investors to verify
- The scale, timing, and financial impact of Thailand facility and supplier recovery, including asset impairments, inventory write-downs, under-absorption, expedited freight, and insurance recoveries.
- Actual December-quarter shipments, revenue, gross margin, operating loss, and cash flow compared with management’s forecast of 22 million to 26 million units, negative gross margins, and a significant loss.
- The status and final economics of the HGST acquisition, including regulatory approvals, financing, share issuance, incremental debt, integration costs, and potential termination-fee exposure.
- The company’s liquidity after flood-related cash outflows, equipment replacement, and the cash-funded portion of the acquisition.
- Resolution of the IRS transfer-pricing matters involving proposed adjustments of approximately $970 million and any resulting change in unrecognized tax benefits.
- Developments in pending intellectual-property litigation and the Seagate arbitration, including any judgments, settlements, injunctions, or additional accruals.