Western Digital Corporation 2019 Form 10-K Summary
Business context and reporting period
Western Digital develops and manufactures HDD, SSD, flash-memory, data-center, client-device and client-solution products, including products marketed under the Western Digital, SanDisk and HGST brands. The filing covers the 52-week fiscal year ended June 28, 2019. The requested “2019 Q4” corresponds to the fourth quarter within this annual filing; fourth-quarter results are separately presented on an unaudited basis.
Western Digital operates as one reportable segment and relies substantially on Flash Ventures, its 49.9%-owned flash-memory joint ventures with Toshiba Memory Corporation.
Financial performance and liquidity
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Net revenue | $16.569 billion | $20.647 billion | Down 19.8% |
| Gross profit | $3.752 billion | $7.705 billion | Down 51% |
| Gross margin | 22.6% | 37.3% | Down 14.7 percentage points |
| Operating income | $87 million | $3.617 billion | Down substantially |
| Operating margin | 0.5% | 17.5% | Down 17.0 percentage points |
| Net income (loss) | $(754) million | $675 million | Turned to loss |
| Diluted EPS | $(2.58) | $2.20 | Turned negative |
| Cash flow from operations | $1.547 billion | $4.205 billion | Down 63% |
Fourth-quarter FY2019 revenue was $3.634 billion, gross profit was $465 million, operating loss was $381 million and net loss was $197 million. Fourth-quarter diluted loss per share was $0.67.
At June 28, 2019, cash and cash equivalents were $3.455 billion, down from $5.005 billion. Working capital was $4.660 billion, compared with $6.182 billion in the prior year. Total debt principal was $10.694 billion, including $10.246 billion of long-term debt, and the company had $2.25 billion available under its revolving credit facility. Management stated that available cash, operating cash flow and credit facilities should be sufficient for working capital, debt, dividend and capital-expenditure needs for at least the next twelve months.
Investing cash outflows were $1.272 billion, including $876 million of capital expenditures and a net $598 million increase in notes receivable issued to Flash Ventures. Financing cash outflows were $1.829 billion, including $681 million of debt repayments, $584 million of dividends and $563 million of share repurchases.
Material changes versus the prior comparable period
- Revenue declined across all end markets: Client Devices fell 19.9%, Data Center Devices and Solutions fell 17.1%, and Client Solutions fell 23.0%.
- HDD revenue declined to $8.746 billion from $10.698 billion; flash-based revenue declined to $7.823 billion from $9.949 billion.
- Lower flash average selling prices, industry oversupply and competitive pressure were the principal revenue and margin drivers.
- Gross profit was reduced by a $264 million Flash Ventures underutilization charge, $145 million of charges related to a June 2019 Yokkaichi power outage, and a $110 million flash-component inventory adjustment.
- Operating expenses declined to $3.665 billion from $4.088 billion, including lower R&D and SG&A expenses.
- Western Digital incurred $166 million of employee termination, asset impairment and other charges, including costs associated with business realignment and the closure of its Kuala Lumpur HDD facility.
- The company implemented cost and expense reductions expected to produce approximately $800 million of annualized savings, split approximately equally between cost of revenue and operating expenses.
- Interest and other expense declined to $374 million from $1.532 billion, primarily because FY2018 included an $899 million loss on extinguishment of debt.
- Income tax expense was $467 million despite a pretax loss, producing a negative 163% effective tax rate. The result included discrete tax effects associated with the 2017 Tax Cuts and Jobs Act and changes to the company’s foreign earnings reinvestment assertions.
Guidance, outlook, commentary and unusual items
- Flash-market conditions remained cyclical, with declining flash prices per gigabyte and supply exceeding demand in recent quarters.
- Western Digital temporarily reduced its utilization of Flash Ventures’ Yokkaichi capacity. The company expects additional power-outage-related charges of less than $100 million by the end of the first quarter of fiscal 2020, while any insurance or other recovery was not estimable.
- The K1 flash facility in Kitakami, Japan is expected to begin initial production in the second half of fiscal 2020, with meaningful output not expected until the first half of fiscal 2021. Western Digital expects approximately $660 million of equipment, relocation and start-up investments and approximately $360 million of building-depreciation prepayments over three years.
- Fiscal 2020 is expected to contain 53 weeks, with a 14-week first quarter. Management expected fiscal 2020 cash used for property, plant and equipment and net Flash Ventures notes receivable and equity-investment activity to be less than $500 million.
- The company declared a quarterly dividend of $0.50 per share in August 2019. Future dividends and repurchases remain subject to cash flow, financial condition, capital needs and debt-agreement restrictions.
- Material contingencies include $1.104 billion of estimated mandatory deemed repatriation tax payments, approximately $695 million of unrecognized tax benefits plus $123 million of accrued interest and penalties, and IRS disputes seeking approximately $516 million and $549 million of additional federal tax for separate periods, plus interest.
- Western Digital guaranteed approximately $1.575 billion of Flash Ventures equipment-lease obligations and reported a maximum reasonably estimable Flash Ventures exposure of $4.563 billion, excluding lost profits.
- The independent auditor concluded that the consolidated financial statements were fairly presented under U.S. GAAP and that internal control over financial reporting was effective.
Most important facts for investors to verify
- Whether flash pricing, demand and inventory conditions improve sufficiently to restore gross margin.
- The timing, cost, yield and customer qualification of the K1 facility and the continuing financial obligations to Flash Ventures.
- Progress toward the projected $800 million annualized cost savings and the remaining costs from restructuring and facility closures.
- Debt maturities, covenant compliance and exposure to LIBOR or other variable-rate changes; approximately $6.431 billion of principal is scheduled for fiscal 2023.
- The cash impact and ultimate resolution of the IRS tax disputes, mandatory deemed repatriation tax and unrecognized tax benefits.
- The financial effect of the Yokkaichi power outage, including additional charges, wafer availability and any recovery.
- The sustainability of dividends and share repurchases in light of lower operating cash flow, elevated leverage and contractual commitments.
- Customer and supplier concentration: the top ten customers represented 45% of FY2019 revenue, while substantially all flash-memory wafers were sourced from Flash Ventures.